Legal compliance is an essential component of risk management and yet it is often put on the back burner.
Directors should have a clear understanding of what is expected of them when carrying out legal duties under the Companies Act, company constitution and industry specific legislation. Directors should also be well aware of the consequences if they fail in their duties including accounting for profit, compensating for loss and even personal liability. Fundamentally, if directors can prove that all reasonable and proper steps have been taken to ensure legal obligations are met, then liability (including personal liability) may be avoided.
The aim of this article is to zoom in on directors, summarise the core duties under the Companies Act and refocus on how to avoid personal liability.
Are You a Director?
If you have been appointed to the position of director then the simple answer is ‘yes’. Additionally, for the purposes of certain core provisions of the Companies Act, the definition of ‘director’ is extended to include:
- Alternate directors(if permitted under your company constitution)
- Deemed or Shadow directors;
- Delegates appointed by the board from time to time.
Effectively, anyone who controls the company from the background is also considered a director. For the most part, these ‘deemed directors’ attract the same legal obligations, duties and liabilities as duly appointed directors.
What Duties Yo You Owe?
While there are numerous obligations and duties imposed on directors, the Act primarily requires directors to:
- Act in good faith and in the best interests of the company;
- Meet a reasonable standard of care, diligence and skill when carrying out these director duties;
- Many of the other directors’ duties under the Act are derivatives of these core duties.
Who do You Owe Director Duties to?
Generally, the key duties as a director are owed to the company. However there are certain duties that are also owed to shareholders and even company creditors.
What are Directors Duties?
We will focus on 9 core legal duties and obligations owed by directors under the Act including:
Acting in good faith and in the best interests of the company
First, directors are required to act honestly, with proper motive and without malice or dishonesty. While this duty is generally accepted and understood, the line is often blurred when it comes to dealing with conflict of Interest situations. Essentially, directors’ personal interests should never be promoted at the expense of the company unless permitted to do so and subject always to the strict disclosure regime under the Act.
Secondly, the ‘best interest test’ is a subjective one. This means that directors are free to act in what they perceive to be the best interests of the company- rather than what an ordinary or reasonable
director might do in the same circumstances. There are a few exceptions, including joint ventures and wholly owned subsidiaries where directors may be justified in acting in the best interests of the appointing shareholder (provided this is permitted in the company constitution).
Exercise of powers in relation to employees
Where a company ceases to carryon business, the focus shifts and directors must also protect the interests of employees. This is a good example of an exception to the duty to act in the best interests of the company. It is important to note that the definition of ‘employees’ here excludes directors who are employees or former employees.
Powers to be exercised for proper purpose
Directors are prohibited from straying beyond their limitations under the constitution and the Act or acting out of ulterior motive. For example, directors may not:
- Issue shares for the purpose of diluting troublesome shareholders’ voting rights;
- Use powers under the constitution to decline registration of a share transfer to thwart a shareholders’ attempt to sell its shares.
breach of this duty attracts personal liability and cannot be defended -even if the ‘improper’ action in question was ultimately in the best interests of the company.
Directors to comply with the Act and Constitution
The Act imposes certain responsibilities on directors which if not complied with can result in personal liability. A good example of this section in action is the obligation on directors to maintain the share register. A breach of this seemingly minor obligation would breach this duty and result in civil and even criminal liability.
Reckless trading and insolvent trading
Directors should not agree to, cause or allow the business to be carried on in away that creates substantial risk of serious loss to the company creditors. Directors may likewise not agree to incur obligations unless the company can perform these obligations. Overall, these duties are aimed at preventing companies from trading ‘insolvent’. Di rectors are at real risk of being held personally liable to compensate creditors for losses suffered as a result of their reckless or negligent actions.
Directors duty of care
As a director you are required to exercise the same care, diligence and skill as a reasonable competent director would in the same circumstances. Your actions will be judged on a number of factors including your role in the decision making, the nature of your business, the decision in question, your position and your responsibilities in the business.
Use of information and advice
Directors are not expected to know everything there is to know about every aspect of the business or have the skills to make all decisions. Directors can rely on information from competent employees, managers, financial advisers, legal advisers or experts provided:
- Reliance on this advice is made in good faith;
- Proper inquiries have been made;
- There is no reason to believe that the reliance on this advice is unwarranted.
Directors’ duties cannot be delegated and so an ‘unquestioned’ reliance on third party information or advice is not permissible. Directors must exercise independent judgement and apply their knowledge of the business and financial position to any expert advice.
Using company information
Directors may not make improper use of their leadership position to gain personal advantage particularly if it potentially causes the company harm. This generally applies to director loans, insider trading and seizing (company) business opportunities. Directors who breach this duty run a real risk of being held personally liable for company losses. In certain circumstances, directors may make use of, act on or disclose company information but usually only with prior shareholder approval.
Declaring interests on the interests register
Where a director stands to gain a financial benefit in a transaction, disclosure must be made in the company’s interest register. Consequences of non-disclosure are:
- The transaction being avoided (unless fair value can be proved);
- The directors being personally liable to account for all profits made;
- Criminal sanctions by way of fines being imposed;
To clarify, a director may be interested in a transaction where s/he
- Is also a party to the transaction (personally);
- Stands to gain a material financial benefit from the transaction;
- Has a material financial interest in another entity who is party to the transaction or is a relative of a party who will derive material financial benefit;
- Is otherwise materially interested in the transaction (either directly or indirectly).
The duty to declare interests on the register is owed to shareholders and not the company. Other duties owed to shareholders also include the duty to supervise the share register and disclose share dealings. A breach of these duties could result in personal action being taken against a director by shareholders (or former shareholders).
Directors Personal Liability Under Other Legislation
Addition to directors’ duties under the Companies Act, directors must also comply with obligations under industry specific legislation. A failure to comply with these obligations may result in directors being personally liable. For example:
Fair Trading Act involvement in misleading or deceptive conduct in relation to trade. This often includes misrepresentation during negotiations or misleading advertising.
Health & Safety in Employment Act-authorising, approving or simply participating in any employee matter that breaches compliance.
Tax Administration Act-mere knowledge of a company’s failure to keep certain records and file tax returns as required.
Commerce Act-mere involvement in a company that breaches certain anti-competitive provisions trade.
Resource Management-mere involvement in management of a company that is convicted of a resource management offence.
Securities Act-mere involvement in a company that breaches certain disclosure requirements in relation to public offer documents.
How to Avoid Personal Liability?
Directors’ owe duties personally and cannot delegate these to third parties. A few practical keys to avoiding personal liability include:
Applying independent thought and knowledge of the company’s financial position to all major decision making rather than relying unquestioningly on expert advice
- Becoming familiar with all duties and obligations under the company constitution, the Act and all industry specific legislation and regulations;
- Ensuring representations regarding your business are factual -particularly when negotiating deals and/or advertising products and services to customers;
- Having at least a basic knowledge of conventional accounting practice and concepts and up skilling if necessary;
- Fully understanding all documents that you sign as director.
Directors should ensure that their leadership and decision making is in line with their directors’ duties and obligations under the Act, the constitution and industry specific legislation. This will go a long way to managing both business risk and indeed the risk of personal liability. In turn, the effective management of risk both creates and protects value i n your business.
Disclaimer — this article prepared by Meryl Duval (an Associate in Morrison Kent, Auckland) is intended to provide a general overview of the area of law only. It is not exhaustive, does not purport to cover all details and should therefore not be relied upon exclusively or be construed as personal advice.