Company director’s duties: New obligations

26 September, 2014 | Peter Smith

Company directors need to know and understand their duties and obligations regardless of the size and nature of the company. Directors can be personally liable if they breach their directors’ duties, and ignorance of the law is no defence.

New changes to the Companies Act will increase the obligations on directors. The courts are also taking a tougher line on less diligent directors as the recent cases involving finance companies have shown.
The current duties of a company director are set out in the Companies Act (Sections 131 to 138).

Directors have to act in good faith, and in the best interests of the company. They have to take into account the interests of all relevant parties — shareholders, creditors, and the staff.

What’s in the best interests of the company is always a matter of judgement. Exercising judgement is what directors are paid to do, using their experience and knowledge, and taking into account the views of the other directors.

All decisions have to comply with the Companies Act (and the constitution of the company), and the activities have to be for a “proper purpose.”

The company cannot trade “recklessly”, that is, to carry on business when the directors know that there is “substantial risk of a serious loss to the company’s creditors” from continuing in business.

Directors have what’s called a “duty of care’, which means that they have to exercise a level of skill, diligence and care that is reasonable in the circumstances.

All of these matters are open to interpretation, but the courts have made it clear that directors are required to do a bit more than just sign off the accounts and reports on the workings of the business as presented to them.

Directors are required to be the guardians of the company, and they have an obligation, legal and moral, to be good stewards of the company’s resources and reputation.

They are entitled to get advice from competent parties like lawyers, accountants, auditors and other professionals like engineers. They are also entitled to rely on that advice when making their decisions.

But at the same time, they are expected to make any inquiries they wish, or need to make, to ensure that they are satisfied with that advice. They have a duty of care, and if their actions show that they took this seriously, generally they are protected in law if things do go wrong.

There will be strong penalties for acting in bad faith – fines of between $50 000 and $200 000, and jail terms of between two and five years are possible for criminal convictions.

One major source of problems is that many companies don’t hold board meetings and don’t record their decisions properly.

In trades like plumbing, the company typically has the husband and wife as directors. They discuss things over dinner or a coffee afterwards. Decisions are made, but records aren’t always properly kept.

If the company goes bung, the liquidators will search the records for transactions that are “voidable”. That is, they can be taken out of the books, reducing the debts, but putting the liability back on the owners as individuals. Even worse, if the transaction breaches the Companies Act, the owners could be up for both civil and criminal penalties.

It is easy to blur the distinction between owner, director and shareholder when one person is all of those, but in law, directors and shareholders have different rights and powers.

One of our jobs is to teach people the need to make decisions and have the various different types of decisions made and recorded properly.

People who own a business cannot treat it as a piece of personal property where they can do what they like. There are always other people involved, particularly employees and creditors, and often the bank as well, and that creates obligations that have to be met.

Get good advice

In small businesses where there are several directors, it is not a good idea to rely solely on the view of a director who happens to know the most about a particular area of the business.

Allowing little fiefdoms to develop where a director’s view cannot be challenged is never good practice. That director might be sincere but wrong. If in doubt, get an opinion from an independent expert.

In the end it is about using common sense. Get and take advice, ask questions. Don’t be a patsy. Be wary. You and your fellow directors are in charge of the company. Act positively and talk things through. If you can’t resolve matters, you may have to resign.

Remember you are a steward. You have responsibilities and you are expected to carry them out properly.

If you want to learn more about your obligations as a company director, contact business lawyer, Peter Smith by phone on 09 837 6882 or email peter.smith@smithpartners.co.nz