Directors' Duties – Duties of Care and Diligence

This week, we bring you another sneak peek of our book with the chapter on Duties of Care and Diligence.  In our earlier blog, we talked about the duty not to act for an improper purpose.  The duty we are discussing this week is one that ensures that the directors do not act for improper purposes by exercising care in reviewing contracts and not overstepping their powers by utilising their skills and diligence to avoid anything that can affect the company or its shareholders in a negative way.

This duty is enforced under the common law as well as the Corporate Law Reform Act of 1992.

The duty is the consequence of the trust and confidence that are entrusted to the directors by shareholders.  With this duty comes the privilege of managing the company on a daily basis and thereby answering to the shareholders.  Presumably, directors are appointed to the office due to their skills, experience, and general understanding of the business.  In return, directors are expected to perform their duties with the same care and diligence that a reasonable and prudent person would under the same circumstances.  The standard of care and diligence that is required of directors may differ from one company to the next.  A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his/her knowledge and experience, Re City Equitable Fire Insurance Co [1925] 1 Ch 407.

“By balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from conduct in question” is the process to inquire whether the director exercised a reasonable degree of care and diligence:  ASIC v Doyle & Anor [2001] WASC 187.

Nature of business and position necessary

The precise nature of a director’s duty of care will also depend upon the nature of the business of the company or the industry in which the company is engaged.  It may also depend upon the specific and personal” experience and skills that the director held himself or herself out to have the support of appointment or election to the office Re City Equitable Fire Insurance Co [1925] 1 Ch 407.

The position of the director may be considered to determine whether the standard of care necessary under the circumstances is complied with. For example, while a non-executive and an executive director must ‘act in good faith in the interests of the company as a whole’, the standard of care for a non-executive director is not as high as that for an executive director. This is because an executive director is involved in the running of the day-to-day business.

When is reliance appropriate?

In some circumstances, the complexity of issues involved in a transaction or contract allows a director to ask for the opinion of an expert or any other person with relevant knowledge.  This leeway is vital especially when directors lack the competence and necessary knowledge to make the decision. Seeking an expert’s opinion is but an exercise of the directors’ duties of care and diligence in making sure that they have considered all the relevant matters in making the decision.  However, such reliance must be made only if it is appropriate under the circumstances.  It may be unnecessary and therefore unfitting on the part of the director and a breach of the duties if one ‘knows, has reason to know or should have known’ by the exercise of reasonable care and diligence that such opinion is not correct or inaccurate:  ASIC v McDonald (No 11) [2009] NSWSC 287.

Breach of Duty

A breach of this duty is punishable by civil penalties or disqualification and eventual removal from the board.

An act that has an adverse effect on the company is not necessarily a breach of the director’s duties.  There must be clear evidence that the act in question was made in violation of the director’s duties of care of diligence.  It is a presumption in favor of the director that the director was acting with due care and diligence in managing the affairs of the company.  Absent any contradictory evidence, this presumption stands to protect the director whilst performing his duties.

What Should I Do Next?

Contact us if you would like further legal advice on Director's Duties.  As usual, our lawyers at You Legal will be happy to answer any of your questions and assist you in reviewing your company constitution.