Legal Advice on Breach of Duty by Directors under Common Law and Corporations Act 2001 (Cth)

This article provides legal advice on breach of duty by directors under common law and Corporations Act 2001 (Cth). It discusses the common law and statutory duties of directors, and applies them to the conduct of three directors of Modern Design Pty Ltd. The potential liabilities for the directors are also discussed, along with recommendations to improve the situation.

LAW2001 Corporations Law
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Issue
The central issue is to offer Tim legal advice in the capacity of legal advisor for Modern
Design Pty Ltd in relation to the issues that the company is facing regarding potential breach
of duty by directors with reference to both common law and Corporations Act 2001 (Cth).
Rule
The directors occupy a significant position in the company and play a vital role in the success
of the company. Considering the importance of their role, there are certain set of duties which
are expected from them. These duties may be common law duties or dictated by statute
particularly the Corporations Act 2001.
Common Law Duties
It is noteworthy that the companies are owned by shareholder who are real owners and these
tend to appoint directors to manage the affairs of company. Hence, it can be concluded that
there is an agency relationship with the directors acting as agents to the shareholders who act
as principal. Owing to this relationship, there are fiduciary duties on the agents to safeguard
the interest of the principal. For the directors, these are summarised below.
 There is a duty on the part of directors to act in good faith and thereby safeguard the
interest of the company and shareholders. This duty is implied on the basis of the
agency relationship where agents need to use the authority provided in a manner that
furthers the interest of the principal i.e. company and shareholders in this case. Thus,
various decisions made by the directors should be aimed towards progress of
company and shareholders’ interest (Harvey, 2009).
 The directors must act with care and diligence. This implies that the directors must
discharge their duty with utmost care and diligence and thereby should not engage in
negligent conduct. Considering the damage that can be incurred by the shareholders
owing to the negligent conduct of the shareholders, it is imperative that various
decisions are taken with reasonable care after conducting requisite due diligence so
that the duty to care owed to shareholders is not breached (Gibson and Fraser, 2014).
 The directors must avoid any conflict of interest since they are required to act in the
interest of the shareholders and this may be adversely impacted by the presence of
conflicting interest. Hence, to discharge fiduciary duty, it is essential for the directors
to avoid such situations (Pathinayake, 2014).

 Owing to the position occupied by the directors, they are exposed to a plethora of
confidential information. It is imperative that the directors should not disclose this
information as the interests of the company and hence the shareholders may be
adversely impacted (Lindgren, 2011).
 Additionally, directors are expected not to abuse the corporate opportunities provided
for serving their own interests and instead focus on the interest of the company and
the owners (Harris, 2013).
Statutory Duties
There are statutes which tend to list down the duties of directors and the potential liabilities
for breach of these duties. The relevant statutory duties are highlighted below.
 Section 180 - In accordance with s. 180(1), the directors are expected to discharge
their duties with adequate care and due diligence which any reasonable person in their
position would be expected to undertake given the underlying circumstances. The
breach of this duty would lead to civil liability for the director as highlighted in
s.1317E (Harris, 2014).
The directors can use the business judgement rule as cited in s. 180(2) as their defence
against the potential breach of the above duty since no liability would arise if the
underlying judgement was made in good faith, with appropriate knowledge and was
aimed at safeguarding the shareholders’ interest (Pathinayake, 2014).
 Section 181 – In accordance with this section, the directors must exercise the
underlying authority in good faith and for the proper purpose only. The breach of this
duty would lead to civil liability for the directors as highlighted in s.1317E (Cassidy,
2013).
 Section 182 – In accordance with this section, the directors should not exhibit
improper use of position for gaining any advantage for self or anyone else. Further,
the directors must not take any action towards the detriment of the company. The
breach of this duty would lead to civil liability for the directors as highlighted in
s.1317E (Ciro & Symes, 2014).

 Section 183 - In accordance with this section, the directors should not exhibit
improper use of any information available owing to occupying the position of director
for gaining any advantage for self or anyone else. Further, the directors must not take
any action towards the detriment of the company. The breach of this duty would lead
to civil liability for the directors as highlighted in s.1317E (Harris, 2013).
 Section 184 - In accordance with this section, the directors should act in good faith
and hence must not behave in a reckless and dishonest manner. Such a behaviour
could be detrimental to the interest of the shareholders and thereby unacceptable.
Since breach of this duty is on account of intentional misconduct, hence there are
criminal liabilities attached with the breach of the same implying that the breaching
director could potentially face capital punishment besides fines (Harris, 2014).
 Section 190 – In accordance with this section, if any director delegates all or part of
the powers to any other individual, then the underlying liability for the actions of the
delegate would be borne by the director appointing the delegate at the first place. This
implies that actions taken by the delegate are essentially actions taken by the director
only (Ciro & Symes, 2014).
 Section 191 – In accordance with this section, it is essential for the company to
disclose any material personal interest that the director may have as it could
potentially lead to conflict of interests. In such situation, it is possible that the director
may not act in food faith and also the judgement may be impaired. Hence, the same
needs to be reported so that the board of directors can take requisite measures in
relation to such matters. Failure to disclose these interests would lead to strict liability
as defined in s. 6-1 of the Criminal Code (Cassidy, 2013).
 Section 286 – In accordance with this section, the directors must take the relevant
measures to ensure that proper accounts and related books are maintained which
capture the financial transactions undertaken by the company. Failure to maintain
financial records would lead to strict liability as defined in s. 6-1 of the Criminal Code
(Pathinayake, 2014).

 Section 588G – In accordance with this section, the directors should take all relevant
measures to prevent insolvent trading of the company. This would involve assuming
limited amount of debt only considering the capability of the business to repay then
same. Also, the directors must not take decision that lead to cash crunch for the
company. Considering the implications of breach of this section, absolute liability and
strict liability both are applicable based on the underlying facts (Harris, 2013).
Additionally, directors have other duties related to taking part in the board meeting which are
meant to discuss critical issues from the company’s viewpoint. Also, it is required that the
directors must take active participation in such board meetings and must use their vote
properly. Besides, there are duties of the directors owed to the third parties such as the
regulators so as to comply with the various regulations laid down for the company structure
in the Corporations Act 2001 (Harris, 2014).
Application
Based on the given information, it is apparent that Alana, Ursula and Tim are the three
directors of Model Design Pty Ltd. Since they are directors of the proprietary company,
hence they would have to adhere to the duties imposed by both common law and also
Corporations Act 2001. The conduct of these directors in wake of the relevant rules has been
discussed as shown below.
Alana
It is known that she is a retired accountant who has failed to update her knowledge about the
applicable legislation. Also, she does not possess any experience or knowledge with regards
to design industry. She is on the board of the company primarily because of her financial
expertise. Also, it is known that the relation between profits and cash flow is not understood
by any director including Alana. Further, all the major decisions are taken by Alana and Tim.
It is apparent that there is a breach of duty of directors by Alana. The conduct of Alana is
clearly in violation of Section 180 primarily because of her lack of skills owing to which she
is not capable of taking decisions with due care and requisite due diligence. This is most
evident from the fact that despite being an accountant, she does not understand the relation
between profits and cash flow. Further, when Alana is aware that she is part of the board

only because of her financial skills, but still she does not take any concrete measures for
upgrading her skills and relevant legislation. Also, despite her limited knowledge she
continues as director and engages in decision making.
Also, through her conduct, there is breach of section 588G, since the company is facing cash
crunch which may be attributed to the financial mismanagement. Considering that Tim has
very limited knowledge of finance , hence the onus lies on Alana to take requisite decisions
in order to manage the cash flow problem. But her failure to take such decisions is directly
for the current insolvency risk that the company faces.
Ursula
Ursula has wide experience in the design industry and looks at the operational aspects of the
business with a focus on the client. She does not participate in the board meetings as she
considers her more suitable in operations and also is not able to spare out time. The orders are
placed by both Tim and Ursula. Ursula has ambitions to start a competitive business on her
own. Further, with the assistance of the warehouse manager Bob, she takes spare items after
the project completion which are then falsely recorded as written off stock.
Ursula is clearly in breach of her duties as director primarily because she does not participate
in the board meetings. If she thinks she lacks managerial decision making capabilities, she
should resign from the position of director and assume only the position of an operational
head or manager. Further, she is neglecting the fact that she has extensive knowledge about
the customer preferences and the design industry and hence her expertise may allow the
board to make better decisions. Thus, there is breach of s. 180 since through her conduct she
does not discharge the duty to care towards the shareholders.
Also, her conduct is in violation of s.182 since she is siphoning off high value inventory from
the company for her own personal use and thereby causing harm to the company since this is
shown as written off inventory. Further, she has plans to start her own business and hence
she also is in breach of s.191 since she intends to open her own business in the same line.
Further, it is highly likely that in her new business she would use the information about the
clients of the company and leverage the existing relationship which would breach duty under
s. 183.
Tim

Tim is responsible for marketing and advertisement. However, his financial knowledge is
quite basic. The conduct of Tim is in violation of s. 180 since he continues to insist that
Alana continue to serve as a director despite her poor financial skills which is apparent from
the poor cash flow management by the company. Additionally, despite all the directors
lacking expertise on deriving cash flow from profits, but no external consultant or specialised
position such as accountant seems to have been created owing to which the company is
suffering as the credit period for the company have been shaved off.
Liabilities for Directors
On the basis of the above discussion, it is apparent that both common and statutory duties
have been breached by all the directors. As a result there would be potential liabilities for
these directors which are explained as follows.
Alana – There would be civil penalty for violation of duty to care under section 180 which
could lead to levying of fine along with ASIC barring her from being the director of any other
company for a fixed period. In relation to s. 588G potential breach, if the company becomes
insolvent while she retains the position of director, then criminal charges may also be levied
on her by the unsettled creditors and shareholders.
Ursula – Ursula doesn’t only breach her common duty to care for the shareholders by not
attending board meeting and taking part in the decision making but it is evident that he is
taking action to financially harm the company through inventory siphoning. Also, she has
plans to commence her own business and has not disclosed these plans to other directors.
Hence, both civil liability and criminal charges would be levied against Ursula. Hence, she
may have to pay fines for the loss caused to the company besides being barred by ASIC from
being director in the future. Further, she may also be given capital punishment if the loss of
her wrongdoing is considerable.
Tim – He has violated the statutory and common duty related to duty to care for which there
is only civil liability and hence he would have to pay fine as determined by the court based on
potential loss faced by the shareholders.
Conclusion & Recommendations

Based on the above discussion, it is apparent that statutory and common duties of directors
have been breached by all the three directors of the company. However, in order to improve
the current situation, the following recommendations are advisable.
 Instead of Alana, Larry should be appointed as the director of the company. This is
because Alara does not have the industry knowledge and the financial knowledge
despite being an accountant. Also, the company is currently facing issues with cash
management which Larry can resolve.
 Ursula needs to be approached as she currently does not take part in managerial
decision making and also has plans to open her business. The company needs to
relieve her of her duties if she has plan of opening her own business. Further, she
should be removed from the position of director owing to her reluctance in
participation regarding managerial decision making and also integrity issues.
 In order to retain Bob or Ursula, instead of giving directorship, the focus should be on
providing a small share in the profits.

References
Cassidy, J. (2013) Corporations Law Text and Essential Cases 4th ed. Sydney: Federation Press.
Ciro, T. & Symes, C. (2014) Corporations Law in Principle 9th ed. Sydney: LBC Thomson
Reuters
Gibson, A. & Fraser, D. (2014) Business Law. 8th ed. Sydney: Pearson Publications.
Harris, J. (2013) Butterworths Questions and Answers Corporations Law 4th ed. Sydney:
LexisNexis Australia.
Harris, J. (2014) Corporations Law. 2nd ed. Sydney: LexisNexis Study Guide.
Harvey, C. (2009) Foundations of Australian law 3rd ed. Victoria: Tilde University Press.
Lindgren, K.E. (2011) Vermeesch and Lindgren's Business Law of Australia 12th ed. Sydney:
LexisNexis Publications
Pathinayake, A. (2014) Commercial and Corporations Law 2nd ed. Sydney: Thomson-
Reuters.