As the director of a company, you have a number of duties to your company, otherwise known as director’s duties. One of these duties is the duty to act in good faith in the best interests of the company and for a proper purpose. But what exactly are directors’ duties, and what does it mean to act in good faith and for a proper purpose? This article will discuss this director’s duty to act in good faith so that you can be sure what your legal obligations are as a company’s director.
What Are the Director’s Duties?
Directors are fiduciaries of their company, meaning they owe the company their undivided loyalty. You can find the different fiduciary duties directors owe to their companies in the Corporations Act 2001 (Cth). Examples of director’s duties include the duty to:
- avoid conflicts of interest;
- act with reasonable care and diligence; and
- prevent insolvent trading.
However, the broadest and most important of the directors’ duties is the duty to act in good faith in the best interests of the company and for a proper purpose.
In Good Faith in the Best Interests of the Corporation
To act ‘in good faith’ is to act honestly or sincerely, without an intention to deceive. This is also known as acting bona fide. A decision made in good faith is a decision where you genuinely believe it to be for the benefit of the company as a whole and not merely for your personal interest. However, this does not mean the decision cannot benefit you too. A decision that benefits both you personally and the company generally is not necessarily one made in bad faith.
Your decision does not have to have an actual benefit to the company. This is because good faith relates to your state of mind when you make the decision. What is important is that at the time you made the decision, you honestly believed it to be in the best interests of the company. This belief also has to be reasonable.
The concept of good faith is closely linked to acting in the best interests of the corporation. Acting in the best interests of the corporation means acting for the benefit of the members (i.e. shareholders) of the company as a whole. Where there are competing interests, you as the director need to balance the competing interests fairly.
A useful concept the courts have developed to consider the best interests of the corporation is the ‘hypothetical member’. Instead of looking at specific shareholders or groups of shareholders, courts imagine a hypothetical average shareholder. This hypothetical shareholder could be either a current shareholder or a future shareholder. This is because you as the director needs to balance the company’s interests in the short, medium and long term. The court then assesses whether the decision is in the best interests of that hypothetical shareholder.
For a Proper Purpose
As a director, you have the power to manage a company, issue shares and determine dividends. These powers are fiduciary and therefore need to be exercised for a proper purpose. You cannot use your powers as a director for private gain, as this would be considered an improper purpose. You should look to the company constitution and shareholders agreement (if you have one) to determine the scope of your power as a director. In order words, determining what you are legally able to do as a director.
Courts follow a two-step step test to determine whether a director has used their power for an improper purpose:
- determine the scope of the director’s power; and
- assess whether the director exercised their power within the scope of their permitted purposes.
Determining the actual purpose of a director’s decision often involves determining what the main purpose was. That is, making a decision that benefits you as a shareholder does not mean the decision was improper, as long as it was not your main purpose for making the decision.
What Are the Consequences of Breaching These Director’s Duties?
If you breach your director’s duties, the company can sue you on behalf of the shareholders. An exercise of power by a director in bad faith or for an improper purpose is voidable. This means that the action is reversible which means everything will be put back into the state it was in before the action occurred.
A court can also order you to stop taking certain actions or order that you pay compensation. This could mean repaying all the profits made from the breach of duty. The court can also order you to restore the company to the position it would be in if it were not for your breach.
Alternatively, the Australian Securities Investments Commission (ASIC) could sue you. If ASIC is successful in suing you, you can be:
- ordered to pay up to $200,000 in fines;
- ordered to compensate the company and its shareholders; or
- disqualified from managing a company for a certain period.
The director of a company owes a number of important fiduciary duties to the company. One of these duties is the duty to act in good faith in the best interests of the company and for a proper purpose. If a company director breaches these duties they can be liable to pay compensation, fined or disqualified from managing a company. If you have questions about your duties as a company director get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
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