Directors' duties and what the Corporations Act requires of you

Directors of Australian companies owe a set of legal duties that sit above their day-to-day decisions. Most come from the Corporations Act 2001 (Cth) (the Act), and they apply personally: when a director breaches one, the company does not wear the loss alone. The director can be ordered to pay a civil penalty of up to $1.65 million, compensate the company or its creditors from their own pocket, be disqualified from managing companies, and in cases of dishonesty face up to 15 years in prison.

Because the duties bite in ordinary, unglamorous situations, many directors only learn they were in breach when a creditor, a liquidator or ASIC comes calling. This article sets out who owes the duties, the five core obligations, what a breach can cost, and the practical steps that keep a director on the right side of the Act.

Who owes directors' duties

Directors' duties are owed by every director and every officer of a company. That sounds straightforward, but the Act's definitions reach further than most people expect.

Under s 9AC of the Act, a director includes anyone appointed to the position, regardless of the title on the business card. It also catches two groups of unappointed people: those who act in the position of a director (de facto directors) and those whose instructions or wishes the board is accustomed to follow (shadow directors). An investor, a founder who has left the register, or an adviser who effectively runs the show can therefore owe the duties even though they were never formally appointed.

The definition of officer in s 9AD is wider again. It includes a company secretary and anyone who makes decisions that affect the whole or a substantial part of the business, or who has the capacity to significantly affect the company's financial standing. Senior managers who do not sit on the board can be caught.

The duties attach from the moment a person is appointed or starts acting in the role, and some continue after they leave. There is no size threshold: the same duties apply to the sole director of a two-person cafe company as to a listed board. Directors must also hold a director identification number, applied for under s 1272A, which stays with them for life.

Care and diligence

Section 180(1) of the Act requires a director or officer to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they were a director of a company in that company's circumstances, and held the same office with the same responsibilities.

The test is objective but context-sensitive. A part-time non-executive director of a small company is measured against what a reasonable person in that position would do, taking into account the company's size, how responsibilities are distributed across the board and what has been delegated to management.

The business judgment rule in s 180(2) protects directors who make a considered decision. A director who makes a judgment in good faith for a proper purpose, informs themselves about the subject matter to the extent they reasonably believe is appropriate, has no material personal interest in it and rationally believes it is in the company's best interests is taken to have met the duty. The rule rewards being informed and documented; it does not protect a director who signs off on something they have not looked at.

In practice, breaches of this duty usually involve failing to inform yourself before a decision, or failing to monitor the company's management and finances over time.

Good faith, the company's best interests and proper purpose

Section 181(1) of the Act requires directors to exercise their powers and discharge their duties in good faith, in the best interests of the corporation, and for a proper purpose. This is the duty that is sometimes loosely described as acting "in the company's interests", and it is a civil obligation rather than a criminal one on its own.

Good faith means acting honestly rather than with an eye to personal advantage. The best interests of the corporation are judged by reference to the company as a whole, and in a financially troubled company that can mean having regard to creditors' interests as well as shareholders'. Acting for a proper purpose means using a power for the reason it was given: issuing shares to raise capital for the business, for example, rather than to dilute a fellow director you disagree with.

Where a director acts dishonestly or recklessly in these areas, the conduct can be prosecuted as a criminal offence under s 184, which carries a maximum of 15 years imprisonment.

No improper use of position or information

Sections 182 and 183 of the Act prohibit a director, secretary, officer or employee from improperly using their position, or information obtained through their role, to gain an advantage for themselves or someone else, or to cause detriment to the company.

The prohibition is broad. Diverting a business opportunity to a family company, using confidential customer lists to set up a competing venture, or awarding contracts to an entity the director controls are all classic examples. It does not matter whether the advantage or detriment actually eventuated; the improper use itself is the breach.

Unlike most of the duties, the information duty in s 183 continues after the person stops being a director or officer. A former director who uses confidential information from their time on the board remains exposed. The dishonest or reckless versions of these duties are criminal offences under s 184 with the same 15-year maximum.

Disclosing material personal interests

Section 191 of the Act requires a director who has a material personal interest in a matter that relates to the company's affairs to give the other directors notice of the interest. The notice must be given at a directors' meeting or to the other directors individually, and the director should also check whether the company's constitution or the Act restricts how they participate in or vote on the matter.

A material personal interest is one that could influence how the director votes or acts on the matter. A director's own financial interest qualifies, and so can an interest held through a family member or an entity the director controls. The Act sets out limited exceptions, such as an interest that arises only from the director's remuneration, or an interest the director holds in common with all members.

Rather than notifying afresh each time, a director may give a standing notice under s 192 setting out the nature and extent of an ongoing interest. Failing to disclose is itself an offence carrying a penalty of 30 penalty units, or $9,900, quite apart from any other consequences of the conflicted decision.

Preventing insolvent trading

Section 588G of the Act makes directors personally liable for insolvent trading. The duty is engaged when three things are true at the time the company incurs a debt: the person is a director, the company is insolvent or becomes insolvent by incurring that debt, and there are reasonable grounds for suspecting that the company is insolvent or would become so.

Solvency is defined in s 95A: a company is solvent only if it is able to pay all its debts as and when they become due and payable. That is a cash-flow test, not a balance-sheet one. A company with healthy-looking assets but no cash to pay its suppliers, staff and tax as they fall due can be insolvent. A temporary shortfall is not necessarily insolvency, but persistent or structural cash-flow problems are a warning sign.

A director contravenes the duty if they were aware of the reasonable grounds for suspecting insolvency, or if a reasonable person in their position would have been. The Act provides defences in s 588H:

Reasonable expectations: the director had reasonable grounds to expect, and did expect, that the company was solvent and would remain solvent.
Reliance on a competent person: the director reasonably believed that a competent and reliable person was providing adequate information about the company's solvency, and relied on that information.
Illness or non-involvement: the director did not take part in the company's management because of illness or another good reason.
Reasonable steps: the director took all reasonable steps to prevent the company from incurring the debt, which can include taking action to appoint an administrator or restructuring practitioner.

If the duty is breached, the director can be ordered to compensate the company for the loss suffered by unsecured creditors, and dishonest insolvent trading is a criminal offence.

What a breach can cost

The duties in ss 180 to 183, 191 and 588G are civil penalty provisions, which brings them within the enforcement machinery of Part 9.4B of the Act. ASIC can seek a court declaration of contravention and then orders for:

A pecuniary penalty: up to 5,000 penalty units for an individual, which is $1.65 million at the current $330 penalty unit, or 50,000 penalty units, $16.5 million, for a body corporate, or three times the benefit obtained if that is greater. For companies the penalty can also be up to 10% of annual turnover.
Compensation: payment to the company for loss or damage caused by the breach. In insolvent trading cases the compensation goes toward the debts owed to unsecured creditors.
Disqualification: the court can disqualify the director from managing corporations for a period it considers appropriate under s 206C.

Where the conduct involves dishonesty or recklessness, criminal liability follows: up to 15 years imprisonment under s 184, or for dishonest insolvent trading under s 588G. A breach can also be enforced against a director personally by a liquidator, which is how many directors first discover the true cost of the duty.

A compliance checklist for directors

A director who wants to stay on the right side of the Act can work through this practical checklist:

Know your role: confirm whether you are a director or officer, including in a de facto or shadow capacity, and hold a director identification number.
Stay informed: read board papers, financial reports and management accounts before meetings, and ask questions until you get answers.
Document decisions: record the information considered and the reasoning behind significant judgments so the business judgment rule can protect you.
Disclose interests: notify the other directors of any material personal interest as soon as it arises, or give a standing notice under s 192.
Watch the cash: keep a rolling view of debts coming due and available cash, and treat persistent shortfalls as a red flag rather than a cash-flow hiccup.
Get advice early: if solvency is in doubt, take advice on restructuring options, administration or the safe harbour from breach of duties in Subdivision C of Part 5.7B before further debts are incurred.

When to get legal advice on directors' duties

Several of these obligations involve judgment calls that an article cannot make for you. A lawyer can help with:

Solvency assessments: whether the company meets the s 95A test, what records to keep, and how close the reasonable-grounds threshold is.
Decision-making processes: setting up board procedures, delegations and information flows that satisfy s 180 and protect the business judgment rule.
Conflict situations: assessing whether an interest is material, drafting standing notices, and structuring transactions so the company's approval is properly obtained.
Enforcement and recovery: responding to an ASIC investigation or a liquidator's demand, defending a claim, and checking whether any directors' and officers' insurance actually responds.
Restructuring: when the company is struggling, advice on the options short of liquidation, including administration and the defences in s 588H.

Artificer Legal advises directors and businesses across Australia on corporate governance and directors' duties. If you are facing a potential breach, or want to review your board's practices before a problem arises, contact us.

The duty that most often catches directors out

The duty that most often surprises Australian directors is not the one about conflicts or good faith; it is the duty to prevent insolvent trading. It turns a business failure into a personal liability because it attaches to debts the company incurred while cash flow was failing, and because it can be enforced against the director personally by a liquidator even when the company itself has nothing left.

The first action to take this week is simple: review the company's current cash position and the debts coming due in the next month, and satisfy yourself that they can be paid as and when they fall due. If they cannot, or you are not sure, treat that as a trigger to take advice before the next debt is incurred, not after.