Duties of Directors under Corporations Act 2001

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LAW00004 0
Southern Cross University
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Contents
Introduction.......................................................................................................................................................2
Duty to act in good faith...................................................................................................................................2
Duty to exercise powers for a proper purpose...................................................................................................6
Conclusion........................................................................................................................................................9
References.......................................................................................................................................................10
Books/Journals 10
Case Laws 10
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LAW00004 2
Introduction
Directors position of the company have vast significance role as they are the people who are
responsible for managing business affairs and making for business decisions. Although a company
has some separate legal status and directors are not liable for the acts of the entity, yet they have
possessed some responsibilities. The reasoning behind the same is that the directors are a natural
person and ultimately responsible for using their business judgment for the company. These
responsibilities are well known as the duties of directors and mentioned under the Corporations
Act1. The Corporation Act is applicable throughout Australia and contains corporate law of the
nation. In besides, to provide the provisions related to the incorporation, meetings, liquidation of a
company and other matters, CA 2001 prescribes general as well as special duties of directors. These
duties have been interpreted in different manners while deciding different cases. In the presented
report, one of the responsibilities, for example, commitment mentioned under section 181 will be
discussed. The responsibility includes two factors, namely good faith and proper purpose. Thus, the
duty of states that directors must perform their duties in good faith and for the best interest and
adequate purposes of the company2. The following report is aiming at researching on the
significance of these terms with the help of various case laws related to the said concepts. Lastly, a
conclusion summarizing the key findings of the report will present.
Duty to act in good faith
Duty to act in good faith is not only a statutory duty but also it is a fiduciary duty under common
law. As per this duty, a director is required to perform the functions in good faith. Here the question
1 Corporations Act 2001 (Cth).
2 Australia, Australian Corporations & Securities Legislation 2011: Corporations Act 2001, ASIC Act 2001, related
regulations (CCH Australia Limited 2011) 221.
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arises that in whose favor directors are required to act or perform the business obligations. If two
competing companies are there, then in whose good faith the director will take the steps ahead,
which is also a question. In the case of Bell v Lever Bros Ltd3, it has decided that directors may hold
directorship positions in the board of the two rival companies. However, in reality, the situation is
different. Directors cannot disclose the information, which is related to one company to another
company, and therefore, at last, they have to resign from one of the companies. The duty to act in
good faith has been developed to create a scenario of corporate governance. It ensures those
directors who are responsible for running and managing a company, must deal with a favorable
opinion. Duty to act in good faith also demands a director works sincerely or honestly without any
intention to cheat. The responsibilities even be known as a duty to act bona fide4. If to discuss the
duty to act in good faith in details it must be noted that, the directors are required to taking decision
that will be leads to the good of the company. It is not mandatory that decisions taken by directors
will bring actual profits for the company each time because nobody cannot control the business
environment. Duty only emphasizes on the intention of directors at the time of decision-making and
states that at the time of making a decision, a director must have believed that the same is in the best
interest of the company. In the case of Darvall v North Sydney Brick & Tile Co Ltd5 it has been
decided that while considering good faith of the company, directors must consider short term as well
long term interest. Duty to act in good faith is closely connected to another task mentioned under the
same section 181 that is known as the duty to work in the best interest.
Some problems are there with the duty of working in good faith when it comes to the discussion of
the nominee director. Nominee directors are those directors who are appointed to the company's
3 Bell v Lever Brothers Ltd [1931] UKHL 2
4 Youlegal.com.au, Directors’ Duties In Focus – Duty To Act Bona Fide (In Good Faith) (You Legal) <
https://youlegal.com.au/directors-duties-focus-duty-act-bona-fide-good-faith/#targetText=The%20duty%20to%20act
%20bona,requirements%20expected%20of%20company%20directors.&targetText=The%20'common
%20law'%20requires%20that,business%20affairs%20of%20the%20company.>.
5 Darvall v North Sydney Brick & Tile Co Ltd (1988) 6 ACLC 154
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LAW00004 4
board to consider and represent the interest of specific shareholders. In the case of Scottish Co-
operative Wholesale Society Ltd v Meyer6, the court considered nominee directors as general
director for the application of section 181 of CA 20017. The court stated that every director who
were nominee director were required to act in the good faith of the company to whose board they
are appointed and not for who made the appointed. The case is important to discuss here as it
clarifies the true meaning of duty of good faith for those directors who have been appointed by
stakeholders rather than company itself.
The duty to act in good faith has proven very specific at many times, and courts have shown their
intention of strict adherence with the same. In the case of Walker v Wimborne8, the directors of the
company guaranteed loans to another company or group, whereas the company in which they
appointed was also in financial difficulty at that time. The court found that this transaction brings
substantial loss to the company directors were appointed. The court further decided that the actions
of directors were total disregard to the interest of the company and its creditors and directors
breached their duties to work in good faith of the company. The decision becomes essential for all
those cases where directors move funds of one good company to another company of group
suffering from financial difficulty. In the case of Jenkins v Enterprise Gold Mines NL9, the court
held that such cases where directors move funds to another company and that determinant to the
first company, actions seem to be oppressive.
After the discussion mentioned above-mentioned, it is clear now that duty to act in good faith is
particular, and directors are not allowed to compromise with it unless the same proves beneficial.
These terms play a significant role in compliance with corporate governance. It shows directors are
6 Scottish Co-operative Wholesale Society Ltd v Meyer [1958] 3 All ER 66
7 Brenda Hannigan, Company Law (Oxford University Press 2018) 72.
8 Walker v Wimborne (1976) 137 CLR 1
9 Jenkins v Enterprise Gold Mines NL (1992) 10 ACLC 136
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liable to ensure that they are ethical with the company irrespective of the results of their actions, and
they are required to consider the interest of the company over and above any other company or
factor. This term clarifies that no matter whether a director is a regular director or a nominee one,
one has to act in good faith of the corporations in which they are appointed. When directors carry
such practices, it develops a good structure of corporate governance. The duty to act in good faith
makes the directors responsible in respect to their conduct and states that they are required to take
the actions, which can bring positive results to the corporations. Where directors fairly believe that
they are doing in the best interest of the company, no breach of duty seems to be there. Corporate
governance can be understood as a set of good governance and modifying the actions of directors in
good way, duty to act in good faith contributes to the same.
Duty to exercise powers for a proper purpose
Similar to duty to act in good faith, another duty is equally important which duty to act for proper
purpose is. Directors have variety of powers with respect to their companies, and therefore, they are
required to act for a proper purpose. Again, the term “Proper purpose” has been discussed and
decided in different ways in the decision of various cases. Here it is required to inform that duty to
exercise power for a proper purpose must not be misunderstood with the duty to act in the best
interest of the company. Both of these duties are different and required to be complying by directors
separately. It is possible for the director to trust that an action is in the best interest but not for the
proper purpose of the corporation. It noted that any of the powers assigned to directors such as the
issue of shares, development of contract might raise the issue of improper purpose. For instance in
the case of Howard Smith v Ampol Petroleum Ltd10, it has been given that the lead purpose behind
issue of share was not to raise capital but was to take over the another company. Court rejected the
10 Howard Smith v Ampol Petroleum Ltd [1974] AC 821
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LAW00004 6
claim considering the same not in best interest of company. In the case of Hogg v Cramphorn Ltd11,
the board of directors has issued the shares with reserved voting rights. The purpose behind the
same was to provide a safeguard to company form takeover as directors had a bonafide belief that it
was in the best interest of the company. The decision of the case, the court held that although
directors thought the agenda to be in the best interest of the company, the same does not seem to be
for a proper purpose. The reason was the same that shares seem to have issued for raising the capital
and nor for prevention from takeover.
In the case of Whitehouse v Carlton Hotel Pty Ltd12, the duty to exercise powers for the proper
purpose has again questioned. In this case, a director of the company issued shares to his son to
control the majority shares of his mother (Son's mother). Later on, the son turned out in against his
father and initiated a claim against him. The court entertained the matter and decided that the
conduct of issue of shares cannot justify as for proper purpose even in the director believed to be the
same in the best interest of the company13. In the reasoning of the decision, court held that the
purpose behind issue of shares was to dilute the control away from his wife. Directors cannot use
the power to issue shares with the intention to manipulate company’s voting right. The situation
arises because there are more than one purpose behind issue of shares, out of which some proper
and some improper. To decide this kind of matter, courts check the principal purpose of an action.
Courts use but for the taste for this determination.
A director may also hold liable for the liable for improper purpose when he/she is aware of the
unethical or improper act of other directors yet failed to intervene. In the case of Permanent
Building Society Ltd v Wheeler14, director of the company became ready to purchase land at
11 Hogg v Cramphorn Ltd [1967] Ch 254
12 Whitehouse v Carlton Hotel Pty Ltd (1987) 5 ACLC 421
13 Lawcasesummaries.com, Whitehouse v Carlton Hotel Pty Ltd (1987) 70 ALR 251 (Law Case Summaries) <
https://lawcasesummaries.com/knowledge-base/whitehouse-v-carlton-hotel-pty-ltd-1987-70-alr-251/>.
14 Building Society Ltd v Wheeler (1994) 12 ACLC 6
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overvalue rate as they wanted to make the vendor eligible to meet his obligation with other
companies where directors of the first company were a board member. One other director who was
not involved in the action also found liable for breach of duty as he contributed to the participation
under section 79.Section 79 of the act states that a director seems liable where the same involves in
contravention. As in the case, directors been a part of the contravention hence their actions did not
consider as proper purpose.
ASIC v Flugge & Geary15 is a crucial case to discuss here where the test to determine the presence
of proper purpose held the objective. In this case, ASIC alleged that former chair, directors and
other officers of Australian Wheat Board (AWB) breached the duties under sections 180 and 181 of
the Corporations Act 2001 as AWB paid a certain amount as transportation fee, which was in
against of Sanctions of United States. As per the belief of ASIC, the incident damaged the board’s
reputation. Being the directors, Flugge and Geary were expected to knowledge about the incident
and might have reported the same. Nevertheless, they have failed to do so and, in this manner,
breached their duties as directors. The case set out a firm reminder that the duties of directors are
extended up to the requirement to make inquiries. Flugge did not involve in any of the actions, yet
he found to be in breach of his duty of care and diligence He did not made any inquiry about the
conducts that were going on and in this manner failed to act like a reasonable person. It decided in
addition to not to do any improper activities. Directors also have to ensure that noting for an
improper purpose is happening in the company16.
In this way, it would not be wrong to mention that the test to determine whether the purpose behind
an act was improper is objective rather than subjective. There is no universally accepted definition
of what comes under proper purpose and what is not. It does not matter of individual concern, and
15 ASIC v Flugge & Geary [2016] VSC 779
16 David Jacobson, Awb V Flugge & Geary (Awb Case) (Bright Law) <https://www.brightlaw.com.au/awb-v-flugge-
geary-awb-case/>.
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LAW00004 8
one cannot argue on the point unless the same specific evidence to prove it. It means motive behind
an action plays an important role in considering whether the same contained proper purpose or not.
In the above-mentioned cases, court focused on intention of the conduct rather than actual conduct.
Courts check the real purpose behind the action and then determine whether the same was proper or
not. This term also helps in setting up and maintaining the excellent structure of corporate
governance. The term stipulates that directors are required to work for a proper purpose and in such
a situation; they need to do acts for a sensible person. The term puts a force on directors where
wisely review the situations and think that whether their actions are for a proper purpose in addition
to being in good faith and best interest of the company. Imagine a situation where no terms like
proper purpose is there. In such a situation, directors would have been doing acts without
considering their consequences. The duty itself as well as decisions given in mentioned cases
outlines the expectations that a corporation has from its directors. When directors manage their
affairs for proper purpose and starts doing things with good intention, a corporate lead to good
governance environment. The terms have enormous significance as it ensures good corporate
governance and prevents all those cases where director take a decision considering the best interest
only and forget to check whether they are working correctly or not.
Conclusion
Conclusively this is to state that section 180 is a significant section of CA 2001 that seems to be
very clear but is not in actual. All the three terms mentioned in this section i.e. duty to act in good
faith, for the best interest, and for proper purpose requires a sound understanding. In the presented
report, two of the terms namely good faith and proper purpose have been discussed in detail with the
help of various examples. In the decisions of different cases, it has been set out that a director owes
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a duty to act in genuine and good faith for the company in whose board the person owe position of
director. If any action does not seem to bring any positive advantages for a company, then directors
must not do the same even if such conduct brings positive results to another company of that group.
It means the duty makes focus on a single company and not the others.
Secondly, the term proper purpose also plays a significant part. Often directors of the companies
understand this term and think that the same is similar to the term good faith and best interest, but it
is not correct. In the decision of various cases, it has been made clear that the term requires directors
to check the reasoning behind their decision. Any decision that directors make and think for the best
interest of the company are not necessarily required to be for a proper purpose. In conclusion, the
director cannot make a decision just because the same seems to be in the best interest but there is
not the proper purpose behind the same. Both of these terms help a company to develop a good
corporate governance framework. When directors manage their activities in good faith and also
consider proper purpose, the think the goodness of the company as a whole and establish a good
structure of corporate governance. Section 180 (2) of the act focus on business judgment rule and
said that directors must make the decisions that are in good faith and proper purpose of the
company. In the ways these two duties are connected with business judgment rule and develop a
good culture of corporate governance.
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References
Books/Journals
Australia, Australian Corporations & Securities Legislation 2011: Corporations Act 2001, ASIC Act
2001, related regulations (CCH Australia Limited 2011)
Hannigan Brenda, Company Law (Oxford University Press 2018)
Case Laws
ASIC v Flugge & Geary [2016] VSC 779
Bell v Lever Brothers Ltd [1931] UKHL 2
Building Society Ltd v Wheeler (1994) 12 ACLC 6
Darvall v North Sydney Brick & Tile Co Ltd (1988) 6 ACLC 154
Hogg v Cramphorn Ltd [1967] Ch 254
Howard Smith v Ampol Petroleum Ltd [1974] AC 821
Jenkins v Enterprise Gold Mines NL (1992) 10 ACLC 136
Scottish Co-operative Wholesale Society Ltd v Meyer [1958] 3 All ER 66
Walker v Wimborne (1976) 137 CLR 1
Whitehouse v Carlton Hotel Pty Ltd (1987) 5 ACLC 421
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Other Resources
David Jacobson, Awb V Flugge & Geary (Awb Case) ,(30 August 2019)
https://www.brightlaw.com.au/awb-v-flugge-geary-awb-case/
Lawcasesummaries.com, Whitehouse v Carlton Hotel Pty Ltd (1987) 70 ALR 251, (30 August 2019)
< https://lawcasesummaries.com/knowledge-base/whitehouse-v-carlton-hotel-pty-ltd-1987-70-alr-
251/>
Youlegal.com.au, Directors’ Duties In Focus – Duty To Act Bona Fide (In Good Faith), (30 August
2019) <https://youlegal.com.au/directors-duties-focus-duty-act-bona-fide-good-faith/
#targetText=The%20duty%20to%20act%20bona,requirements%20expected%20of%20company
%20directors.&targetText=The%20'common%20law'%20requires%20that,business%20affairs
%20of%20the%20company.>
Legislation
Corporations Act 2001 (Cth)
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