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What is the Directors’ Duty of Care and Diligence 

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As a company director, one of your duties is to exercise care and diligence when carrying out your role. There are a range of consequences which can arise if you breach your director’s duties, including:

  • civil penalties;
  • disqualification as a company director;
  • orders to pay compensation; or
  • in serious cases, criminal charges leading to jail time.

It is therefore important to understand your obligations as a company director, including what the duty of care and diligence entails. This article will explain:

  • what the duty of care and diligence is;
  • the business judgement rule; and
  • some practical ways to discharge this duty.

Due Care and Diligence

A director must perform their role with the degree of care and diligence that a ‘reasonable’ person would exercise. A reasonable person is a hypothetical person who:

  • is a director of the company in the same circumstances;
  • occupies the same office held by the director; and
  • has the same responsibilities as the director.
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What Is ‘Reasonable’?

When objectively determining what is ‘reasonable’, a court will assess a director’s conduct taking into account all of the circumstances at the time and without the benefit of hindsight. There is no single standard of care and diligence which applies to all directors. In other words, there is no one size fits all test for ‘reasonableness’. There are various factors which will impact the standard, including the:

  • type of company;
  • nature of business (for example, some businesses may require a particular skill set from a director);
  • experience and skills of the director;
  • size of the company;
  • board composition; and
  • work distribution among the board.

For example, Director A has never run a company before and owns a small business under a single company structure with three employees. Director B has been a director and chair of the board of a company for over 15 years. The company has several subsidiaries specialising in financial services, and there are over 100 employees. Under these circumstances, Director B will likely be required to exercise a higher standard of care and diligence than Director A.

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What Is the Business Judgement Rule?

The business judgement rule can be used as a defence to claim that a director has not breached their duty of care and diligence. It protects directors in situations where they legitimately believed that they were making the right decision and where they made the decision honestly, or in good faith. To benefit from the rule, directors must have made a conscious decision. This includes any conscious decision not to take any action. A director who fails to inform themselves on business matters will not be protected under the rule as they have not consciously made a judgement.

A director who makes a business judgement will usually not have breached their duty of care and diligence if they:

  • made the judgement honestly (in good faith) and to benefit the company (proper purpose);
  • do not have a significant personal interest in the subject matter of the judgement;
  • properly inform themselves about the subject matter to the extent they believe is reasonable and appropriate; and
  • rationally believe that the judgement is in the best interests of the company.

How Do I Satisfy the Duty of Care and Diligence?

As a company director, you have a positive obligation to inform yourself about the affairs of the company properly. You could be in breach of your duties as a director if you are:

  • not paying enough attention to the company;
  • not keeping yourself informed about the company; or
  • acting dishonestly.

Some situations where directors have breached this duty in practice include:

  • approving of financial statements without being properly informed;
  • failing to monitor the business financials;
  • approving the statements issued by the company without checking if they are accurate;
  • causing a company to enter into a risky transaction that does not show any prospects of success; and
  • failing to inform the board of relevant matters.

Here are some key things you can do to discharge your duty effectively:

  • actively informing yourself about the business;
  • understanding what external factors might impact your business (such as the broader economy);
  • monitoring the business’ affairs and policies;
  • taking reasonable and active steps to guide and monitor business management.

Consequences for Not Acting With Care and Diligence

A director who has breached their duty to act with care and diligence can face a range of consequences. The consequences will depend on the nature and severity of the act. Possible consequences include:

  • civil penalties (fines or orders to pay compensation);
  • disqualification as a director;
  • personal liability implications;
  • negative commercial impact on the business’ reputation; and
  • in serious circumstances, criminal sanctions.

Key Takeaways

As a director, the law requires you to act with the care and diligence expected from a reasonable person in the same role and same circumstances. All company directors should ensure that they are properly informed about the business and that they are acting in the company’s best interests. The business judgement rule may apply if directors are deemed to have made a decision honestly and while believing that they were making the right decision for the company. In these cases, the director will be considered to have carried out their duty of care and diligence. If a director breaches their duties, a range of legal and commercial consequences can arise. If you need advice about your duties as a company director, get in touch with LegalVision’s business lawyers by calling 1300 544 755 or fill out the form on this page.

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