In Australia, directors have a duty to act in good faith in the best interests of the company. However, translating the term ‘good faith’ and understanding the concept of ‘the best interests of the company’ can make understanding this duty difficult. This article explains the duty, details its sources in law and outlines remedies in cases of breach.
What are the ‘Best Interests of the Company’ and ‘Good Faith’?
The term ‘best interests of the company’ refer to the company’s body of shareholders. If a director acts in the best interest of the corporation, it benefits shareholders by increasing profitability, dividends and capital gains.
At law, acting in good faith means acting honestly. In the context of directors’ duties, the term means that when a director makes a decision, undertakes an action or uses their powers, they do so genuinely, believing it to be for the benefit of the company. Directors show bad faith when they act for private gain.
What is the Duty to Act in Good Faith in the Best Interests of the Company?
The duty to act in good faith in the best interests of the company requires directors to act honestly, for the benefit of all shareholders. It is closely related to the obligation to act for a proper purpose. If a director exercises their power for personal profit, they have typically acted for an improper purpose and failed to show good faith for the best interests of the company.
While the duty to act in good faith originates in equity, it has also been enshrined in the Corporations Act 2001 (Cth).
This duty stems from the fiduciary obligations found in equity. This obligation requires a person in a fiduciary capacity to act in a position of trust for the benefit of the beneficiary. As the relationship between a company and a director is regarded to be a fiduciary one, this obligation extends to directors.
Even though the duty focuses on honest actions and genuine beliefs, the test for breach of it is not entirely subjective. An honest director could still fail to fulfil their obligations even if they believed that their actions were in the best interests of the company.
If a court is required to determine if a director has failed to act in good faith in the best interests of the company, it uses a test that is both objective and subjective. If a director genuinely believed their actions were in the best interests of the company, the court will not refute that assertion by evaluating the commercial value of the act itself. However, it will look for independent, objective evidence that the director truly held that belief.
The Corporations Act 2001 (Cth) also requires directors (and officers) to discharge their duties in good faith in the best interests of the corporation.
The legislative obligation is substantially similar in content and scope to its equitable counterpart. As such, the statutory duty closely resembles equitable notions of it. Case law precedent also applies.
Despite the similarities between the common law and legislative obligations, the remedies applicable for breaching your duty is different.
In common law, only the company can sue the director. If they are successful, it might be awarded (as is relevant):
- Account of profits: a director must account for any profits made from their breach;
- Equitable compensation: to put the company in the position it would have been without breach;
- Rescission of contract: if a director has an interest in a contract to which the corporation is a party, the company can rescind the contract;
- Constructive trust: a court creates a trust whereby the director holds any assets derived from their breach, in trust for the company;
- Injunction: the court orders a director to cease engaging in an activity
The Australian Securities and Investment Commission (ASIC) is responsible for taking action against a director under the Corporation Act 2001 (Cth). It does so because it enforces and regulates compliance with the Act.
The duty is a civil penalty provision. If a court makes a declaration under section 1317E(1) of the Act, it can then make pecuniary penalty orders against a director. The director is required to pay ASIC, on behalf of the Commonwealth, a sum of money. The maximum penalty is $200,000.
The court can also disqualify a director or order them to pay compensation. In some cases, a court may also issue an injunction for a director to cease an act.
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