Fiduciary duties of directors

The Australian corporate governance landscape is changing. Gradually, there has been a shift towards imposing greater personal liability on directors.

Whilst the law still accepts error of judgment involving commercial risk, the standard expected of directors is high and duties must be met.

Each director of an Australian company owes duties to the company. At a basic level, those duties are designed to protect the company and ensure that directors satisfy high standards of good faith and loyalty to the company.

Directors are generally required to apply their particular skills and experience relevant to the matter being considered. If a director breaches their duties, they individually, as well as the company, could be subject to sanctions, including financial penalties and imprisonment.

Three types of directors duties

In Australia, there are three sources of directors duties. Corporations Act duties, fiduciary duties and statutory duties. Companies are primarily governed by the Corporations Act 2001.

One of its principal purposes is to set out the obligations of companies and its boards, executives and members. Additionally, fiduciary duties are duties developed over time as a result of caselaw (commonly referred to as judge made law). Fiduciary duties work in cohesion with the Act. Although there is overlap, the Act does not replace fiduciary duties.

In Australia, fiduciary duty is defined by the Corporations Act 2001. A director owes a fiduciary duty to the company, that is he or she must “act honestly, in good faith and to the best of his or her ability in the interests of the company.” Section 181(1) of the Act requires that directors act 'in good faith in the best interests of the corporation'.

Section 184 (1) of the Corporations Act also seeks a criminal offence for a breach if a director or other officer of the corporation is reckless or intentionally dishonest. The board of directors may not delegate duties of care to others; whatever the circumstances, they are personally responsible for outcomes.

Finally, numerous legislative instruments, both federal and state, impose additional duties and liabilities on directors. Legislation governing Workplace Health and Safety (WHS), environment, competition and consumer regulation, anti-bribery and corruption, and taxation law are of particular importance for directors.

Four main legal duties

There are two sources of directories duties: general law and statute. Under the general law, directors have duties that are based on the relationship they have with the organisation. This is a special relationship based on trust; a relationship akin to being the trustee of someone else’s money, and for this reason directors’ duties are sometimes called ‘fiduciary duties’.

Directors’ duties are usually also set out under statute, though the way this is done will depend on how the organisation is incorporated.

The four main legal duties based on general law and statute are to:

1. Act in good faith and for a proper purpose

This duty has two parts. Firstly, acting in ‘good faith’ means that directors must act honestly, fairly and loyally. It requires that directors act in the best interests of the organisation (rather than in their own personal interests). The requirement to act for a ‘proper purpose’ means that a director’s decisions must further the organisation’s purpose and be made within the board’s legitimate authority.

2. Act with reasonable care, skill and diligence

Directors must take their roles seriously and be diligent in the exercise of their responsibilities. That includes taking the necessary time to prepare for board meetings, keeping abreast of the organisation’s activities and understanding the organisation’s financial position (including making sure the organisation can pay its debts when they are due), and attending and participating in board meetings.

3. Not to improperly use information or position

Information provided to directors to support them to fulfil their roles must only be used for the benefit of the organisation. Directors cannot use information provided to them as a director, or their role as a director, to harm the organisation or to gain an improper advantage for themselves or another person or organisation.

4. Disclose and manage conflicts of interest

Conflicts of interest are often unavoidable. They do not represent a problem in and of themselves. However, where a conflict of interests do arise, directors must disclose them, and manage them appropriately.

There is some misconception that directors who are not remunerated for their work (sometimes called ‘volunteer directors’) are subject to lower standards of legal responsibility. This is not the case, and individuals should think carefully before accepting the responsibilities of directorship.

There are several laws that set out the specific duties to which directors are subject. For example, there are directors’ duties under the common law, the laws that govern incorporated associations and under the Corporations Act. The Australian Charities and Not-for-Profit Commission (ACNC) governance standards also refer to directors’ duties.

ACNC Governance Standards 5: Duties of Responsible Persons

• To act with reasonable care and diligence;

• To act honestly and fairly in the best interests of the charity and for its charitable purposes;

• Not to misuse their position or information they gain as a responsible person;

• To disclose conflicts of interest;

• To ensure that the financial affairs of the charity are managed responsibly; and

• Not to allow the charity to operate while it is insolvent.

To whom do directors owe their duties?

Directors’ duties in Australia reflect the relationship that directors have with the organisation and its members. Directors are entrusted with the responsibility of governing an organisation and so the law expects that they will act in the best interests of the organisation and be accountable for their actions.

Directors owe their duties to the organisation as a whole – meaning that they must act in the best interests of the organisation and its members. It is assumed that the organisation will exist on an ongoing basis (in perpetuity), and as such the interests of future members should also be considered.

In exercising their responsibilities, it is a good idea for directors to consider how their decisions might impact other stakeholders who are not members, such as clients and community members. This may be beneficial to the organisation’s strategy and assist with improved decisionmaking, but it is important to recognise that directors do not have a specific legal duty to act in the interests of these stakeholders (aside from obligations arising from other specific laws, for example regarding environmental protection or WHS).

Some directors are appointed to the board to contribute the perspective of a certain stakeholder group. For example, a federated organisation might appoint directors from its state and territory divisions to its national board. This can provide valuable insight and promote a sense of involvement among stakeholders.

However, it is important to recognise that even though a director may be appointed because of their relationship to a stakeholder group, they must exercise their duties in the interest of the organisation and apply an independent mind to their responsibilities.

More detail on duties can be found in the AICD Director Tool General Duties of Directors.

Stronger penalties for corporate breaches

Recent law changes have substantially strengthened the maximum penalties for breaches of corporations law, including directors’ duties. The maximum civil penalties for individuals have increased from $200,000 to over $1m, and possible maximum prison terms from five years to 15 years. 

The Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Bill 2018 was passed by Parliament on 18 February 2019. The Bill strengthens civil and criminal penalties for corporate and financial sector misconduct.

Implications for directors

The stronger penalties underscore the substantial obligations under the law on both directors and officers. Legal duties and obligations will be top of mind for directors, and will compel a closer look at risk and compliance management policies and processes.

Further, the new civil penalties introduced for important obligations owed by Australian Financial Services Licence (AFSL) holders will prompt a review of processes, procedures and systems in place to facilitate compliance.

These reforms further embolden and empower ASIC, which released an update on implementing Royal Commission recommendations, confirming a “why not litigate” approach and its intended establishment of a functionally separate Office of Enforcement. Directors should consider whether their organisation’s approach to dealing with the regulator remains appropriate, in light of the Financial Services Royal Commission Final Report.

Key changes to Corporations Act 2019

New civil penalty provisions

The Bill extends the civil penalty regime to a number of other obligations under the Corporations Act, which means that breaches will now attract financial penalties imposed by the courts.

Importantly, a civil penalty has been introduced for obligations owed by AFSL holders under the Corporations Act to:

• do all things necessary to ensure the financial services covered by the licence are provided efficiently, honestly and fairly (under section 912A); and

• report significant breaches or likely breaches to ASIC within 10 business days of becoming aware of the breach or likely breach (under section 912D).

This represents an expansion of ASIC’s regulatory tools in relation to financial services licensees, and a notable shift in the enforcement landscape given a penalty regime will now apply to subjective concepts like ‘fairly and efficiently’.

Increased civil penalties

New Corporations Act penalties and those under the ASIC Act have been increased for both individuals and corporations. For an individual, the maximum pecuniary penalty has been increased to the greater of 5,000 penalty units ($1,050,000) or the benefit derived (or detriment avoided) because of the contravention multiplied by three.

For a corporation, the maximum financial penalty has been increased to the greater of 50,000 penalty units ($10,500,000), or the benefit derived (or detriment avoided) because of the contravention multiplied by three, or 10 per cent of the annual turnover of the body corporate, but to a maximum monetary value of 2.5 million penalty units ($525 million). This is an uplift from previous iterations of the Bill, with the Opposition successfully pushing to increase the cap to 2.5 million penalty units from 1 million penalty units ($210 million).

In addition, courts will now have the power to make a ‘relinquishment order’. This order aims to recover any financial benefit that might have been gained from misconduct. It will effectively operate to deprive the individual or corporation from any financial benefits or profits gained from the breach of the civil penalty provision. A relinquishment order could apply in addition to any pecuniary penalty.

Increased terms of imprisonment

The maximum imprisonment penalties for certain criminal offences have been increased to reflect the seriousness of the misconduct. In particular, terms of imprisonment are increased from five years to 15 years (rather than 10 years as proposed in previous iterations of the Bill) for certain serious criminal offences including:

• recklessly or dishonestly breaching directors’ and officers’ duties (s 184);

• dishonestly failing to comply with financial and audit obligations (s 344(2));

• intentionally or recklessly breaching the duties of officers or employees of the responsible entity of a registered scheme (ss 601FD, 601FE); and

• knowingly or recklessly providing defective disclosure documents or statements (ss 952D, 952F, 1021D).

Maximum prison terms for individuals convicted of certain other offences will increase (in some cases by up to five years), and significant maximum financial penalties have also been introduced. There are a large number of offences affected, including misleading or deceptive statements in or omissions from takeover, compulsory acquisition and buyout documents; and obligations on AFSL holders, including in relation to providing assistance, notice of certain matters and/or statements to ASIC.

Dishonesty test

Another change is that the “dishonesty” test applying in the Corporations Act 2001 (Cth) is now defined as “dishonest according to the standards of ordinary people”. This impacts potential criminal offences for breaches of the duty on directors to act in good faith in the best interests of the corporations and for a proper purpose (in section 184(1) of the Corporations Act) where previously directors had to be “intentionally” dishonest. This means the prosecution will not be required to prove the defendant’s state of mind — the test will be whether the conduct was dishonest by the standards of ordinary people. Importantly, criminal prosecution under s 184(1) would still need to meet a very high bar — proving beyond reasonable doubt that the defendant had failed to act in good faith in the best interests of the company or for a proper purpose, and was either reckless or dishonest.