While companies provide limited liability and are considered a separate legal entity, directors can become personally liable if they breach their duties.
These duties have become increasingly important in light of the recent financial downturn - in times of financial uncertainty, directors may be morelikely to make decisions for which they could be held liable.
The media have reported in depth lately on cases where the Securities Commission has taken proceedings against the directors of finance companies for misleading investors. Under the Securities Act, these directors face fines of up to $500,000 and up to five years imprisonment.
Directors therefore need to be aware of their obligations to the company.
A director's key duties are described in Part 8 of the Companies Act 1993 and include:
- The duty to act in good faith and in the best interests of the company
- The duty to use their powers for the purpose for which they were conferred and not for any ulterior motive
- The duty to act in accordance with the obligations under the Companies Act 1993 and the company's constitution
- That a director must not agree to cause, or allow the company's business to be conducted in a manner that is likely to create a substantial risk of serious loss. To determine this, the Court will look at what an 'ordinary prudent director' would have done in the circumstances.
- The duty not to take on any obligations unless it is believed on reasonable grounds that the company will be able to perform those obligations when required to do so.
- The duty to use the reasonable care, diligence and skill that a reasonable director would exercise in the circumstances.
Directors must actively ensure that they are meeting their obligations. The recent case FXHT Fund Managers Ltd v Oberholster held that directors who are not actively engaged in the company (so called 'sleeping directors') can be liable. In this case, the inactive director was held liable for a breach of his duty of care even though it was his co-director who defrauded investors. Initially, he was not aware of his co-director's dealings, but as soon as he became aware, he reported the matter to the authorities. However he was still liable.
Similarly, in Lewis v Mason and Meltzor, the directors relied on a manager and did not exercise sufficient control over the company's financial position or the day to day running of the company. It was found that reliance on a manager does not excuse a director from liability and the directors were ordered to contribute to the company's debts.
These cases demonstrate the need for directors to take positive steps to meet their obligations under the Companies Act, and ensure they are aware of and adhere to the duties imposed upon them.