Litigation and Dispute Resolution

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31 July, 2015

A recent Queensland Court of Appeal case reinforces the long-standing principle that directors must not let their private interests conflict with the fiduciary duties they owe to the company.

As was expressed by Lord Cranworth in the seminal case of Aberdeen Railway Co v Blaikie Brothers [1843-1860] All ER 249:

“…it is a rule of universal application that no-one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect.”

This equitable principle and the common law duty of directors to avoid conflicts of duty and interest and not take advantage of their position to secure a personal benefit* has been reinforced by the statutory duties set out in the Corporations Act 2001 (Cth) (the Act) which strictly prohibits directors from:

1. not exercising their powers and discharging their duties with a reasonable degree of care and diligence: section 180 of the Act;

2. not acting in good faith in the best interests of the company or for a proper purpose: section 181 of the Act;

3. using their position to obtain an advantage for either themselves or a third party, or to cause detriment to the company: section 182 of the Act;

4. improperly using information gained through their position as a director to obtain an advantage for either themselves or a third party, or to cause detriment to the company: section 183 of the Act. This obligation continues to apply even after a directorship ends.

The recent case of Jones and Ors v Invion Ltd and Anor [2015] QCA 100 (Invion) highlights the consequences of acting in breach of these statutory duties. Invion successfully brought proceedings against three directors who had, without authorisation, purported to act on behalf of Invion when they varied the termination provisions in their contracts. The variation conferred on each of the directors an entitlement to 12 months’ remuneration upon resignation. The directors deliberately withheld their conduct from the Board and resigned six months later, seeking payment in accordance with the variation. The Queensland Court of Appeal upheld the finding that the directors’ conduct was dishonest and ‘in dereliction of their duties as directors.’ Accordingly, they were ordered to pay compensation to Invion for breaching their statutory duties under sections 180, 181 and 182 of the Act.

Given the ramifications to directors of breaching their duties and their liability to account for any benefit received and to compensate the company for any damage suffered by the company, it is important to be mindful of the circumstances in which a conflict may arise and to be aware of some best practice guidelines that should be followed by directors to prevent such conflicts.

Circumstances in which conflicts can arise

The circumstances in which a conflict of interest can commonly arise include where a director:

  • will receive a personal benefit and/or profit (even if the company is unable to gain the advantage of the opportunity). Examples include where the director:
  1. has major shareholdings in the company that they are a director of or in a competing company;
  2. is involved in the potential purchase of an asset and is simultaneously managing the asset and has responsibilities to shareholders with regard to the sale of the asset;
  3. pursues personal opportunities discovered through information obtained through their directorship for personal gain.
  • is deciding their own remuneration, including an increase to their remuneration;
  • is a director of two (or more) competing companies. While directors are permitted to be a director of two (or more) competing companies, in these circumstances, a director:
  1. cannot disclose confidential knowledge obtained through their position as director of either company to the other; and o
  2. is not permitted to use their position as a director within a company to assist with the establishment of a competing company and should resign as a director from the former company before doing so;
  • enters into a contract with another company in which they hold an interest as either an employee, shareholder or director. This is permissible provided the company’s constitution authorises such a contractual arrangement and the interest is fully declared by the director;
  • holds multiple directorships. Directors in this position must ensure that they do not divulge confidential information between the companies. A misuse of confidential company information to gain a benefit or cause a company detriment may result in criminal action: section 184 of the Act;
  • is involved in negotiating a takeover and is making recommendations about offers which would confer financial rewards.

What should you do if a conflict arises?

Make full disclosure of material personal interests

As soon as a director becomes aware that there is a “real, sensible possibility of conflict”** between their personal interests and the company’s interests, a director must immediately declare their interests to the company.

Under section 191(1) of the Act, directors have a strict duty to notify other directors of their ‘material personal interest’ when a potential conflict arises unless there is an exception to disclosing that interest under section 191(2) of the Act.

All facts related to an interest must be declared at a directors meeting, including the nature and extent of the material interest and the relationship between the interest and company affairs.

The meaning of ‘material personal interest’ is not defined in the Act. However, in McGellin v Mount King Mining NL (1998) 144 FLR 288, Justice Murray held that a material interest “should be seen to have a capacity to influence the vote of a particular director upon the decision to be made.” Whether the interest is a material personal interest depends largely on whether the director has a beneficial interest (for example, by way of shareholding).

If you are a director and are not sure whether you have a conflict of interest, consider whether your interest is capable of affecting your ability to make an impartial decision. If so, then it is likely that you do have a conflict of interest and full disclosure should be made.

Can a director vote on a matter where they have a ‘material personal interest’?

This will depend on whether the director is a director of a proprietary company or a public company:

For proprietary companies: a director can vote, subject to the director fully disclosing the nature and extent of the interest before a directors meeting on the transaction. The director may also retain benefits under the transaction under section 194 of the Act.

For public companies: a director cannot vote. Under section 195 of the Act, the conflicted director of a public company must avoid attending the directors’ meeting while the matter is being considered or voting on the matter unless a resolution allowing the director to be present has been passed or an order has been made by ASIC.

Positive duty to prevent the transaction going ahead

In some circumstances, declaring that a conflict of interest may exist, may not, in of itself, be sufficient to fulfil a director’s fiduciary duty to promote the best interests of the company. The case of Adler v ASIC (2003) 179 FLR 1, highlights that a director in a “position of power and influence” may also have a positive duty to use their position to prevent a transaction going ahead in order to protect the company’s best interests:

  • In that case, a $10 million payment was made from a company of which Mr Adler was a non-executive director (HIH Insurance Limited) to a company of which Mr Adler was the sole director. Mr Adler had sought approval for the investment from HIH without informing the board of directors about the financial risk associated with the investment.
  • This obligation was also held to apply in Permanent Building Society (in liq) v McGee (1993) 11 ACSR 260 where a director of a company that was advancing a loan had knowledge about the borrower’s inability to service the loan, due to his substantial shareholding in the borrowing entity. The fact that the director disclosed his interest and abstained from voting at a board meeting did not mean that he was protected from liability for the loss. Instead, the director should have disclosed his knowledge about the financial incapacity of the borrower to repay the loan and the interest on the loan. As Justice Anderson held: “One word from him would have been enough. He should have done so. He could not escape from his continuing duty to act bona fide in the interests of society as a whole ‘by the simple expedient of leaving the room.’***

Ultimately, the positive action that must be taken by directors to prevent transactions going ahead will depend upon the level of involvement the director has had in the transaction and the “gravity of the possible outcome” that could follow for the company.****

Avoiding a conflict: best practice guidelines

To assist in avoiding a conflict of interest, directors can follow some best practice guidelines, including:

  • Formulating a conflict of interest policy: This will make it clear what procedure should be followed in the event of a potential conflict of interest.
  • Full disclosure by way of standing notice: From the outset of your appointment as a director, make full disclosure, by way of a standing notice under section 192 of the Act regarding any material personal interests you have. The standing notice should include:
  1. the nature and extent of the interest; and
  2. how the interest does, or may, in the future relate to the affairs of the company.

A register of all standing notices issued by directors should be maintained by the company secretary so that it can be referred to and circulated where appropriate.

  • Obtain the informed consent of the board: In the event of a potential conflict of interest, ensure that the informed consent of the full board of directors is obtained and that there has been a consideration by the board of whether the proposed transaction is of benefit to the company.
  • Don’t participate in decision-making processes where there is a potential conflict:
  1. Public companies: Directors of public companies should not participate in decision-making processes if their potential conflict of interest is to be discussed. For example, directors who have a potential conflict should communicate with the company secretary to ensure that documents relating to board meetings concerning the interest are withheld from them.
  2. Common directors: If a potential conflict exists between two companies with common directors, the common directors should not participate in the decision-making process of the board of directors regarding the facts in issue.

* Chan v Zacharia (1984) 154 CLR 178, 198-9

** Boardman v Phipps [1967] 2 AC 66, 124

*** Permanent Building Society (in liq) v McGee (1993) 11 ACSR 260, 290 (Anderson J).

****Fitzsimmons v R (1997) 23 ACSR 355; Adler v ASIC (2003) 179 FLR 1.

McCabes expertise

McCabes is experienced in advising and assisting companies, directors and company officers in respect of their corporate duties, conflicts of interest, exposure to personal liability, and corporate governance, particularly under the Corporations Act and the Australian Consumer Law.

This article was written by Andrew Lacey, Principal, Fiona Lymant, Senior Associate, Christina Kafalias, Associate, and Erin Turner Manners, Lawyer.

This article is not legal advice. It is intended to provide commentary and general information only. Access to this article does not entitle you to rely on it as legal advice. You should obtain formal legal advice specific to your own situation. Please contact us if you require advice on matters covered by this article.

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