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Australian Government Solicitor

 

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Legal Practice Briefing

Number 7

20 October 1993

DIRECTORS' DUTIES AND RELATED PARTY TRANSACTIONS

The Corporate Law Reform Act 1992 made changes to the Corporations Law relating to the directors' duty of care and diligence, related party transactions, and sanctions for contraventions of certain key directors' duties.

Care and Diligence

In Re City Equitable Fire Insurance Co Ltd, Romer J observed that a director is obliged to take '"reasonable care" to be measured by the care an ordinary man might be expected to take in the circumstances on his own behalf'. His Honour then went on to observe:

'A director is not bound to give continuous attention to the affairs of his company. His duties are of an intermittent nature to be performed at periodical board meetings, and at meetings of any committee of the board upon which he happens to be placed. He is not, however, bound to attend all such meetings, though he ought to attend whenever, in the circumstances, he is reasonably able to do so'.

This statement of general principle has found itself incorporated into company law at Corporations Law subs 232(4). Before its amendment on 1 February 1993 by the Corporate Law Reform Act 1992, this sub-section provided that 'An officer of a corporation shall at all times exercise a reasonable degree of care and diligence in the exercise of his or her powers and the discharge of his or her duties'.

This formulation raised the question: what is the reasonable standard of care and diligence required of an officer? Sub-section 232(4) now answers that question, providing that:

'In the exercise of his or her powers and the discharge of his or her duties, an officer of a corporation must exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporation's circumstances'.

The words 'in a like position' are intended to allow the court to consider the distribution of functions among members of the Board (for example, between executive and non-executive directors) and any special expertise that a particular director might possess (for example, a geologist on the board of a mining company). The words 'in the corporation's circumstances' are intended to allow the court to have regard to any special circumstances surrounding the corporation (for example, its solvency).

One concern raised in the public consultation on the amendment was that courts might apply hindsight to honest and reasonable decisions which, in the light of later events, turn out to be commercially ill-advised. The Second Reading Speech and the Explanatory Memorandum refer to Harlowe's Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL, in which the High Court said that it would not review fair and reasonable decisions that were taken by directors.

Financial Benefits To Related Parties

The Corporate Law Reform Act 1992 inserted into the Corporations Law a new Part 3.2A entitled 'Financial Benefits to Related Parties of Public Companies'. Part 3.2A provides that a public company, or a child entity of a public company, may not give a financial benefit to a related party of the public company, unless the benefit falls within one of a number of exceptions. The key concepts are therefore 'child entity', 'related party', and 'financial benefit'.

Child Entity

The child entity of a public company is any entity over which the public company exercises control. The concepts of 'control' and 'entity' are defined by reference to Approved Accounting Standard AASB 1017, which defines 'control' and 'entity' as follows:

Control means the capacity of an entity to dominate decision making, directly or indirectly, in relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in pursuing the objectives of the controlling entity.

Entity means any legal, administrative or fiduciary arrangement, organisational structure or other party (including a person) having the capacity to deploy scarce resources in order to achieve objectives.

Related Party

The Part defines 'related party' in a way that focuses on persons who may be able to influence the decision to give the benefit. The simplest case is a benefit given by a company to one of its directors. The following are also 'related parties':

  • any entity that may exercise control over the public company, such as its holding company (referred to as a 'parent entity' of the public company);
  • the directors of a parent entity;
  • the spouse (including a de facto spouse) of a director of the public company or a parent entity;
  • a parent, son or daughter (but not any remoter family) of any such director or spouse; or
  • any entity over which the above people (or entity) have control.

A person will also be a related party now if the person was a related party in the previous six months, or if the person reasonably expects to become a related party.

Where a financial benefit is provided to an associate of a related party, in the expectation that a person will give a corresponding financial benefit to a related party of the public company, the associate will be a related party for the purposes of the new Part.

A child entity of a public company is not a related party of the public company. The Part does not therefore affect transactions between a public company and its child entity (unless the child entity is a public company that is not a wholly-owned subsidiary). Similarly, the Part does not affect transactions between the various subsidiaries of a public company.

Financial Benefit

The expression 'financial benefit' is defined in the broadest of terms to include the giving of any benefit, even if adequate consideration has been given.

Exceptions

The prohibition on giving financial benefits to related parties of the public company is subject to the following exceptions:

  • benefits approved at a general meeting of the company's fully informed disinterested members;
  • benefits provided on the same terms and conditions as would be provided to an unrelated party;
  • benefits provided to related parties as part of a proposal to provide benefits to members of the company (provided the proposal does not unfairly discriminate in favour of related parties);
  • the payment of reasonable remuneration;
  • advances totalling less than $2,000 (or such other amount as is prescribed);
  • intra-group benefits given to or by a 'closely-held subsidiary' (a company in which another company controls 100% of the voting shares);
  • benefits required to be given under a contract made before the Part first applies to the public company; or
  • benefits required to be given pursuant to a court order.

Commencement and Transitional Provisions

The Part does not become compulsory until 1 February 1994. This allows all companies a lengthy period to prepare for the new requirements and to bring any necessary resolutions before an annual general meeting.

The Corporate Law Reform Act 1992 amended Corporations Law s 234 to confine its effect to public companies. Section 234 will be repealed on 1 February 1994, when Part3.2A will commence to apply to all public companies.

Sanctions

A person who receives a benefit contrary to Part 3.2A contravenes Corporations Law subs 243ZE(2). A person who is involved in that contravention contravenes Corporations Law subs 243ZE(3). Sub-sections 243ZE(2) and (3) are civil penalty provisions. The sanctions for contravention of a civil penalty provision are considered below. Corporations Law subs 243ZE(6) provides a defence where the defendant was not aware of a fact or circumstance essential to the contravention. Neither the public company nor the child entity commits an offence because of the contravention.

The rules established by Part 3.2A have effect despite anything in the Corporations Law, any other law or a company's constitution. Moreover, compliance with the new Part does not relieve a person of any other duty the person might have. This means that even though a proposed transaction might not be contrary to Part 3.2A, consideration should nevertheless be given to whether the transaction contravenes any other provision of the Corporations Law.

Civil Penalty Orders

The Corporate Law Reform Act 1992 inserted into the Corporations Law a new Part9.4B entitled 'Civil and Criminal Consequences of Contravening Civil Penalty Provisions'.

Part 9.4B applies where a person has contravened a 'civil penalty provision'. The expression 'civil penalty provision' is defined to mean the following provisions of the Corporations Law:

  • the company officer's duties of honesty, care and diligence and not to make improper use of the office or information acquired through the office-s 232;
  • the related party transactions provisions considered above subss 243ZE(2) and (3);
  • the director's duty to take all reasonable steps to ensure that the company complies with the provisions of the Corporations Law relating to the preparation of financial statements subs 318(1); and
  • the director's duty to prevent the company from incurring further debts if he or she suspects the company is insolvent subs 588G(1).

Where the Court finds that a person has contravened a 'civil penalty provision' it must make a declaration that the person has contravened the civil penalty provision. The Court may then order that the person pay a pecuniary penalty of up to $200,000 to the Commonwealth. The Court may impose a pecuniary penalty only if it is satisfied that the contravention is serious. Further, the Court may not impose a pecuniary penalty if a court has already made an order for punitive damages. The Court may also disqualify the person from managing a corporation for such period as it thinks fit. However, the Court may not make a disqualification order if it is satisfied that the person is a fit and proper person to manage a corporation.

An application for a civil penalty order will be tried using the civil rules of evidence and procedure and standard of proof.

A person who contravenes a civil penalty provision with a dishonest intent commits an offence punishable by a maximum fine of $200,000 or five years jail, or both.

Once an application has been made for a civil penalty order, a prosecution may not be commenced in relation to the same contravention. Subject to limited exceptions, nor may an application for a civil penalty order be made once a prosecution has been commenced in relation to a contravention of a civil penalty provision. In general terms, where the prosecution ends otherwise than with a conviction, the criminal courts may nevertheless make a civil penalty order in relation to the person.

The company in relation to which the person contravened the civil penalty provision may apply to the court for a compensation order. Similarly, on the hearing of an application for a civil penalty order, or on the conviction of a person for an offence constituted by a civil penalty provision, the court may order the defendant to pay compensation to the company.

ISSN 1448-4803 (Print)
ISSN 2204-6283 (Online)

The material in this briefing is provided for general information only and should not be relied upon for the purpose of a particular matter. Please contact the Legal Practice before any action or decision is taken on the basis of any of the material in this briefing.

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