Navigating Director Duties - what if problems arise?
As outlined in a previous insight, directors must comply with various duties imposed upon them, in addition to their Company’s constitution and relevant legislation.
What happens if issues arise?
Directors must take steps to actively comply with their obligations. When a company enters troubled waters, a careful and considered assessment of the company's position is required.
By way of example, Don is the sole director of his company. Don recently entered into a large transaction unconditionally, without organising finance. He assures the other party that he will have no trouble meeting the repayments. However, Don is not sure what the company’s financial position is, but has noticed cash flow is low because he is struggling to pay his subcontractors. Don checks the business accounts and discovers that the Company is regularly exceeding its overdraft limit each month. He is not too concerned as no action has ever been taken and is hopeful the market will shift to allow him to pay both existing debts as well as payments under the new agreement as they fall due.
It is clear Don is aware the company is facing financial difficulty. The Court of Appeal in Mason v Lewis held that directors must take proper steps to place themselves in a position to guide and monitor the management of the company. Don cannot simply ignore these obligations and places the company at risk by doing so. He needs to consider the financial position in addition to other factors (environmental, social and governance matters) when decision making, to enable him to best make decisions that he believes are in the best interests of the company.
It is questionable whether Don’s actions to enter into another agreement with significant financial ties when he is unsure if he will be able to make the repayments is likely to create substantial risk of serious loss to the company’s creditors. The court in Fatupaito v Bates emphasised that this duty is stringent, with directors needing to carefully scrutinise the financial position to determine whether pre-existing debt and future obligations are likely to be met.
As maintained in the case of AWA Ltd v Daniels, as Don is a director, he has a continuing obligation to keep informed about the company and maintain familiarity with his company’s activities and finances. It is important that Don does not turn a blind eye to warning signs and proactively deals with problems as they arise.
If Don’s company is eventually liquidated and it is found Don has breached his duties owed to the company, the creditors can apply for an order for Don to personally pay money or return property to the company. For more serious breaches, s 138A of the Companies Act 1993 introduced criminal liability for directors acting in bad faith. If Don continues to disregard his duties and is found to be in serious breach of his duty to act in good faith and in the best interests of the company, he could be liable to be convicted for a term of imprisonment not exceeding five years or to a fine not exceeding $200,000.00.
It is important if you are a director that you are alert to the realities of what is happening in your company, to enable you to comply with key duties and responsibilities. Compliance with the director duties will ultimately assist in the success of your business. If you are thinking about becoming a company director or are already a company director and want to discuss these obligations and how they might impact you, please contact us on 03 379 3880.