Legal Practice Briefing No. 7

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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