Understanding Directors’ Duties in Australia: A Complete Guide

Being a director of a company in Australia comes with significant responsibilities. Directors have legal obligations to act in the best interests of their company, its shareholders, and the broader community. These duties, derived from common law and statutory laws such as the Corporations Act, are essential to ensure that companies are run ethically, transparently, and responsibly.

This guide covers the key directors’ duties you need to be aware of and how to comply with them.

What Are Directors’ Duties?

Directors’ duties are the prescribed behaviours and rules that a director must follow when acting on behalf of a company. These duties are not only dictated by the Corporations Act but also shaped by case law, which interprets and clarifies directors’ responsibilities.

All directors of Australian companies must comply with these duties. Failure to do so can result in civil penalties, disqualification from being a director, or, in some cases, criminal charges.

Key Directors’ Duties in Australia

The primary duties of directors in Australia are as follows:

Duty to act in good faith in the best interests of the company
Duty to act for a proper purpose
Duty to exercise reasonable care and diligence
Duty to avoid conflicts of interest
Duty to prevent insolvent trading

Let’s explore each duty in more detail.

Duty to Act in Good Faith in the Best Interests of the Company

What Does Acting in Good Faith Mean?

Directors must act for the benefit of the company and its shareholders. This means prioritising the company’s long-term success rather than personal interests. Directors must always act with honesty and integrity.

Breaching this duty can have serious consequences. Typically, it is a civil offence, resulting in fines or disqualification from being a director. However, if the director acts recklessly or dishonestly, criminal charges may apply.

Duty to Act for a Proper Purpose

Ensuring Decisions Serve the Right Purpose

Directors must ensure that the powers granted to them are exercised for a proper and legal purpose. The company’s constitution will usually outline what constitutes a ‘proper purpose’. For example, using the power to issue shares to raise capital is a proper purpose. However, issuing shares solely to dilute an existing shareholder’s voting power is not.

It’s crucial for directors to align their actions with the purpose for which those powers were granted to avoid breaching this duty.

Duty to Exercise Care and Diligence

The Importance of Competence in Decision Making

As a director, you are responsible for overseeing the company’s operations and making decisions on behalf of the shareholders. The level of care, skill, and diligence expected from a director is that of a reasonable person in a similar position.

This includes being informed and making decisions based on the best available information. Directors are expected to act with a level of competence that reflects their role.

Business Judgment Rule

The Business Judgment Rule provides protection for directors when they make decisions in good faith, with reasonable care and diligence, even if the decisions result in financial loss. To qualify for this protection, directors must demonstrate:

They made reasonable inquiries before making the decision.
They believed the decision was in the company’s best interests.
They did not make the decision for personal gain.

Duty to Avoid Conflicts of Interest

What is a Conflict of Interest?

A director must not place themselves in a situation where their personal interests conflict with the interests of the company. Even if no harm has occurred, the potential for a conflict can still breach this duty.

If a director has a material personal interest in a matter that relates to the company’s affairs, they must disclose this interest to the other directors. Failure to disclose such interests can result in penalties.

Director’s Disclosure Obligations

Directors must declare any personal interest in company matters, particularly if it involves a proposed contract or decision. In public companies, directors must also abstain from voting on matters in which they have an interest, unless disinterested directors determine otherwise.

For proprietary companies, the restrictions may be less stringent, but the principle remains the same: directors must always act in the best interests of the company.

Duty to Prevent Insolvent Trading

Understanding Insolvent Trading

Directors must prevent their company from continuing to trade while insolvent. Insolvency occurs when a company cannot pay its debts when they fall due. If a company trades while insolvent, the director can be held personally liable for the debts incurred during this period.

Consequences of Breaching Insolvent Trading Laws

If you allow your company to trade while insolvent, you risk serious consequences, including:

Being required to personally compensate creditors, such as suppliers, lenders, and employees.
Having to compensate the company for debts incurred after the company became insolvent.
Facing criminal penalties, including fines or imprisonment, if the breach was dishonest.

Safe Harbour Exemption for Directors

The Corporations Act provides a ‘safe harbour’ for directors who are taking steps to remedy their company’s financial issues. If a director can demonstrate they are working on a plan that is likely to improve the financial situation, they may avoid liability for insolvent trading. However, this exemption does not apply if the company is not meeting its employee entitlement or tax obligations.

Why Understanding Directors’ Duties is Crucial

As a director, understanding your duties is crucial for ensuring your company’s long-term success and for safeguarding your personal liability. These duties are designed to protect the company, its shareholders, and other stakeholders from potential harm caused by poor management or unethical decision-making.

Legal and Financial Implications

A breach of directors’ duties can result in serious legal and financial consequences, including personal liability, penalties, and damage to your reputation. It is therefore essential that you stay informed about your responsibilities and take steps to comply with the law.

Seeking Professional Advice

Being a director is a major responsibility, and it’s important to ensure you understand all of your obligations. If you’re unsure about any aspect of your duties or if you face a complex situation, it’s wise to seek professional legal advice.

At Allied Legal, our team of experienced commercial lawyers can help you navigate your responsibilities as a director and ensure your business remains compliant with Australian law.

Get in Touch with Allied Legal

If you’re a director or planning to become one, don’t hesitate to reach out to us. We can assist you with understanding your duties and provide tailored advice to suit your business’s specific needs.