Directors are Warned of their Personal Risks

I recently attended the Australian Institute of Company Directors’ (AICD) briefing on the essential Directors’ Up-date. During this 3 hour briefing, members were given the heads-up on current issues facing company Directors. A good proportion of time was spent discussing the James Hardie case. The judgment against the Directors makes this a landmark case and one that is likely to be referenced for some time. For those unaware, the Directors of James Hardie that were embroiled in the 2001 Board meetings linked to a media release were both personally fined and excluded from becoming company Directors for varying lengths of time. The James Hardie case has drawn significant attention to director’s personal liability and the risks that Directors are carrying. The judge found the Directors had contravened numerous sections of the Corporations Act 2001, including key areas such as: 

  1. Breach of duty of care and diligence by director or officer (sec 180(1)).
  2. Breach of the duty to act in good faith (sec. 181 (1))
  3. Failure to keep accurate minutes in a timely manner (sec 251A (1) (6)) 

There are numerous lessons learnt from the James Hardie case. The ones that stand out are: 

  1. The directors’ duty of care cannot be delegated to co-directors, management or expert advice.
  2. Directors cannot rely on management’s advice in place of their own consideration of an issue which is within the board’s responsibilities.
  3. Directors should formally object if the issued board minutes do not reflect what accurately took place in the board meeting.
  4. Directors should not vote to pass a resolution unless they have properly reviewed and understood the terms of the resolution. 

One of the clear themes that came from the briefing was how vulnerable company directors have become. The James Hardie case serves only as a warning to practicing company directors. The issue is that there are more than 600 state and territory laws in Australia imposing personal liability in individual directors and officers for corporate misconduct. Gabrielle Upton, Legal Counsel at AICD, highlighted key findings from a survey of 600 directors from ASX-200 listed companies. The results of the survey showed that 78% of respondents considered there was a medium to high risk of being personally liable for decisions they or their boards made in good faith. Similarly, 78% believed that the risk of personal liability had caused them, or their board on which they sat, to occasionally or frequently take an overly cautious approach to business decision-making. The survey also highlighted the negative impact of personal liability on board retention and recruitment: 

  • 71% of respondents had declined the offer of a company directorship because of the risk of personal liability
  • 75% knew of other people who had resigned from a company directorship because of the risk of personal liability.  

These responses come from experienced board directors of public listed companies. What hope does the small business company director have a private company? The Corporations Act 2001 does not make special allowances for the size of the company. Small business owners are often poorly informed about the extent of personal liability imposed as company directors. Many of these companies are comprised of a small number of directors and are often governed more as a partnership than under a formal company board. Their legal structure, often advised by the tax accountant, is a corporation. The company constitutions are often never tailored to reflect the true decision-making processes of the partners. The tax accountant is likely to purchase a template from a legal ‘vending’ machine instead of customising the constitution. Where does this leave the small business director? 

From my own research it leaves the company directors of a small business terribly exposed and ill-informed. I would like to see a survey undertaken of small business company directors to test their knowledge regarding key aspects of the Corporations Act 2001 and see the results. It would not be a surprise to many of us if a large number would fail this basic knowledge test. The courts have demonstrated that ignorance, feigned or otherwise, is no defence in a legal case. Small business directors are often confronted with different issues to those of directors of public listed companies. These issues are often related to the lack of preparedness in governing the company under a proper board of directors. For instance I know of a number of company directors in small businesses who have been entangled in expensive oppression litigation under sections 232 and 233 of the Corporations Act. Oppression cases are more common than most people realise and are almost always related to shareholder and director disputes of private companies.

 The James Hardie case serves as a timely reminder for directors of private and public companies that as a director you are personally exposed. Pleading ignorance on the issues will not absolve you of any wrongdoing. The message is clear: if you are a director, then ensure you know the Law well; ensure you know what processes you need to follow if you are asked to make a decision at board level; and ensure you take total ownership for your decision-making.

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