Sample HD Essay s181(1)(A) PDF

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Introduction Directors have a number of duties to which they must conform. These duties include those imposed by contract, common law, statute and equity. The equitable fiduciary duty to act in good faith is reinforced in section 181(1)(a) of the Corporations Act 2001 (Cth) (the Act).1 It provides that ‘[a] director … must exercise their powers and discharge their duties in good faith in the best interests of the corporation’.2 But whether a director should act under their own honest belief, or in a way which a reasonable person with the director’s same skill and knowledge would act is not settled. This paper will consider this dichotomy in an attempt to determine whether a director acting with honest belief is acting in good faith in the best interests of a company, or whether, regardless of their honest belief, they could have breached their duty under section 181(1)(a). To do this, it will begin by providing a background to the formation and purpose of section 181(1)(a) by discussing the origins of directors duties. It will then consider each element of the section in turn. It will conclude that the answer to the question at hand will be based on the facts of each case, with the honest belief of the director being only one factor considered by the courts. The Origins of Directors Duties To understand the interpretation of section 181(1)(a), it is helpful to look at the origins of directors duties. From the outset, development of these duties came from equity, analogous to the duties of trustees.3 This presumed fiduciary relationship was clearly stated in Hospital Products Ltd4 where Justice Mason provided that ‘accepted fiduciary relationships are sometimes referred to as relationships of trust and confidence or confidential relations’,5 citing director and company as one such relationship. The purpose of fiduciary duties is to protect one party (the company)

1 Justice McMurdo, ‘Caveat Director – Recent Developments and Future Directions’ (Speech, Inaugural Australian Women Lawyers Conference for Excellence, Sydney, 30 September 2006) 6. 2 Corporations Act 2001 (Cth) s 181(1)(a). 3 Justice Geoffrey Nettle, ‘The Changing Position and Duties of Company Directors’ (2018) 41(3) Melbourne University Law Review 1, 3. 4 Hospital Products Ltd v United States Surgical Corporation Surgeons Choice (1984) 156 CLR 41. 5 Ibid 68.

from the abuse of trust from another party (a director).6 Duties of a director fiduciary include to ‘act as best to promote the interests of the corporation whose affairs they are conducting’, avoid conflicts of interest, and not use their position for personal gain.7 They have an obligation to act to high standards, as provided by Justice Cardozo, they owe: ‘the duty of the finest loyalty … [a] trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity’.8

At common law, it has long been established that honesty is an element of a directors duty. In the 1872 case The Overend & Gurney Co v Gibb,9 Lord Hatherley explained that if a director acted in a way that he believed was carrying out his duty, regardless of a mistake made by the director in hindsight, the only question is whether he acted within the scope of his powers. If not within his power, then consideration should be given to whether he was aware of circumstances so obvious ‘that no men with any ordinary degree of prudence, acting on their own behalf, would have entered into such a transaction’.10 If so, then it amounted to ‘crassa negligentia on their part … so that they should be fixed with the loss’.11 Thus, it appears that the subjective versus objective dichotomy was in favour of subjectivity in the late 1800s. The court’s current position will be discussed below. Section 232(2) Corporations Act 1989 (Cth) was the predecessor to section 181(1). It put an obligation on directors to act honestly.12 Notably during the drafting of section 181(1)(a), there was debate about whether the test should be subjective or objective. In one form, the section read ‘in good faith in what they believe to be in the best interests of the corporation’ (emphasis added).13 However, these words were removed as the ‘wording was too subjective and did not reflect the standard set by

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G E Dal Pont, Equity and Trusts (Thomson Reuters, 6th ed, 2015) 96 [4.05]. Peter Radan and Cameron Stewart, Principles of Australian Equity and Trusts (LexisNexis Butterworths, 3rd ed, 2016) 236, [10.28]. 8 Meinhard v Salmon (1928) 249 NY 458. 9 The Overend & Gurney Co v Gibb (1872) LR 5 HL 480 (‘The Overend’). 10 Ibid 486–7. 11 Ibid. 12 Robert Austin and Ian Ramsay, Principles of Corporations Law (LexisNexis Butterworths, 17th ed, 2018) 468 [8.065]. 13 Ibid 473 [8.070.3].

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the courts’.14 Some commentators have argued that the removal of the words turns the subjective test into an objective one.15 While others claim it aligns the test with the common law.16 Justice Owen in Bell Group v Westpac17 took the time to consider the legislative history of section 181(1) concluding ‘the legislature has recognised, and not abrogated, the underlying principles on which directors' general law duties are based’. Thus, it appears from the history of directors duties that in equity, at common law and arguably under statute, an element of subjectivity will be taken into account. Good Faith and Honest Belief The Act does not define good faith, but relies on the common law interpretation. Unfortunately the court has not provided a definitive definition of good faith. Instead it opens a debate around whether good faith requires an honest belief of the director making decisions, and/or the objective view of the reasonable person with the same skill and knowledge of the director. As noted above, historically the courts have put high value on a director’s honest belief their actions were in the best interest of the company, citing gross negligence as an indicator that they had breached their duty.18 However the use of the term ‘good faith’ in section 181(1)(a) and whether it requires a director’s subjective intention versus the courts objective assessment is not settled. In ASIC v Adler,19 Adler breached his duty of good faith by conducting transactions without knowledge of the board or shareholders, for his own personal benefit.20 The court took an objective approach, however it also appears that Justice Santow has considered sections 181(1)(a) and (b) concurrently. He states: ‘I consider that the standard of behaviour required by s181(1) is not complied with by subjective good faith or by a mere subjective belief by a director that his purpose was proper, certainly if no reasonable director could have reached that conclusion’ 21 (emphasis added).

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Ibid 474 [8.070.3]. Ibid. 16 Ibid. 17 Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239 (‘Bell’). 18 The Overend (n 9) 486–7. 19 ASIC v Adler & Ors [2002] NSWSC 171. 20 Ibid 735. 21 Ibid 738. 15

As these duties have been determined to be separate duties22 it is arguable that this objective outcome is not satisfactory to determine the approach solely focussed on good faith. Another argument for an objective approach was found in ASIC v Sommerville23 where a solicitor was found guilty of aiding and abetting directors ‘to bring about asset stripping but to attempt to make this seem legitimate’.24 Here it was held that section 184(1) of the Act expressly states dishonesty as a factor causing criminal offence for ‘breach of the duties to act in good faith in the best interests of the corporation’.25 Thus, where a director is aware their conduct is dishonest, section 184(1) should apply, but where a director honestly believes his behaviour is in the interests of the company, but the court disagrees, section 181(1)(a) applies.26 This position means that in the absence of honesty being expressly set out in section 181(1)(a), it should not be considered and an objective standpoint should be taken. Conversely, in a case concerning illegal fundraising ASIC v Maxwell,27 the court took a subjective approach. Here the court looked to the ‘historical origins of the duty’,28 citing the predecessor to section 181 (discussed above) and the 1970 case Marchesi v Barnes29 which required subjective dishonesty. It came to the conclusion that ‘absence of good faith requires much more than negligence’.30 This is in line with the origins of directors duties discussed above, where historically subjectivity was given more weight than an objective test and mere negligence was not enough for a director to breach his duty. In Bell Group v Westpac,31 Bell Group was unsuccessful in a restructure of loans with its unsecured bank creditors resulting in Bell Group entering into liquidation proceedings.32 Here the court considered both an objective and subjective

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Austin and Ramsay (n 12) 468 [8.065]. ASIC v Somerville & Ors [2009] NSWSC 934. 24 Ibid 50. 25 Ibid 36. 26 Ibid 36. 27 ASIC v Maxwell (2006) 59 ACSR 373 (‘Maxwell’). 28 Ibid 109. 29 Marchesi v Barnes [1970] VR 434. 30 Maxwell (n 27) 109. 31 Bell (n 17). 32 Martin Clark, ‘Westpac Banking Corp v Bell Group Ltd (in liq)’, Melbourne Law School Opinions on High (Blog, 10 April 2014) . 23

approach, with Justice Owen helpfully considering a number of authorities, setting out a number of legal principles: 

The test for whether a director ‘acted bona fide in the interests of the company’ is partly subjective and based on fact, focussing on the state of mind of the director. The question is whether a director considers that the power exercised is in the best interests of the company.33

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Directors make business decisions, the courts therefore do not question a commercial justification.34

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A director’s ‘subjective intention or belief are relevant but not conclusive of the bona fides of the directors’.35

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The court can consider extrinsic evidence and circumstances which give proof to the director’s state of mind to determine ‘whether they were honestly acting in discharge of their powers in the interests of the company’.36

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The degree of consideration given by directors to the interests of the company ‘must be more than a mere token’.37

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The court looks objectively at the circumstances of the matter and the disputed transaction or exercise of power. It does not consider any commercial justification, but rather to decide whether the director’s subjective intentions or beliefs are justified.38

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A court may intervene where it believes ‘that no reasonable board of directors could think the decision to be in the interests of the company’.39

Thus, in Bell Group v Westpac40 both subjective and objective tests were applied. Daikyne v Ralph41 followed, adding that while honest belief may exist, honesty by itself was not enough explain the actions of the director42 and the circumstances as a whole needed to be taken into account.43

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Bell (n 17) 4619. Ibid. 35 Ibid. 36 Ibid. 37 Ibid. 38 Ibid. 39 Ibid. 40 Ibid. 41 Diakyne Pty Ltd v Ralph and Another (2009) 72 ACSR 450. 42 Ibid 475. 43 Ibid 476. 34

In the recent case of ASIC v Geary concerned with payments to the Iraqi government,44 the court stated that the test to be applied was objective. However it also provided that ‘the subjective beliefs and intentions of the director or officer may still be relevant.’45 Thus, while the law is not settled, even in cases stating the test is objective it appears the courts are willing to acknowledge that honest belief may be considered. Notably, the courts can grant relief to directors who have breached section 181(1)(a) under sections 1317S and 1318 of the Act where it finds the director has acted honestly and should fairly be excused.46 However, this is beyond the scope of this paper and will not be discussed further. Acting in the Best Interests of the Corporation It is a fundamental duty for a director to act in good faith, in the best interests of a corporation.47 The courts have used the terms ‘interests’ and ‘best interests’ interchangeably.48 In Bell Group v Westpac49 Justice Owen provided that there was no material difference between the terms. Thus, there is no higher standard of interest imposed by section 181(1)(a). Generally, what is in the interests of the corporation will be set out in the company’s constitution.50 Decisions should be made factoring in competing short-term versus long-term benefits. Globalisation factors such as environmental concerns may also be relevant, particularly when long-term damage is for short-term profits.51 With regard to what encompasses a ‘corporation’, Justice Robson stated in Re S & D International Pty Ltd52 that ‘[t]he basic common law duty of a director is that he or she must act bona fide in what he or she believes is in the best interest of the company as a whole. This duty is encompassed in s 181’.53 That is, not the corporation as a legal entity separate from its shareholders, but ‘the corporators as a

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ASIC v Geary [2018] VSCA 103, 2 (‘Geary’). Ibid 409. 46 Robert Ishak, ‘Directors’ Duties’ William Roberts Lawyers (Article) . 47 Austin and Ramsay (n 12) 471 [8.070]. 48 Ibid 475 [8.070.6]. 49 Bell (n 17) 4389. 50 McMurdo (n 1). 51 Ibid. 52 Re S & D International Pty Ltd (No 4) [2010] VSC 388. 53 Ibid 283.

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general body’.54 However, even with the nexus between interests of the corporation and its shareholders, there may be situations where a decision appears contrary to some shareholders. For example, decisions which benefit the company and shareholders in the long term, but are seen to disadvantage short term shareholders.55 Also, where there is divergence between the interests of different classes of shareholders, the director should endeavour to act fairly across all classes.56 The above is based on a company which is solvent, with no obligation to consider the interests of company creditors. However, when a company ‘is insolvent or approaching insolvency’,57 a directors duty may extend to include the interest of company creditors.58 Breach of Duty under section 181(1)(a) Research undertaken has revealed sources stating the duty imposed by section 181(1)(a) attracts an objective test.59 However, they also acknowledge that this does not mean the subjective honest belief of a director is irrelevant.60 Thus, it is arguable that the duty imposed by section 181(1)(a) requires a two-step test: 1. the intention of the director to determine honest belief; and 2. whether a reasonable person, acting in the director’s position with the same knowledge and skill, would have acted the same way, taking into account all circumstances. The weight the court will put on each element is determined by the facts of the case. However, it appears the objective standpoint carries more weight than a directors honest belief in their actions. Thus, if a director has acted with honest belief yet no reasonable director would have undertaken the same actions, the director will be in breach of their duty under section 181(1)(a). The reason for this was aptly stated by 54

Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286, 291. ‘Chapter Four – Directors Duties’ Parliament of Australia (Web Page) 4.6 . 56 Edmund Finnane and Jason Harris, Corporations Legislation 2019 (Lawbook Co, 2019) 246 [CA.180.100]. 57 Ibid. 58 Ibid. 59 See eg Geary (n 44) 409; Finnane and Harris (n 56) 245 [CA.180.20]; McMurdo (n 1) 6. 60 See eg Geary (n 44) 409; Finnane and Harris (n 56) 245 [CA.180.20]; Austin and Ramsay (n 12) 469 [8.065]. 55

Justice Bowen in Hutton v West Cork Railway Co,61 ‘[b]ona fides cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company, and paying its money with both hands in a manner perfectly bona fide yet perfectly irrational.’62 Conclusion The history of directors duties both as a fiduciary and at common law, along with the formation and purpose of section 181(1)(a) all indicate that an element of subjectivity concerning a directors honest belief should be considered. However, a director is also in a fiduciary position of trust and confidence and ‘subject to higher standards of behaviour’,63 acting on behalf of multiple parties in their role. Thus, it is understandable that the objective view of a reasonable person with the same skill and knowledge as the director would be considered. If the reasonable person would never have come to the same result, then the director should be held accountable. Consequently, the courts give consideration to both the honest belief of the director, and the objective view of the reasonable person. The extent to which the court will rely on each side of the dichotomy will depend on the facts of the case. Thus, the answer to whether a director acting with honest belief is acting in the best interests of a company, or whether they will have breached their duty under section 181(1)(a) is, on its own, not conclusive. As a result, I am unable to agree with the statement posited in the assessment question.

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Hutton v West Cork Railway Co (1883) 23 ChD 654. Ibid 671. 63 Austin and Ramsay (n 12) 470 [8.070].

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Bibliography

A Articles/Books/Reports Austin, Robert and Ian Ramsay, Principles of Corporations Law (LexisNexis Butterworths, 17th ed, 2018) Dal Pont, G E, Equity and Trusts (Thomson Reuters, 6th ed, 2015) Finnane, Edmund and Jason Harris, Corporations Legislation 2019 (Lawbook Co, 2019) Nettle, Justice Geoffrey, ‘The Changing Position and Duties of Company Directors’ (2018) 41(3) Melbourne University Law Review 1 Radan, Peter and Cameron Stewart, Principles of Australian Equity and Trusts (LexisNexis Butterworths, 3rd ed, 2016) B Cases ASIC v Adler & Ors [2002] NSWSC 171 ASIC v Geary [2018] VSCA 103 ASIC v Maxwell (2006) 59 ACSR 373 ASIC v Somerville & Ors [2009] NSWSC 934 Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239 Diakyne Pty Ltd v Ralph and Another (2009) 72 ACSR 450 Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 Hutton v West Cork Railway Co (1883) 23 ChD 654 Hospital Products Ltd v United States Surgical Corporation Surgeons Choice (1984) 156 CLR 41 Marchesi v Barnes [1970] VR 434 Meinhard v Salmon (1928) 249 NY 458 Re S & D International Pty Ltd (No 4) [2010] VSC 388 The Overend & Gurney Co v Gibb (1872) LR 5 HL 480

C Legislation Corporations Act 1989 (Cth) Corporations Act 2001 (Cth) E Other Chapter Four – Directors Duties’ Parliament of Australia (Web Page) 4.6

Clark, Martin, ‘Westpac Banking Corp v Bell Group Ltd (in liq)’, Melbourne Law School Opinions on High (Blog, 10 April 2014) . Ishak, Robert ‘Directors’ Duties’ William Roberts Lawyers (Article) . Justice McMurdo, ‘Caveat Director – Recent Developments and Future Directions’ (Speech, Inaugural Australian Women Lawyers Conference for Excellence, Sydney, 30 September 2006)...