Directors’ ignorance of what happens in their companies in a breach of duty is no defence when things go wrong
D irectors are generally familiar with their duty to act with reasonable care and diligence. It resides in section 180 of the
Corporations Act 2001. In considering this duty, regard must be had to the surrounding circumstances.
However, it is not unusual for section 180 to act as a “catch-all” against directors. That is, if a director has breached another duty, then they have almost certainly also breached section 180 by doing so, thereby also exposing the company to a contravention of the law.
One species of care and diligence breach can be categorised as acting with ‘ information deficiency’. That is, making decisions or acting without the requisite information a reasonable person in their circumstances ought to require. So, does a director have a positive duty to make enquiries about their decisions?
First, company directors will be relieved to hear that there are special protections with this duty where responsibilities are delegated. At general law, because a director acts in a fiduciary manner towards the company, their duties cannot be delegated.
However, the law now recognises that business can place huge burdens on a director, and commercial reality demands directors rely on others.
Therefore, the general law rule is trumped by the operation of sections 198D and 190 of the Act. Barring anything contrary in the constitution of a private company, a director can delegate their powers, including to another director or employee of the company. The delegating director is then responsible for all of the actions of the delegate, except where the director, acting in good faith and after making the proper enquiries, reasonably believes the delegate is competent and reliable. If the delegating director is able to satisfy the court of this, then it acts as a shield.
Directors must take reasonable steps to guide and monitor company management. This generally means they must become familiar with the company, keep informed of its activities, attend board meetings, and understand its financial status.
However, as the NSW Court of Appeal held in Daniels v Anderson ( 1995), a further duty to ‘make enquiries’ can be enlivened: “if … directors know, or by exercise of ordinary care should have known, any facts which would awaken suspicion and put a prudent man on his guard, then a degree of care commensurate with the evil to be avoided is required, and want of that care makes them responsible.”
Therefore, there is an objective test for the positive duty to make enquiries.
This test was recently considered by Robson J in the colourful case of ASIC v Flugge & Geary (2016). This case considered whether two former directors of the Australian Wheat Board ( AWB) had breached their duties regarding AWB’s contraventions of United Nations resolutions by paying sham fees to Saddam Hussein’s Iraq.
Flugge was found to have breached his duty as he was aware of a complaint levied by the UN against the AWB, which should have been sufficient to awaken his suspicions. He was ultimately penalised $ 50,000 and was disqualified from managing a corporation for five years.
Whilst the Flugge case has unusual factual matrix that many Australian companies would rarely find themselves in, the case stands out as a firm reminder as to scope of a director’s duty to positively make enquiries.
Despite Flugge not being aware of any contraventions, he was still in breach of his duty to act with reasonable care and diligence.
The sentinel must be alert and curious, ready to jump into the trenches and satisfy themselves that nothing improper is taking place. Anything short of this may result in a civil penalty against the director who is asleep at their post.
“There is an objective test for the positive duty to make enquiries.”