MODULE 2 INTRODUCTION TO DIRECTORS’ DUTIES ADB Private Sector Development Initiative Corporate and Financial Governance Training Solomon Islands Dr Ann Wardrop La Trobe University

Acknowledgement These materials were produced by the Asian Development Bank’s Pacific Private Sector Development Initiative (PSDI). PSDI is a regional technical assistance facility co-financed by the Asian Development Bank, Australian Aid and the New Zealand Aid Programme.

Module 2 Outline

Directors’ Duties  Contained in:  Companies Act 2009 (sections 64 − 70)  Directors of state-owned enterprises (SOEs) The State Owned Enterprises Regulations 2010 regulations 17 − 27 (made under the State Owned Enterprises Act 2007)

Directors’ Duties  Directors’ duties are owed to the company. This flows from the fact that the company is a separate legal entity.  Because the directors are the ones who are controlling the company’s affairs, they are in a position to harm the company and the shareholders through: fraud or enriching themselves at the company’s expense; and mismanagement

Directors’ Duties Two fundamental types of directors’ duties  To act in good faith, and in a manner that the director believes to be in the interests of the company (the good faith and interests duty)  To act with due care: a director must exercise the care, diligence, and skill that a reasonable person would (the duty of care)

The good faith and interests duty  The key aspect of this duty is to act:  honestly  for the company and NOT to treat the company assets as a treasure chest for the directors’ own personal use. What if the directors and shareholders are all the same people?

The good faith and interests duty Examples of breaches of this duty:  stealing from the company  making loans to friends, family, shareholders or other directors on favourable terms  writing off debts owed to the company for no good reason (e.g. just so a director won’t have to repay a loan)  Acquiring a competitor of the director’s company and using company information to assist in acquiring the competitor  hiding company assets from creditors

The good faith and interests duty  Examples of breach (cont)  Sole director of a company diverts company assets to a new company the director has set up, sells the assets to the new company at an undervalue so that the original company is left with no assets only liabilities and the original company then goes into liquidation;  MD purchases shares in the company using mother’s share trading account, the price of the company’s shares goes up temporarily and he is able to claim a cash bonus (b/c his bonus was tied to the share price)

The good faith and interests duty  MD authorises a large payment to another company that he controls, where he knows it is not clear the payment is due, and:  he pushes through the decision to make the payment without debate or discussion at the board meeting;  there is a conflict of interest and nothing is done to protect the interest of the company from the conflict.

The good faith and interests duty  Using a power for an improper purpose is a breach of this duty. This means:  powers given to the board or others cannot be used for their own private purposes, e.g. Using the power to issue shares to create a new majority of shareholders over the old majority; or Changing contracts with employees or suppliers to discourage someone from buying the company.

Conflicts of interest  A lot of the examples above involve conflicts of interests between the director’s private interests and his or her duty to the company.  There are sections in the Companies Act and the SOE Act that specifically deal with conflicts of interest and the procedures a director must follow when there is a conflict. This will be covered in detail in a later training session.

Other duties specifically mentioned in the Act  Duty to comply with the Act  Duty to comply with the company rules  Duty not to disclose information or make use of company information unless in the interests of the company or required by law or in some other limited circumstances  Duty to prevent insolvent trading  Note a D can be personally liable for the company’s debts incurred after she or he fails to call a meeting to consider appointing a liquidator in certain circumstances

2 nd fundamental duty: the duty of care  Director must exercise or perform her or his duties with care, diligence, and skill that a reasonable person would exercise in the same circumstances.  The director must actively consider all decisions and cannot sit passively by and allow other directors to make inquiries and effectively make the decision

The duty of care  Director will be judged by what could reasonably be expected of a person in the director’s position; In other words, directors not required to exhibit a greater degree of skill than may be reasonably expected of people with the same degree of knowledge and experience in the circumstances

Duty of care  So for example, if a director is a lawyer, she or he would be expected to understand better the legal implications of what the company is doing;  But, while a director’s experience is taken into account, it is assumed a director will be reasonably informed about the company’s financial capacity

Examples of breaches of duty of care  Directors failed:  To monitor management;  Didn’t assess the company’s financial position properly  Didn’t ensure there was a proper system to provide accurate and reliable financial information  To maintain enough cash to allow for liquidity  Failed to employ a qualified finance director

Examples of breaches of duty of care  MD breached his duty of care by authorising the company to make misleading and deceptive statements to the stock exchange;  Directors breached duty by allowing the company to  overpay their directors’ fees  make two loans to another director where no rate of interest agreed or repayment terms, not in writing;  sold assets of the company and distributed the assets to shareholders and another director leaving the company insolvent

Examples of breaches of duty of care  Director:  approved a payment of a dividend when the company did not have any profits to pay a dividend;  Approved the company accounts knowing the profit included certain amounts but had not made proper inquiries as to whether the inclusion of these amounts would result in the accounts not providing a true and fair view of the company’s profit and loss

Directors of SOEs  Their duties are similar to the duties we have just been discussing – to act in good faith, in the best interests of the SOE and for a proper purpose;  Can’t allow the SOE to contravene legislation or rules  Must exercise, care, diligence and skill that a reasonable director would exercise in the same circs (2 specific obligations that would also be a breach of the care duty are also set out in the Act)  Must only use information for SOE purposes  Duty against conflicts and managing those conflicts

Duties of Directors Exercise