Risk Management Part 1: Director's Duties.

Hi everyone and welcome to the Davidson Institute and Dentons’ webinar on risk management. Before we continue, we would like to acknowledge the Traditional Owners and pay our respects to all elders, past, present and emerging. My name is Renee Emzin and I am a proud Bundjalung woman, originally from the Gold Coast in Queensland. I work at Dentons and am currently completing a Juris Doctor at the University of NSW.

My name is Teeyanna Tapim-Savage I am a proud Bindal, Daurareb and Wagadagam woman from Townsville. I also work at Dentons in the Dispute Resolution team and have recently completed a Bachelor of Law and Arts at the University of NSW majoring in Indigenous Studies and Criminology.

This webinar is the first of a 2-part series on risk management and today we will be focusing on directors’ duties. The webinar will contain information that is applicable for organisations registered under the Corporations Act, the Corporations (Aboriginal and Torres Strait Islander) Act – we will be referring to this as the CATSI Act, and organisations which are registered with the Australian Charities and Not-for-Profits Commission which will be referred to as the ACNC.

In this webinar we will be considering: 1. What are directors’ duties? and 2. What can happen if someone does not comply with their directors’ duties, including insolvent trading? Before we begin, it is important for us to say that this webinar is not designed to provide legal or other advice. You should seek your own independent legal advice before taking any steps suggested within this presentation.

What are Directors’ Duties? Directors’ duties are obligations owed by directors to the company as a whole. Directors’ primary duties are owed to its members (being the company’s shareholders), but it can also be owed to other stakeholders, including employees, creditors and other funding bodies. Directors are ultimately responsible for the management of a company and have authority to act on behalf of a company. This is the reason that directors’ duties exist and why they are so important –

they are legal obligations which ensure that directors are accountable and act in the best interests of the company.

Who do these duties apply to? You don’t necessarily have to be formally appointed as a director, or be listed as a director on ASIC records, in order to be subject to directors’ duties. For example, under the Corporations Act, even if you have not been formally appointed as a director, you would still be considered to be a director if:

1. You act in the position of a director (generally referred to as a “de facto director”); or 2. The directors of the company are accustomed to acting in accordance with your instructions this is generally referred to as a “shadow director”. This can become an issue where individuals do not realise they are shadow or de facto directors. It is important to note that if you find yourself in a position where you are performing tasks that would be expected of a director or if directors of a

company are influenced or reliant on advice or instruction you may be considered a shadow or de facto director and as a result the director duties will apply to you.

To explain this a bit more we’ll go through two examples of a shadow director and a de facto director Alan is an elder and has lived and been in the community for many years. He has always been involved in the local footy club from when he was playing to coaching and now as a spectator Due to his longstanding involvement in the club and respect in the community it is common for the directors of the board to come to him for advice on the community and also with decision making Directors rely on

Alan’s advice and act on his recommendations. In this circumstance Alan would be considered as a shadow director.

Sue and her husband John live in a small regional town. Sue has been appointed to the director of the Aboriginal Health Service as a community member. Sue becomes unwell and during that time her husband John takes over her duties including regularly attending board meetings, exercising management roles, advising on decision making and generally acting as if Sue would in her role as a director.

In this situation although Sue is still appointed to the board John would be considered as a de facto director.

In addition, other officers of a company are bound by the same or similar duties to those of directors, these include company secretaries, and administrators, receivers and liquidators appointed to company. When we refer to “directors” in this presentation, those same duties apply to all of these officers, and de facto and shadow directors.

The various duties come from Corporations Act, the CATSI Act, the common law (being the law that is set out in judgments written by judges) and company constitutions. We will now discuss some of those duties.

The general duties of a director are set out in the Corporations Act. If there is any breach of these duties, a director may be liable for civil penalties and in some circumstance criminal penalties. These are the critical duties for directors to understand.

The first one is care and diligence A director must exercise their powers and duties with the degree of care and diligence that a reasonable person would in their position. To do this a director would need to ensure that: a. the decision is made in good faith for a proper purpose; b. the director does not have a material interest in the subject matter of the decision meaning there is no conflict of interest between the company and the director;

c. the director made an informed decision, and this would include seeking appropriate professional advice; and d. the director rationally believes that the decision is in the best interests of the company. This 4-step process I just mentioned is also featured in the CATSI Act and the ACNC regulations. We will explain this in further detail, in just a bit.

Good faith Directors must exercise their powers and duties in good faith in the best interest of the company and for a proper purpose. An example of this is if a director or directors of a company that operates an established medium sized electronic retail business decides to expand the business to the production of food products. Without the appropriate market research, this type of action would be viewed as the directors not managing or conducting business in the best interest of the company

and not considering the type of company or size. This is because it is outside of what the company was designed or created to do and would be contrary to the company’s constitution.

Use of position Directors must not improperly use their position to gain advantage for themselves or someone else or to cause detriment to the company. A case study: So essentially directors must act in the best interest of the company, and not obtain some type of personal benefit. An example would be directors contracting work to a family member or a company owned by the directors, without notifying the other directors.

Use of information Directors must not use any information obtained through their position to gain advantage for themselves or someone else, or cause detriment to the company. This duty is very similar to the example we just talked through, this duty is again around getting a personal benefit from a position of power, or from the information that was only gained through that position as a director.

An example would be if a director, we’ll call him Alan, owns shares in a fishing company, we’ll call that company Fish Co. and acted as a director for an oil company which we’ll call Oil Co. Whilst acting as a director, Alan obtains information that there was an oil spill which would cause considerable damage to the ecosystem and fish population which are relied on by Fish Co. On finding out this information Alan sells his shares. This would be in breach of Alan’s directors’ duties, as he acted

on information obtained from his position as a director.

The 2 key elements in relation to use of position and use of information that we want to bring to your attention is as a director you must: 1. Disclose to the other directors when there is a conflict of interest and 2. Remember to always act in the best interest of the company.

If a director does not meet the above requirements, the directors’ can be personally liable, including for losses which flow from the breach of those duties. The following are examples of what the court can order if a director is found to have breached their duties: - A monetary fine; - A disqualification order to disqualify a director from managing companies; and - A compensation order to compensate the company for damage suffered by the company.

Directors’ can also be criminally liable if: - They are reckless or dishonest when acting as a director. Directors’ must not intentionally or recklessly use their position or information obtained through their position to gain advantage for themselves or for others, or cause detriment to the company; and - If they fail to prepare accurate financial accounts. If a director is found to be criminally liable, they may be fined or imprisoned for up to five years or in some cases both.

Directors should also be aware of other areas of law which impose obligations on directors. Examples include: Securities Law, Insolvency Law which we’ll talk about in more detail a little bit later, Health and Safety Law, and Environmental Law. For example, Directors’ may be liable if a company contravenes laws, like breaching Workplace Health and Safety laws. Depending of the type of company, different areas of law may be more applicable.

However, it is a director’s responsibility to ensure that they are across all the relevant areas and that they and the company are not in breach of those laws. It is also important to remember that laws can differ from state to state so directors’ must be aware of the differences in legislation. This of course may be more relevant for a company which operates in different states.

For those that may not know, the CATSI Act is legislation which is a law passed by parliament that was introduced by the Commonwealth as a special measure for the benefit of Aboriginal and Torres Strait Islander people, and it regulates the operation of certain companies registered under that Act. If you would like to know about the differences between registering a company under the CATSI Act or the Corporations Act

please visit the Davidson Institute website and watch their webinar ‘Expert’s Angle: Strategies for Successful Businesses.

While the CATSI Act is based on the Corporations Act, the purpose of the CATSI Act was to take into consideration the needs and circumstances of Aboriginal and Torres Strait Islander peoples. For our listeners that are directors of businesses that are registered under the CATSI Act this section applies to you.

The Duties under the CATSI Act: We have briefly discussed these obligations but so you are aware, under the CATSI Act there are 5 key directors’ duties: Duty of care and diligence. This means that directors take their responsibilities seriously and are interested in what’s happening in their organisation and are well prepared to make decisions.

Some examples of things directors can do to demonstrate that they are across their organisation’s include: 1. following their organisation’s rule book; 2. attending directors’ meetings, arriving on time and coming prepared for the meeting; and 3. knowing their organisation’s financial position. A breach of this duty may result in a civil penalty but not criminal liability.

Duty of good faith This means that directors and other officers must be honest and loyal in their dealings with each other and with the organisation and must act in the best interest of the company. A breach of this duty may lead to a civil penalty and or criminal liability if the breach is reckless or intentionally dishonest.

The duty to not improperly use position or information Directors, and other officers and employees must not misuse their position, or information gained from their position, to benefit themselves, someone else or to cause harm to the organisation. For example, a director, officer or employee of a company must never pass on personal details about members to other people or provide information that might be detrimental to the company.

A breach of this duty may lead to a civil penalty or criminal liability if the breach is reckless or intentionally dishonest. The duty to disclose material personal interest Directors must tell each other their personal interests in matters relating to the affairs of the organisation. Essentially, a director must declare any conflicts to the other directors. And a breach of this duty may result in a criminal penalty.

The duty not to trade while insolvent Directors must not allow their corporation to trade when it does not have enough money to pay its bills when they fall due. We will be talking a bit more about insolvency in just a bit. As you can see much of what is outlined in the CATSI Act was also addressed in the Corporations Act.

When a duty is breached the consequences will depend on the nature of the duty and the seriousness of the breach. Examples of potential consequences are: • Action by the organisation—the organisation can take its own action to remove the person involved in the breach. The organisation can also take its own civil action to recover compensation for any loss.

• Civil penalty proceedings by the Registrar—this happens if a person breaches a civil penalty provision, for example, if a director fails to exercise reasonable care and diligence in carrying out their duties. The penalty will depend on the seriousness of the breach. • Disqualification—a director can be disqualified by a court for a breach of a civil penalty provision and in some circumstances a person may be automatically disqualified from a director or officer position, if they:

have been convicted of certain serious criminal offences including fraud; or are bankrupt.

• Criminal prosecution—a breach of certain duties may attract criminal prosecution and heavy penalties. Where a criminal penalty applies, the person may be fined and/or sentenced to imprisonment.

Directors’ duties under the company’s constitution It is important for a director to understand the company’s constitution documents, as these may also set out duties and obligations of a director. Those documents will generally address, among other things: 1. How directors are appointed 2. The powers and duties of directors 3. If there are multiple directors, how one or more of those directions may have powers to act on behalf of the company

4. Procedures for issuing and transferring shares in the company and 5. Rights and duties of members – members being shareholders, including as to whether shareholders’ consent is required in order for directors to take certain actions.

The Australian Charities and Not-for-Profits Commission (ACNC) is the independent national charity regulator in Australia. The following discussion is applicable if your organisation is registered as a Charity or a Not-for-Profit. The ACNC has similar duties for Responsible Persons as the Corporations Act and the CATSI Act. Responsible Persons are considered to be the directors.

If you are a director of a Not-for-Profit registered under the ACNC, the ACNC Governance Standards impose similar duties on directors to those set out in the Corporations Act. These include: • Acting with reasonable care and diligence; • Acting honestly and fairly in the best interest of the charity and for its charitable purposes; • Not misusing their position or information they gain as a responsible person; • Disclosing action or potential conflicts of interest;

• Ensuring that the financial affairs of the charity are managed responsibly; and • Not allowing the charity to operate while it is insolvent. As you can see, again there is overlap between the Corporations Act, CATSI Act and the ACNC Governance Standards. The ACNC also have additional reporting requirements, which require that the ACNC registry be updated when there is a change to the charity’s Responsible Persons.

Insolvent Trading As mentioned before, directors have a duty to prevent the company from trading if it is insolvent. A simple definition of insolvency is usually that a company is unable to pay its debts when they fall due. This means that before you incur a new debt on behalf of the company, you must not be aware of any reasonable grounds for suspecting that the company is insolvent at the time or would become insolvent as a result of incurring that debt or entering into that transaction.

The Corporations Act also adds a “reasonable person test”, meaning that a reasonable person in your position would not have had reasonable grounds for suspecting that the company was insolvent or would become insolvent. In other words, ignorance is not a defence, and that you must ensure you understand the company’s financial position at all times, to the extent that a reasonable person would in your position.

If you breach your duty and the organisation is trading whilst insolvent, then you can be personally liable for the debt that the organisation has incurred while insolvent. You may also be disqualified from managing a company. The analysis of whether a company is solvent or insolvent at any point in time can be very complex, and in legal proceedings it is usually necessary for expert accountants to provide evidence in relation to solvency.

If you have any concerns that your company might be insolvent, you should immediately seek advice from an accountant and a lawyer. In some circumstances, you may be able to defend a claim against you for insolvent trading if you can demonstrate that you sought professional advice at an early stage this is known as the “safe harbour” defence.

Case Study of insolvent trading John was the sole director of a building company called John’s Construction Company Pty Ltd. In August 2013, John entered into a contract on behalf of John’s Construction Company with a demolition company for demolition services costing $345,000. The demolition service was provided and a debt was incurred by John’s Construction Company and payable within 30 days of the demolition.

The demolition company was never paid and obtained a judgement against John’s Construction Company. The demolition company then issued winding up proceedings against John’s Construction Company, which led to a liquidator being appointed. The liquidator appointed to the company sued John for insolvent trading. The liquidator claimed that at the time the company entered into the demolition contract, John knew, or had reasonable grounds to suspect, that the company was insolvent

or would become insolvent as a result of the demolition contract.

Some potential outcomes in this situation might be: 1. The liquidator might be able to demonstrate that John knew, or should have known, that the company was insolvent when it entered into the demolition contract. He might be able to do this by showing that the company already had overdue debts owing before the contract was entered into, or that John was aware of future cash flow difficulties which would mean that it would not be possible to pay the demolition costs on time.

Without any valid defence, John may ultimately be personally liable to repay the $345,000 demolition debt probably along with interest and costs, even though that debt was incurred by the company.

2. John might also be able to demonstrate that the company was in fact solvent at the time he entered into the demolition contract, and that it was another subsequent event that caused the company’s problems example. a significant customer went into administration and could pay amounts owing to John’s Construction Company.

3. John might also be able to defend the liquidator’s claim if he could demonstrate that at an early stage he sought advice from an expert insolvency accountant, and that John acted in accordance with that advice, even though the company was not able to turn around its position this is the “safe harbour” defence.

Key Takeaways Directors’ are crucial to the management and overall success of a company. Directors’ duties are important to ensure that directors act in the best interests of the company. It is important to take the role of director seriously and also be aware of what is required and expected from a director. Breaching director duties can incur costly personal liabilities.

We have now come to the conclusion of part 1 of our risk management webinar. To recap, we hope that moving forward you will now critically think about: • the directors’ duties under the Corporations Act, the CATSI Act and also the ACNC • the potential consequences for breaching your duties as a director; • what insolvent trading is and the potential liabilities involved; and • the importance of seeking advice from an accountant or lawyer if you have any concerns about your obligations

as a director, and the company’s position more generally.

Please tune in for part 2 of the Davidson Institute and Dentons’ Risk Management series where we will be discussing conflicts of interest.

If you require any further assistance with what we have discussed today, please feel free to contact our Indigenous lawyers in our Indigenous Business Practice at Dentons to request legal advice at a reduced rate for Indigenous businesses.