The law imposes certain responsibilities on directors known as director’s duties. One such duty is the obligation to act with care and diligence. We explain below the duty of care and diligence – what it is, the implications for directors, and the possible penalties for breach.
1. What is the Duty of Care and Diligence?
This responsibility requires all directors and other officers (such as secretaries and others involved in managing company property) to perform their obligations to the company with the care and skill. The duty exists to protect shareholders, creditors and investors and provide a means by which directors can be held accountable for their actions and decisions.
However, it does not aim to place unrealistic expectations on or expect extraordinary capabilities from, company directors. Rather, it is an objective test and acts as a legal mechanism to distinguish between legitimate and reckless commercial actions. The law knows that business involves risk and has no interest in stifling commerce. As such, the law does not consider that failure and financial loss necessarily implies a lack of care and diligence.
Nonetheless, companies receive capital from investors (members of the public) and can significantly influence the economy. In those circumstances, there exist valid public policy reasons to insist that directors act carefully and responsibly in the exercise of their functions.
2. What Does this Mean for Directors?
As noted above, this duty does not mean that directors must have extraordinary skills and abilities. Rather, it requires that they undertake real and sustained efforts to understand the company and their obligations.
Directors must inform themselves about the operations and affairs of the company. They cannot remain passive or ignorant. They must be able to read and comprehend critical financial statements and attend company board meetings.
They must always act in good faith for a proper purpose, inform themselves about the subject matter to an extent they reasonably believe is appropriate and rationally believe that the decisions they make are in the best interests of the company.
If a director or officer does have extensive experience and qualifications, then this is taken into account when considering what a reasonable person would do if they had the same knowledge and experience.
3. What is the Legal Basis of the Duty?
The duty of care and diligence exists both at common law and under particular legislation.
At common law, the duty is one of care, skill and diligence. Historically, the duty had a low threshold because Australian courts (following English precedent) used a subjective test to ascertain whether a breach had occurred. In essence, they determined breach according to what directors were thinking at the time of taking an action or making a decision. However, this changed after the decisions of AWA Ltd v Daniels (t/as Deloitte Haskins & Sells) (1992) 7 ACSR 759 and Daniels (formerly practising as Deloitte Haskins & Sells) v Anderson (1995) 37 NSWLR 438. These cases introduced and confirmed the use of an objective test to determine a breach of the duty at common law. In those circumstances, the test became what a reasonable person in the position of the director, with the same skills and knowledge of that director, would have done in a similar situation.
This duty is also actionable under statute. The Corporations Act 2001 (Cth) (the Act) requires all directors and officers of a company to exercise their powers and discharge their duties with care and diligence. The legislative duty is not absolute. Rather it requires that degree of care and diligence that a reasonable person would exercise if they were a director of that company with the same responsibilities and in the face of similar circumstances. The statutory test is, therefore, an objective one although it contains subjective elements in considering the specific circumstances of individual directors or officers acting for a particular company.
4. What Happens if Directors’ Breach Their Duty?
Content wise, the duty of care and diligence at common law and under the Act are substantially similar. However, the common law prescribes different consequences for breach of the duty than statute.
At common law, if a party successfully proves breach of this obligation, they might be entitled to the remedy of damages. However, it is not merely a question of proving breach. As the duty is technically a species of tort law, the party must also demonstrate damage – that is that the breach of the duty caused the damage and loss suffered by a company. Of course, these are two separate questions. Someone can conceivably prove breach but receive no remedy if they cannot show that the breach caused their loss.
Under the Act, a director who has breached the duty may be given a Civil Penalty Order. These orders require the director to pay a sum to the Australian Securities and Investment Commission on behalf of the Commonwealth. These orders can reach a maximum of $200,000.00. A court can also disqualify a director from acting as a director for a period or require them to pay compensation to the company or others for any loss or damaged suffered.
If you have any questions about your director’s duties, get in touch with our commercial lawyers on 1300 544 755.