Chapter 12: Directors Duties

Good Faith
and Proper
Purpose
C O R P O RAT I O N S L AW: I N P R I N C I P L E
TONY CIRO & CHRISTOPHER SYMES
MARIA ANGELICA BALMEO & RODA CRIS

Topic Outline
Outline of duties of loyalty and good faith
To whom are the duties owed?
Duty to act in good faith in the interest of the
company
Duty to use powers for proper purposes
Section 181 Good faith and proper purpose
Duty to retain discretion

Overview of duties of
directors
SHOW DIAGRAM
HIGHLIGHT WHICH PART ARE WE DISCUSSING

Overview of duties of
directors
Directors are in fiduciary relationship with the
companies on whose behalf they act.
To act in good faith in the interests of the
company;
To use powers for their proper purpose;
To retain discretionary powers;
To avoid actual and potential conflicts of
interests and duty.

To whom are the duties

owed?
The duties of loyalty and good faith are

owed to the company, not the

individual members.

To whom are the duties

owed?
Percival v Wright [1902]
Shareholders in Nixon's Navigation Co. wanted to
sell their stocks.
They requested that the company's secretary look
for purchasers.
Some directors purchased the shares at 12.10 per
share.
Shareholders discovered that the board of directors
were under negotiations to sell the entire company.
This would have made the price of the shares higher
than 12.10.

To whom are the duties

owed?
Percival v Wright [1902]
Judgment
Courtheld that the directors owed duties to the
company and not shareholders individually.
There is no question of unfair dealing in this case.
The directors did not approach the shareholders with
the view of obtaining their shares.
The shareholders approached the directors, and
named the price at which they were desirous of
selling. The plaintiffs case wholly fails, and must be
dismissed with costs.

Persons to whom duty

may also be owed
1. Individual members
2. Creditors
3. Beneficiaries of trust
4. Employees

Persons to whom duty may also be owed

Individual Members
In special circumstances:
where members dependent on information or
advice given by directors
Close relationship of confidence between
members and directors

Persons to whom duty may also be owed

Individual Members
Coleman v. Myers [1977]
The board directors of a family owned company
had recommended to the shareholders a
takeover offered by a company controlled by
one of the directors

Persons to whom duty may also be owed

Individual Members

Persons to whom duty may also be owed

Individual Members

Persons to whom duty may also be owed

Creditors
Duty arises where company is insolvent or
nearing insolvency, but duty does not give
creditors the right to sue directors for breach of
duty.

Persons to whom duty may also be owed

Creditors
Geneva Finance Ltd v Resource Industry Ltd [2002]
What duties of the directors of a company that is in financial
difficulty are owed to creditors. Hawkins, who was a nonexecutive director of Geneva, was also a director of another
company, which later changed its name to Resource Industry Ltd
(Resource). That company deposited A$550,000 with Geneva
and became a secured debenture holder. Geneva later lent
A$250,000 to another director of Resource and this loan was
gradually increased. There were serious questions about whether
the director had provided sufficient security to support the loan.
Geneva agreed to extend the time for repayment of the loan, but
no steps were taken by it to seek repayment for some time even
though the director was in arrears.

Persons to whom duty may also be owed

Creditors
Geneva Finance Ltd v Resource Industry Ltd [2002]
Later, Hawkins negotiated for the loan to the director to be
repaid by a trustee of a fund that was managed by his company.
That company, Fidelity, became a secured creditor of the director
and took up securities issued by Geneva. Hawkins was also a
directors of Fidelity. In order to provide this money to Geneva,
Hawkins company had to withdraw A$300,000 of its a$550,000
deposit with Geneva, advances that amount to Fidelity, which
then used that to repay the directors loan.
Geneva encountered financial difficulties and the
receiver/manager argued that the relevant transactions had
caused Geneva Finance loss or damage for which Hawkins and
his company were liable and constituted a breach of duty by
Hawkins as a director of Gevena, which resulted in his company,
as a third party, deriving an improper advantage..

Persons to whom duty may also be owed

Creditors
Geneva Finance Ltd v Resource Industry Ltd [2002]
Rule::

Persons to whom duty may also be owed

Beneficiaries of Trust
Where trust is managed by directors of
company beneficiary may be able to sue for
breach of trust.

Persons to whom duty may also be owed

EMPLOYEES
Duty may be imposed by other laws dealing with labour,
consumer or environment protection.

Duty to act in
good faith in the
interest of the
company

Duty to act in good faith in the

interest of the company
DESCRIPTION OF DUTY

bona fide [in good faith] in what

they consider is in the best interest
of the company

to act

not in the best interest of the court

directors must give proper consideration to the interest of the
company in their dealings
the courts are reluctant to interfere with the internal management
of companies by second guessing their management decisions

Duty to act in good faith in the

interest of the company
SOURCES OF DUTY
1. the general law collectively known as fiduciary law
2. ss 181 and 184 of the corporations act

Duty to act in good faith in the

interest of the company
EXAMPLES OF BREACH OF DUTY
controlling members treating company assets as if they are
assets held in their own names
providing personal benefits to directors or particular members
undertaking transactions with directors or particular members
on terms very favorable to them
forgiving debts owed to the company by directors or
particular members
transferring company assets to others in an attempt to avoid
recovery by creditors or receivers

Duty to act in good faith in the interest of the company

Examples of breach of duty

controlling members treating company assets as if they are
assets held in their own names
providing personal benefits to directors or particular members
undertaking transactions with directors or particular members
on terms very favorable to them
forgiving debts owed to the company by directors or
particular members
transferring company assets to others in an attempt to avoid
recovery by creditors or receivers

Duty to act in good faith in the interest of the company

Scope of duty
the duty requires directors to act for the

benefit of

the company as a whole, not just the

majority of members

Duty to act in good faith in the interest of the company

Scope of duty
Greenhalgh v Arderne Cinemas Ltd [1951]
Facts
Mr Greenhalgh was a minority shareholder in Arderne
Cinemas and was in a protracted battle to prevent majority
shareholder, Mr Mallard selling control. The company had two
classes of shares; one class was worth ten shilling a share and
the other class worth two shilling a share. The ten shillings
were divided into two shilling shares, and all carried one vote.
Mr Greenhalgh had the previous two shilling shares, and lost
control of the company.
The articles of association provided by cl. 10 (a): "No shares
in the company shall be transferred to a person not a member
of the company so long as a member of the company may be
willing to purchase such shares at a fair value to be
ascertained in accordance with sub-clause (b) hereof".

Duty to act in good faith in the interest of the company

Scope of duty
Greenhalgh v Arderne Cinemas Ltd [1951]
Facts
The company changed its articles by special resolution in
general meeting allowing existing shareholders to offer
any shares to person/members outside the company. Mr
Mallard, the majority shareholder, wished to transfer his
shares for 6shillingseach to Mr Sol Sheckman in return
for 5000 and his resignation from the board.
Mr Greenhalgh wished to prevent control of the company
going away, and argued that the article change was
invalid, a fraud on him and the other minority
shareholders, and asked for compensation.

Duty to act in good faith in the interest of the company

Scope of duty
Greenhalgh v Arderne Cinemas Ltd [1951]
Judgements:
Share issues
Lord Greene MR held, instead of Greenhalgh finding
himself in a position of control, he finds himself in a
position where the control has gone, and to that extent
the rights are affected, as a matter of business. As a
matter of law, I am quite unable to hold that, as a result
of the transaction, the rights are varied; they remain what
they always were a right to have one vote per sharepari
passuwith the ordinary shares for the time being issued
which include the new 2s ordinary shares resulting from
the subdivision.

Duty to act in good faith in the interest of the company

Scope of duty
Greenhalgh v Arderne Cinemas Ltd [1951]
Derivative action
Lord Evershed MR (with whom Asquith and Jenkins LLJ concurred)
held that the 5000 payment was not a fraud on the minority.
None of the majority voters were voting for a private gain. The
alteration of the articles was perfectly legitimate, because it was
done properly.
Lord Evershed MR stated,
When a man comes into a company, he is not entitled to
assume that the articles will always remain in a particular form,
and so long as the proposed alteration does not unfairly
discriminate, I do not think it is an objection, provided the
resolution is bona fide passed, that the right to tender for the
majority holding of shares would be lost by the lifting of the
restriction [to transfer shares to individuals outside the company

Scope of duty

Members
The duty required directors to have regard for the
interests of both:
1.
2.

The company as a commercial entity

The members of the company

Corporations act provides remedies to members

where the affairs of the company are conducted in a
manner which is contrary to the interests of the
members as a whole

Scope of duty

Classes of shares
In companies with two or more classes of shares,
directors may make decisions which affect the different
classes in different ways. One class of shares may benefit
and the other suffer from the transaction. In those
situations, the courts have focused on whether the
decision was fair as between the different classes of
members.

Scope of duty

Classes of shares
Mills v Mills [1938]
Case Facts:
A resolution was approved by the directors of Charles
Miss (Uardy) Ltd which increases the managing directors
extent of voting power. This was increased in order for the
passage of an increase in the dividend received by the
ordinary shareholders, including the managing director, in
the form of bonuses.

The reliability of the resolution was challenged by the

minority director on the reasoning that the passage of the
resolution was not abona fideact for the interest of the
enterprise.

Scope of duty

Classes of shares
Mills v Mills [1938]
Case Issue:
The issue of the case was whether or not the majority
directors infringed their fiduciary duty to act truthfully for
the benefit of the company, and if proven so, can the
resolution be changed on the said grounds.

Scope of duty

Classes of shares
Mills v Mills [1938]
Case Decision:
The decision of the court was that the resolution passed
by the majority directors was made underbona
fidegrounds even though it resulted to the benefit of the
majority directors.

Therefore, if a group of directors carry on decisions which

benefits a group of directors it does not immediately
equate to infringing their fiduciary duties.

Scope of duty

Classes of shares
Mills v Mills [1938]
Case Significance:
This case is significant in the aspect that when directors
benefit from a decision then the directors had
automatically violated their duties towards the company,
specifically acting improperly within a purpose.

Scope of duty

Creditors
If the company is insolvent or nearing
insolvency then interests of the company
includes the interests of creditors.
The directors must avoid action contrary to
their interest.
Directors are to be mindful of creditor rights.

Scope of duty

Corporate Groups
The duty to act in good faith in the interests of a
company also applies to dealings between companies
in a corporate group.
E.g. inter-group loan or guarantee given by one
company on behalf of another within the group.

Scope of duty

Nominee Directors
Conflict can arise between the best interests of the
company of which they are a director and the interests
of the group or company that has appointed them.
S187 permits directors of wholly owned subsidiary
companies, who were nominated by the holding
companies, to have dual loyalties provided that they
satisfy certain requirements.
Dual loyalty is possible but in the event of an actual
conflict, a nominee directors foremost duty is to the
company of which he is a director

Scope of duty

Employees and the Community

Interests of employees should not be considered by the
directors ahead of the interests of the company as a
whole.
But, if the interests of current employees can be
regarded as affecting the interests of the company,
then they could be taken into account.

Scope of duty

Employees and the Community

Parke v Daily News [1962]
Facts:
Daily News Ltd was the owner of 2
newspapers.
Both newspapers had declining sales and the
board decided that it was in the best interests
of the company to sell the newspapers to an
external party.
Board decided to sell the intangible assets
and their plants and equipment.
This lead to widespread job losses.

Scope of duty

Employees and the Community

Parke v Daily News [1962]
Facts:
Sympathetic to the past employees, the board
decided to distribute the surplus funds from
the sale of business to the staff that they no
longer employ.
A minority shareholder objected to the
distribution of the surplus proceeds to the
past employees

Scope of duty

Employees and the Community

Parke v Daily News [1962]
Decision:
The board was not entitled to distribute the
surplus proceeds from the sale of the business
to its past employees because to do so would
not be in the best interests of the company
Past employees do not provide current or
future benefit to the company.

Duty to act in good faith in the interest of the company

Impact of Companys Internal Rules

the companys constitution may permit
directors to take account of a particular
stakeholders interests ahead of others

Duty to use
powers for
proper
purposes

Duty to use powers for proper

purposes
How directors exercise the powers given to them
by..
their employment contract,
the companys internal rules and
the Corporations Act
Example:
s198S replaceable rule listing powers of
directors
s198C replaceable rule listing powers of
managing directors
Depending on the particular company, directors

Duty to use powers for proper purposes

Description Of Duty
Directors are under a duty to the company to
exercise their powers according to certain
standards.
Directors of a company are fiduciary agents,
and a power conferred upon them cannot be
exercised in order to obtain some private
advantage or for any purpose foreign to the
power.

Duty to use powers for proper purposes

Sources Of Duty
1. the general law collectively known as
fiduciary law
2. ss 181 and 184 of the corporations act

Duty to use powers for proper purposes

Determining breach of duty

Burden of proof rests on the party making the
allegations
1. Ascertain nature of the power and the purposes for
which it was conferred the legal purpose
2. Ascertain from the circumstances the actual purpose
or reasons for which the power was exercised by the
directors.
*if the actual purpose for the exercise of the power is
within the range of legal purposes, the directors have
acted properly and discharged their duty.
*if the actual purpose is outside the legal purposes, a
breach of duty will have taken place

Duty to use powers for proper purposes

Scope of duty
Legal purpose
Actual purpose
Multiple purposes

Duty to use powers for proper purposes SCOPE OF DUTY

Legal Purpose
Found in the internal rules of the company
Internal rules may limit the circumstances in
which the power is to be exercised
The court interprets the power in light of any
such restrictions ans the other internal rules of
the company.
In the absence of any guidance from the internal
rules, court infer what the purpose of the power
is from the type of company, its internal
structure and activities.

Duty to use powers for proper purposes SCOPE OF DUTY

Actual Purpose
This requires the court to determine t\what the
directors subjectively believed at the time they
exercised the power.
It can be very difficult for the court to ascertain this
information.
It must be shown that the substantive purpose of the
directors was improper or collateral to their duties as
directors.
Honest or well-intended actions by directors do not
prevent the court from finding that their conduct
amounted to an improper use of their power.

Duty to use powers for proper purposes SCOPE OF DUTY

Multiple Purposes
What if several purposed can be ascribed to the
directors actions?
The mere presence of an improper purpose will not of itself make
the directors act invalid.
If the substantive or dominant objective is improper, however, the
act will be invalid.
If there are a number of significantly contributing causes, you
must ask whether, but for that impermissible purpose, the
directors would not have exercised the power.

Duty to use powers for proper purposes EXAMPLE

Power to Allot Shares

Kokotovich Constructions Pty Ltd v Wallington
(1968)
- where a companys assets are given away to family
company for no consideration of the motive is
improper
Harlowes Nominees v Woodside Oil Co NL
(1968)
- high court said that shares could be issued for
purposed other than that of raising finance

Duty to use powers for proper purposes EXAMPLE

Power to Allot Shares

Howard Smith Ltd v Ampol Petroleum
(1974)
- Privy council said that it was impossible to say
in advance what would be a proper or improper
purpose. However if the predominate purpose of
the allotment of shares was to defeat a hostile
takeover or to dilute the holdings of a particular
shareholder the allotment would be invalid.

Duty to use powers for proper purposes EXAMPLE

Power to Allot Shares

Allotment of shares may be invalid if:
1. To transfer control of a major company asset
2. To preserve the position of the existing
majority members, or to displace them
3. To make the rights of the existing members
valueless and there is no other demonstrable
benefit to the company

CORPORATIONS ACT 2001 - SECT 181

Good faith--civil obligations
Good faith--directors and other officers
(1) Adirectoror other officer of a corporation must exercise
their powers and discharge their duties:
(a) in good faith in the best interests of the corporation;
and
(b) for a proper purpose.
Note 1: This subsection is a civil penalty provision (seesection1317E).
Note 2:Section187deals with the situation ofdirectorsof wholly-owned
subsidiaries.

(2) A person who is involved in a contravention of

subsection(1) contravenes this subsection.
Note 1:Section79definesinvolved.
Note 2: This subsection is a civil penalty provision (seesection1317E).

CORPORATIONS ACT 2001 - SECT 184

Good faith, use of position and use of information--criminal offences
Good faith--directors and other officers
(1) Adirectoror other officer of a corporation commits an
offence if they:
(a) are reckless; or
(b) are intentionally dishonest;
and fail to exercise their powers and discharge their duties:
(c) in good faith in the best interests of the corporation;
or
(d) for a proper purpose.

Note:Section187deals with the situation ofdirectorsof wholly-owned

subsidiaries.

CORPORATIONS ACT 2001 - SECT 184

Good faith, use of position and use of information--criminal offences
Use of position--directors, other officers and employees
(2) A director, other officer or employee of a corporation
commits an offence if they use their position dishonestly:
(a) with the intention of directly or indirectly gaining an
advantage for themselves, or someone else, or causing
detriment to the corporation; or
(b) recklessly as to whether the use may result in
themselves or someone else directly or indirectly
gaining an advantage, or in causing detriment to the
corporation.

CORPORATIONS ACT 2001 - SECT 184

Good faith, use of position and use of information--criminal offences
Use of information--directors, other officers and employees
(3) A person who obtains information because they are, or
have been, a director or other officer or employee of a
corporation commits an offence if they use the information
dishonestly:
(a) with the intention of directly or indirectly gaining an
advantage for themselves, or someone else, or causing
detriment to the corporation; or
(b) recklessly as to whether the use may result in
themselves or someone else directly or indirectly
gaining an advantage, or in causing detriment to the
corporation.

Duty to retain discretions

Directors power may also e thought of as
discretion
Directors have a discretion to determine if and
when to exercise their powers

Duty to retain discretions

Description Of Duty
1. a duty to exercise an active discretion
Directors cannot unthinkingly follow the directions of
another person

2. a duty to retain their discretions

Directors cannot delegate their responsibilities or
fetter the exercise of discretions without authority

Duty to retain discretions

Sources Of Duty
By an agreement, written or oral, to vote in a
certain way in relation to the exercise of their
powers
.Nominee director agrees with their appointor to vote
in a certain way
.If the directors have entered into a contract on behalf
of the company in the bona fide exercise of their
powers, then they can validly agree in that contract to
vote in favour of certain matters.

Duty to retain discretions

Limits on the Duty

Scope of the duty may be limited by the
companys internal rules:

Appoint agents to carry out the boards policies

Delegate functions to a managing director
Delegate a matter to a committee od senior management
Act primarily in the interests of the person or company who
nominated or appointed them