The growing complexity of managing a business and increasing availability of information, together with the rising focus on corporate governance, makes it vital for every director of a company to know their legal responsibilities.
Directors do not need to know the Corporations Act requirements inside out, but they must broadly understand what their responsibilities are, and the practical application of those responsibilities.
Following are the main requirements of the Corporations Act 2001 for directors:
Company as a separate entity
Many directors can find it difficult to separate themselves and their personal situation from that of the company. The company should not be treated as part of anything else, and decisions made must be solely for the company.
Becoming a director
To have the responsibilities of a director, you don’t necessarily need to have been appointed as a director. Anyone who acts as if they are a director and does the things that a director does might be found to be one under the Act.
Companies limited by guarantee
Companies limited by guarantee are a “public company” for Act purposes. Many not-for-profit organisations, including industry associations and charities, are set up as companies limited by guarantee. Directors of these organisations should be aware that they have the same duties as directors of for-profit companies.
The Act includes four requirements for directors:
- They must act with care and diligence
- They must act in good faith
- They must not make improper use of their position
- They must not misuse information that comes to them through their position as a director.
The Act imposes criminal sanctions for failure to meet these duties.
Common law requirements
Over the years, the courts have added to the requirements of the Act, and given guidance on how they are to be applied. In general, these common law requirements cover:
- Care and diligence
- Acting in good faith
- Not using information for improper purposes
- Not abusing corporate opportunities
- Not disclosing confidential information
- Retaining discretion
- Avoiding conflicts of interest.
The business judgement rule
Directors fulfill their responsibilities if:
- They make judgements in good faith, for a proper purpose
- They don’t have a material personal interest in the decision that is made
- They inform themselves to the extent reasonably believed to be appropriate (i.e. ask questions!)
- They rationally believe that the decision is in the best interest of the company.
Other duties outlined in the Act include:
- Directors should not allow a company to trade while insolvent – to do so might result in them being personally liable for any debts created
- They must disclose any interest in any transactions being considered
- They have responsibilities for financial reporting.
The Act requires that directors must ensure that the company keeps financial records; prepares a financial report and directors report (if required); has them audited, if required; and reports to members, and lodges reports with ASIC if required.
Following the publication of the judgement in Centro, many directors became wary of continuing to act as directors because of the court’s findings.
In the Centro case, a significant issue was that borrowings were shown as non-current liabilities when they should have been shown as current liabilities. The court found that the directors should have known this, given the significance of the repayment requirements for the business.
Directors do not have to be experts in accounting standards and financial reporting – but they do have to make sure that the overall financial report gives the story that it should.
Financial reporting actions
To make sure that they meet their requirements for financial reporting, directors should discuss the financial report with management, and make sure the report tells the full story. If you don’t understand anything, ask!
Also, contact any advisers to the company with any questions, and ask for their thoughts on the presentation of the financial report.
The position of director has significant responsibilities, but directors should not be put off from accepting a position, as long as they are aware of what is involved, and make sure that they ask questions.