What are the legal obligations of a board director?

What are the legal obligations of a board director?

Each board director of an Australian company owes duties to the company established by statute and at common law. With a fiduciary relationship existing between a director and the company, there is an overriding responsibility to act in the company’s best interest. Thus, the legal duties imposed by the Corporations Act 2001 and at common law aims to protect the company. In addition, it ensures that directors satisfy high standards of good faith and loyalty to the company.

Section 9 of the Corporations Act defines the term “director”. Here, it is broadly defined to include persons who may not be validly appointed as a director, but act as ‘de facto’ or ‘shadow’ directors. 

Four Primary Duties

Both statute and common law have developed the legal obligations imposed upon board directors. Specifically, the Corporation Act specifies four main duties for directors, which similarly exist at common law: 

1. Exercise powers with reasonable care and diligence 

Imposes an obligation on the director to act with the degree of care and diligence that a reasonable person would exercise if in that role. Fulfilling this duty involves keeping informed about the companies activities and appropriately guiding and monitoring the company’s activities. Additionally, a director should attend and be attentive at board meetings unless exceptional circumstances prevent otherwise. 

2. Act in good faith 

This duty requires a director to act in good faith in the best interest of the company and for a proper purpose. Common law considers this duty a fiduciary duty. Indeed, to act in good faith includes avoiding conflicts of interest and to properly manage conflicts if they arise. A director will breach this duty if they fail to give proper consideration to the separate interests of the company ahead of other interests. A director must take into account the interests of the company’s shareholders. 

3. Not to improperly use position 

Directors must not improperly use their position to gain an advantage for themselves or to the detriment of the company. For example, a director should not apply the company’s property either; for their own personal benefit, or for the benefit of any other person without the company’s authority. 

4. Not to improperly use information 

Similar to the above duty. Directors must not improperly use the information gained in the course of their position as board directors to gain a personal advantage or to cause a detriment to the company. They must not make unauthorised use of confidential information belonging to the company. 

Other Statutory Duties 

In addition to the four basic duties, there are other legal duties that the Corporations Act imposes.

Insolvent Trading

Directors have a duty to prevent insolvent trading:

  • when the company is insolvent; or 
  • when, by incurring the debt, the company becomes insolvent; and 
  • there are reasonable grounds for suspecting, at the time of incurring the debt, that the company is insolvent or will become insolvent. 

Specific provisions under the Corporations Act allow for a director to become personally liable to the company or to a third party creditor for the amount of the debt and any loss or damage suffered by the creditor in relation to the debt because of the company’s insolvency. Furthermore, the nature of the duty to prevent insolvent trading is discussed in great detail in our previous article.

Keeping of Financial Records 

Directors are expected to take reasonable steps to ensure that a company complies with its obligations regarding the adequate keeping of financial records and financial reporting. 

Disclosing Interests 

Under the statue, directors should also disclose matters relating to the affairs of the company in which he/she has a personal interest. Consequently, this imposed responsibility helps ensure the director is acting in good faith as the overriding duty of the fiduciary relationship is to act in the interest of the company. 

Consequences of Breaching Directors’ Duties 

If a board director breaches one of their legal obligations, they can be liable under Australian law. The legal consequences can vary depending upon the severity of the breach and the particular duty breached.

A director in breach can be subject to significant criminal or civil liabilities, or liability to pay compensation for the loss and damages incurred due to their breach. Directors are typically only exposed to criminal sanctions when the breach has been committed with intentional dishonesty. Under the corporations act, a director may even be disqualified from managing companies for a period of time. There can also be commercial consequences. 

Proceedings can be brought against a breaching director either by: 

  • the company; 
  • shareholders under the statutory derivative action provisions 
  • regulators such as ASIC or the ACCC 
  • third parties for misleading and deceptive conduct or anti-competitive behaviour; or
  • creditors.  

Summary 

Both statute and common law imposes various legal obligations upon a board director that are considered to be significant legal responsibilities. Designed to protect the company and ensure that directors satisfy high standards of good faith and loyalty to the company. 

With the relationship between a board director and a company being one of fiduciary, it is imperative that a director acts in good faith and does not engage in any activity that could be to the detriment of the company. Indeed, there can be severe legal consequences when breaching a director’s duty, so it is important if you are a director to be aware of your duties both at common law and statute. 

About Raymond Chbib

Raymond is a legal intern at OpenLegal, working with our legal content team. He is currently a penultimate student at the University of Technology Sydney, studying a Juris Doctor degree with an undergraduate Bachelor of Global Studies. He is particularly interested in Intellectual Property law and the increasing internationalisation of that area of business.