Duties of directors
The Companies Act specifies the duties owed by the directors. In some cases, these duties are owed to the company (and so are only enforceable by the company or a receiver or liquidator of a company) and in some instances, the duties are owed to shareholders.
The Act has two underlying concepts from which all directors’ obligations flow. These are that directors must:
- Act in good faith and in the bests interests of the company; and
- Meet a reasonable standard of care, diligence and skill when carrying out their duties.
In addition, some specific duties owed by directors are:
- To exercise their powers for a proper purpose (that is, in pursuance of the company’s objectives);
- To avoid reckless trading (that is, trading while insolvent);
- To avoid incurring certain obligations;
- To declare all conflicts of interest;
- To not disclose, make use of, or act on company information except as permitted by the Act.
Conflict of interest
A director is interested in a transaction to which the company is a party if the director:
- Is a party to the transaction.
- May derive a material financial benefit from the transaction.
- Has a material financial interest in any other party to the transaction or has a specified indirect interest.
- Is the parent, child or spouse of another party to, or who may derive a material financial benefit from, the transaction or
- Is otherwise directly or indirectly materially interested in the transaction.
An interested director must disclose the interest and ensure that the interest is recorded in the interests register which the company must maintain. The disclosure must state:
- The monetary value of the director’s interest.
- The nature of that interest.
- Information on the extent of the interest.
This disclosure rule is very strict. Failing to disclose an interest can lead to avoidance of the contract by the company, recovery of any profits made by the director and/or a criminal sanction by way of a fine.
Reliance on managers and professional advisers
The Companies Act states that the directors manage the business of the company. The board is entitled to delegate the management of the company to managers. One of the most important duties of a board is to employ the Chief Executive Officer (CEO). It is the Chief Executive who usually employs the balance of the management staff of the company. A director may rely on information by a competent employee, or director, or financial adviser or expert, as long as the reliance is made in good faith and the director makes proper inquiry and has no knowledge that such reliance is unwarranted. A healthy relationship between the CEO and the Board, particularly the chair, is vital. The CEO reports to the board and with the board on the development of strategy for the company.
In certain circumstances, the directors must each sign a solvency certificate certifying that the company meets the solvency test. Solvency is often not easy to determine. It requires the company to demonstrate that it is able to pay its debts as they become due in normal circumstances and to certify that the value of the company’s 10 assets are greater than the value of its liabilities, including contingent liabilities.
These are known as trading and balance sheet solvency, respectively. Failure to apply the solvency test properly when required may make a director personally liable. The situations requiring a signed solvency certificate are:
- Distributions by the company for the benefit of a shareholder, including a dividend, and incurring a debt to or for a shareholder’s benefit.
- Share repurchases.
- Share redemption options being exercised.
- Financial assistance to acquire shares is offered by the company.
- An amalgamation.
Directors who do not fulfil their obligations under the Companies Act are open to penalties and personal liability. The liability of a director will be determined by his or her involvement in the decision. Failing to vote on a board matter should be carefully considered as the directors are collectively responsible for any decision made by the board.
A director of a company which is experiencing financial difficulties must be very careful, as a director may become personally liable for the company’s debts if the director allows the company to trade recklessly. Reckless trading occurs where a company continues to ‘trade’ in a manner likely to create substantial risk of serious loss to the company’s creditors. If there is any possibility of this occurring, the board must carefully consider the consequences of continuing to trade and should seek professional advice.
Receivership and liquidation
A receiver is normally appointed by the holder of a charge over a company. A charge over the undertaking of a company is called a debenture or general security agreement (under the Personal Property Securities Act 1999). A receiver, when appointed, assumes control of the company’s business and the board’s powers are effectively suspended. A receiver may continue to trade the company. A liquidator is the equivalent of a company undertaker. A liquidator may be appointed by the Court, generally in a situation where a company is unable to pay its debts when they fall due. A company may also be put into liquidation voluntarily by resolution of the shareholders. The liquidator winds up the company and must sell or release the assets of the company, pay its debts and return any surplus to the shareholders.