Like all those occupying positions of trust, company directors cannot improperly use their position of power. However, it can be confusing when considering what actually constitutes a director’s misuse of office. This article explains the proper purpose obligation that is imposed upon directors and sets out the penalties for breaching these 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, therefore, become a permissible and appropriate use of directorial powers.
The proper purpose duty originates from fiduciary duties. These are the duties of individuals to act in the best interests of someone who has placed their trust in them.
However, public policy makers considered the proper purpose duty to be so important that it became included in the Corporations Act 2001 (the Act). Furthermore, the Australian Securities and Investments 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 breach either their fiduciary duties or breached the Act.
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 fulfilling their fiduciary duties to the organisation. That is, their obligation to act in good faith and for the benefit of it.
Most commonly, improper actions by directors involve those motivated by the desire to secure a private gain or advantage. However, this 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:
1. Ultimate Purpose
First, the court establishes the ultimate purpose of the power used. It questions why the power exists in the first place. In identifying the parameters of the power, the court defines any inappropriate reasons to employ that power.
The court then determines if the purpose that motivated the director in question lies within the range of appropriate objects for that power.
A director or board of directors can use their powers for several different purposes. In these cases, a court examines all motivations and determines what mainly inspired the use of the power in question. The court questions whether if it were not but for having an improper motivation, would the director still have exercised their power? if not, the director has breached their duty.
Consequences of Breach
The consequences for misuse of office differ depending on whether a party takes action under the fiduciary duties or the Act. Under the fiduciary duties, the only party who can bring an action against a director is the company. If they are successful, a court can order:
- equitable compensation: which puts 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 actions under the Act. Potential penalties include:
- pecuniary penalty: a director must pay a sum to ASIC on the Commonwealth’s behalf;
- compensation; or
If a director has breached their duties, they could face a number of consequences. The main duty that a director must uphold is that their actions are done with a proper purpose. If they have breached this proper purpose, claims can be brought under either the Act or under fiduciary duties. If you have any questions about whether a director has breached their duties, contact LegalVision’s litigation lawyers on 1300 544 755 or fill out the form on this page.
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