Directors Duties: Duty of Care and Diligence

More on Directors Duties

Since our last edition of Directions, we have received further enquiries about directors duties and how best to ensure compliance with section 180(1) of the Corporations Act 2001 (Cth) – the obligation to exercise care and diligence in the discharge of a director’s duties.

For this reason, it worthwhile for us to consider further the either case in the proceeding of ASIC –v– Cassimatis (No 8) [2016] FCA 1023 (Cassimatis).

Further to our last Directions article on this topic, this proceeding is the eighth in a series of hearings concerning Storm Financial and breaches by its directors and shareholders, Mr and Mrs Cassimatis.

The decision of Justice Edelman considered and clarified the duties owed by directors under section 180(1).

With reference to the previous decision of Justice Ipp in Vrisakis –v– Australian Securities and Investments Commission (1993) 9 WAR 395, Justice Edelman outlined the three factors that go into the consideration of whether or not there has been a breach of section 180(1).

Those factors are: harm, balancing and interpretation of the section on whole.

1. Harm

His Honour considered that the notion of harm to a corporation is not to be construed narrowly and should be considered in the context of harm to any of the interests of the corporation, and not limited to the financial harm that a corporation may suffer.

In determining this, an account of the foreseeable risk against any potential benefit the company could have incurred must be balanced. This takes into account the inherent risk of business decisions, and does not automatically make a foreseeable risk a harm which should be attributable to the director as a breach. The mere risk (or outcome) of harm occurring does not automatically constitute a breach by a director.

Moreover, the Judge disagreed with submissions made by ASIC that in the event of an actual breach, the directors would be automatically in breach of their duties. His Honour emphasised that this would make the duty of a director one of strict liability, and section 180(1) was not such a provision.

However, harm to the reputation of the corporation will also be considered when assessing this factor of section 180(1).

In the case of Cassimatis, Justice Edelman found that the potential consequences and harm of the directors’ actions were so financially severe that they unquestionably threatened the existence of the company itself.

2. Balancing

The nature of running a business will often see the balance of two things; the inherent risks and challenges that the corporation must face in their decision making, and any potential injury such  risks could cause to the company’s business.

On this point, Justice Edelman reiterated that the test is not intended to be taken literally, in that it does not require that the potential benefit must outweigh the potential harm.

The test should be interpreted as assessing from the standpoint of what a reasonable person in the director’s shoes would have done at the time, not what a reasonable person should have done to avoid the injury with the benefit of hindsight.

3. Interpretation with reference to the terms of the section as a whole

In making a determination of the foreseeable risk of harm with the potential benefits reasonably expected, one must make the determination with reference to the perspective of the company’s circumstances and the responsibilities of the directors in those relevant circumstances.

In the case of Cassimatis, Justice Edelman considered that in light of the extent of the responsibilities and control Mr and Mrs Cassimatis exercised over the company, this consideration was especially relevant as a reasonable person in Mr and Mrs Cassimatis’ position (exercising that level of control) would have been aware of the foreseeable risk of the contravention which was not only financially dangerous but ultimately threatened the existence of the company itself.

Directors who are the sole shareholders of a company can still be held liable for breaches of their duties

According to Justice Edelman, the directors’ duties are not limited to the interest of the shareholders, but the company as a whole as a separate legal entity.

In making this decision, Justice Edelman did not accept the submissions from Mr and Mrs Cassimatis that as they were the sole directors and shareholders of the company, section 180(1) did not apply. You are not absolved from liability under section 180 (1) for your breaches as a director just because you are also a shareholder and you consented to the actions of the director.

The decision of Cassimatis is a good one for reinforcing the fact that a company is a separate legal entity, such that it is not just the grievances and prejudices of its shareholders that ought to be taken into account in ascertaining a breach of section 180 (1). The expansion of harm to include its reputation means that it is also the public interest that the duties are there to protect. In practice, the effect of this is that directors are held broadly accountable for their decision making.

Balancing the risks and benefits in decision making processes as a director can be difficult. We will continue to watch closely the changes to the law as cases are handed down on section 180 (1). If you are a business owner and you want advice on legal compliance of Board decisions or directors duties, please contact Peter North (Senior Associate, Corporate Practice Group) or Amanda Carruthers (Director, Insolvency Practice Group).