Like all those occupying positions of trust, company directors cannot improperly use their position of power. However, what constitutes a director’s misuse of office can sometimes be confusing. This article explains the proper purpose obligation imposed upon directors and sets out the penalties for breaching the obligations.
What is the Proper Purpose Duty?
Directors are required to exercise their powers for a proper purpose. A purpose is proper if it is motivated by the desire to benefit the company. All actions founded on it thus become a permissible and appropriate use of directorial powers.
The proper purpose duty originates from fiduciary duties. However, public policy makers considered it important and necessary that it was included in the Corporations Act 2001 (Cth) which is the primary legislation governing companies in Australia. The Australian Securities and Investment Commission (ASIC) is responsible for enforcing it.
The substance of the proper purpose duty in each source of law is substantially the same. However, the penalties for breaching the duty differ depending on whether a party undertook legal action in equity or under statute.
Proper Purpose Rule
The proper purpose rule states that if a director uses their power for reasons other than the benefit of the company, it is improper. The director has failed in fulfilled in their fiduciary duty to the organisation. That is, their obligation to act in good faith for the benefit of it.
Most commonly, improper actions by directors involve those motivated by the desire to secure a private gain or advantage. Of course, that is not the only way that a director can inappropriately use their office. Without the founding principle of the benefit of the company, any action could be improper. If a court needs to determine if a director has breached the duty, it uses a two-tiered process.
First, it establishes the ultimate purpose of the power used. The court answers the question: why does the power exist? In identifying the parameters of the power, it necessarily defines inappropriate reasons to employ that power.
Second, and building on the first answer, the court determines if the purpose that specifically motivated the director in question lies within the range of appropriate objects for that power.
A director or board of directors can use any power for several different purposes. In these cases, a court examines all motivations and determines what mainly inspired the use of power. The court does this using the ‘but for’ test: but for the existence of an improper motivation, would the director still have exercised their power? An answer in the negative for this question would be interpreted as a breach of duty.
The Corporations Act
The Corporations Act 2001 (Cth) mandates that directors use their position appropriately. The legislative obligation is in substance the same as its equitable counterpart. That means the same principles guide it, and case law precedent is applicable. A director breaching this duty is not the same as a company in contravention of their obligations. His Honour Justice Brereton remarked in ASIC v Maxwell (2006): ‘This duty is imposed not to secure compliance with the various requirements of the Corporations Act, but . . . to prevent abuses of directors’ powers for their own or collateral purposes’.
Consequences of Breach
The remedies available for misuse of office differ depending on whether a party takes action in equity (under civil law) or under statute. In equity, the only party who can bring an action against a director is the company. If they are successful, a court can order:
- Equitable compensation: to put the company in the position it would have been without breach and its resulting loss;
- Rescission of contract: if a director has an interest in a contract to which the company is a party, the company can rescind the contract;
- Account of profits: a director must account for any profits made from their breach;
- Constructive trust: a court creates a trust whereby the director holds any assets derived from their breach, in trust for the company; or
- Injunction: the court orders a director to cease an action.
In contrast, ASIC brings action under statute. As breach of this duty is a civil penalty provision, ASIC must prove their case on the balance of probabilities only. Potential penalties include:
- Pecuniary penalty: a director must pay a sum to ASIC on the Commonwealth’s behalf;
- Compensation; or
LegalVision can assist you with understanding directors’ duties under the Corporations Act. Call LegalVision today on 1300 544 755 or fill out the form on this page.