House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

6 Directors duties and corporate governance

Business Judgment Rule

6.1 In general terms a statutory business judgment rule will offer directors a safe harbour from personal liability in relation to honest, informed and rational business judgments.

6.2 The introduction into the Corporations Law (the Law) of a business judgment rule has been considered and recommended by various committees (Senate Standing Committee on Legal and Constitutional Affairs, Company Directors Duties , November 1989; Companies and Securities Law Review Committee (CSLRC), Company Directors and Officers: Indemnification, Relief and Insurance , 1990; House of Representatives Standing Committee on Legal and Constitutional Affairs, Corporate Practices and the Rights of Shareholders , 1991; Companies and Securities Advisory Committee (CASAC), Directors Duty of Care and Consequences of Breaches of Directors Duties , September 1991).

6.3 The fundamental purpose of the business judgment rule is to protect the authority of directors in the exercise of their duties, not to insulate directors from liability. While it is accepted that directors should be subject to a high level of accountability, a failure to expressly acknowledge that directors should not be liable for decisions made in good faith and with due care, may lead to failure by the company and its directors to take advantage of opportunities that involve responsible risk taking.

6.4 The statutory formulation of the business judgment rule will clarify and confirm the common law position that the Courts will rarely review bona fide business decisions. However the statutory formulation will provide a clear presumption in favour of a directors judgment. In particular, while the substantive duties of directors will remain unchanged, absent fraud or bad faith, the business judgment rule will allow directors the benefit of a presumption that, in making business decisions, if they have acted on an informed basis, in good faith, and in the honest belief that the decision was taken in the best interests of the company, they will not be challenged regarding the fulfilment of their duty of care and diligence.

6.5 Under proposed subsection 180(2) a director or other officer of a corporation will therefore be taken to have met the requirements of the duty of care and diligence as set out in proposed subsection 180(1) of the Law and the equivalent duty at common law or in equity in respect of a business judgment made by them if they fulfil all of the following requirements:

•

the business judgment was made in good faith for a proper purpose;

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the director or other officer did not have a material personal interest in the subject matter of the business judgment;

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the director or other officer informed themselves about the subject matter of the business judgment to the extent they reasonably believed to be appropriate; and

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the director or other officer rationally believed that the business judgment was in the best interests of the corporation.

6.6 It will be presumed that a directors or officers belief that a business judgment is in the best interests of the corporation is a rational belief unless no reasonable person in the position of the director or officer could hold that belief.

6.7 It should be noted that proposed subsection 180(2) only operates in respect of duties under proposed subsection 180(1) and the equivalent duty at common law or in equity including common law principles governing liability for negligence. The proposed business judgment rule does not operate in relation to any other provision of the Law or any other Act or any Regulation under which a director or other officer may be liable to make payment in relation to any of their acts or omissions as an officer.

6.8 The proposed provision does not apply, for example, to business judgments made by directors in the context of insolvent trading or in relation to misstatements in a prospectus or takeover document. These are discrete areas that are each regulated by a separate liability regime. The operation of the business judgment rule will be confined to cases involving decision making about the ordinary business operations of the company. For example, the decision to undertake a particular kind of business activity promoted in a prospectus would be the kind of business judgment to which the proposed rule may apply. However, compliance (or otherwise) with the prospectus requirements imposed by the Law would not be a decision to which the proposed rule could apply. In this regard, proposed subsection 180(3) specifically provides that a business judgment means any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.

6.9 Provided directors or other officers fulfil the requirements of proposed subsection 180(2) paragraphs (a) to (d):

•

such directors have an explicit safe harbor, being effectively shielded from liability for any breach of their duty of care and diligence; and

•

the merits of directors business judgments are not subject to review by the Courts.

6.10 Proposed subsection 180(2) acts as a rebuttable presumption in favour of directors which, if rebutted by a plaintiff, would mean the plaintiff would then still have to establish that the officer had breached their duty of care and diligence.

Statutory Derivative Action

Proposed Part 2F.1A - Proceedings on behalf of a company and others

6.11 In recent years, a number of reports have recommended the introduction of a statutory derivative action to enable an individual shareholder to bring an action on behalf of a company for a wrong done against the company, where the company is unwilling or unable to do so.

6.12 The first of these reports was the 1990 report by the CSLRC entitled Enforcement of the Duties of Directors and Officers of a Company by means of a Statutory Derivative Action. The CSLRC recommended that the Companies Act 1981 be amended to enable the Court to grant a person leave to take derivative proceedings. The report included a draft provision, which formed the basis for consideration in subsequent reports (House of Representatives Standing Committee on Legal and Constitutional Affairs, Corporate Practices and the Rights of Shareholders , 1991; Companies and Securities Law Review Committee (CSLRC), Enforcement of the Duties of Directors and Officers of a Company by means of a Statutory Derivative Action , Report No. 12, 1990; Legal Committee of Companies and Securities Advisory Committee (CASAC), Statutory Derivative Action , 1993).

6.13 The Corporate Law Economic Reform Program Proposal Paper No. 3, Directors Duties and Corporate Governance , released on 20 October 1997, proposed a statutory derivative action as a measure to reduce the cost to the members and directors of a company of establishing and enforcing their relationship with one another.

Current position

6.14 Shareholder derivative proceedings may currently be pursued at common law under the so-called exceptions to the rule expounded in Foss v Harbottle that the company is the proper plaintiff for wrongs done to it. However, a number of practical and legal difficulties regarding the operation of the exception have meant that very few derivative actions have proceeded.

6.15 The main difficulties associated with the common law action centre around:

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the effect of ratification of the impugned conduct by the general meeting of shareholders (if effective, the purported ratification by a majority of shareholders could deny the company as a whole, and hence minority shareholders, any right of action against the directors);

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the lack of access to company funds by shareholders to finance the proceedings (where a shareholder seeks to enforce a right on behalf of a company, they are likely to be disinclined to risk having costs awarded against them in a case which will ultimately benefit the company as a whole, not just individual shareholders); and

•

the strict criteria which need to be established before a Court may grant leave.

6.16 Appropriate checks and balances will be provided in the legislation to prevent abuse of the proceedings and to ensure that company managements are not undermined by vexatious litigation and that company funds are not expended unnecessarily.

6.17 In summary, the proposed statutory derivative action will allow an eligible applicant, which will include shareholders and directors, to commence proceedings on behalf of a company where the company is unwilling or unable to do so. Proceedings could be commenced in respect of wrongs done to the company and the company would benefit from successful actions.

Persons who may bring, or intervene in, proceedings on behalf of a company

6.18 To better reflect the nature of the proceedings involved, the term proceedings on behalf of a company will be used rather than the term statutory derivative action in the legislation.

6.19 Under the draft provisions, a person as defined, may commence or intervene on behalf of a company (proposed subsections 236(1) and (2)).

6.20 The proceedings could be in respect of a cause of action, which a company has against either:

•

a director of the company for breach of duties owed to the company; or

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a third party for a breach of contract or in respect of a tortious act committed by that third party (it will however be presumed that where proceedings involve a third party, granting leave is not in the best interests of the company unless the contrary is proved (proposed subsection 237(3)).

6.21 The draft provisions will also allow a person to intervene in proceedings to which a company is a party, on behalf of the company, for the purpose of taking responsibility on behalf of the company for those proceedings, or for a particular step in those proceedings. This could include continuing, defending, discontinuing, compromising or settling the proceedings on behalf of the company.

6.22 To be able to commence or intervene in proceedings, in the name of, and on behalf of a company, a person will need to first apply for leave from the Court (proposed paragraph 236(1)(b) and proposed section 237).

No right of action except as provided in this part

6.23 The common (general) law derivative rights under the exceptions to the proper plaintiff rule in Foss v Harbottle will be abolished. This is designed to promote certainty regarding the nature of the action and avoid confusion between any diverging principles relating to the statutory action and the common law action (proposed subsection 236(3)).

6.24 However, the common law personal action exception to the rule in Foss v Harbottle will remain, since under this action a member is not bringing or intervening in proceedings on behalf of the company (proposed section 236 note 3).

Who can apply for leave

6.25 Pursuant to proposed paragraph 236(1)(a), an application for leave will be able to be made by:

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members of the company (including those with a present entitlement to be registered);

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former members of a company or related body corporate; and

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directors and officers, present and former, of the company.

6.26 Under the common law, only members can institute derivative proceedings on behalf of a company.

6.27 Under the draft provisions, former members will be included because they may have been compelled to leave the company in view of the dispute potentially giving rise to the litigation on behalf of the company. Members and former members of a related body corporate will also be included as they may be adversely affected by the failure of the company to take action and therefore may have a legitimate interest in applying to commence a derivative action.

6.28 The conferral of standing on officers recognises that they are most likely to be the first to become aware of a right of action which is not being pursued by the company.

6.29 The CSLRC and the Standing Committee recommended the inclusion of former members and former directors.

6.30 The Australian Securities and Investments Commission (ASIC) is not included as an eligible applicant, as the basic policy objective of derivative proceedings is to provide an effective remedy for investors and to overcome the difficulties in Foss v Harbottle there is no proper role for ASIC to bring such proceedings. In particular, the statutory action is not intended to be regulatory in nature, but to facilitate private parties to enforce existing rights attaching to the company effectively, the action is designed to be a self help measure. In this regard, a statutory derivative action has the potential to remove some of the regulatory burden from ASIC by making it easier for investors themselves to protect the interests of a company. (There are other means by which ASIC may commence actions on behalf of investors, for example, under section 50 of the ASIC Act ).

Criteria for granting leave

6.31 The Court will be required to grant leave if the following five criteria have been satisfied:

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inaction by the company (proposed paragraph 237(2)(a));

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the applicant is acting in good faith (proposed paragraph 237(2)(b));

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the action appears in the best interests of the company (proposed paragraph 237(2)(c));

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there is a serious question to be tried (proposed paragraph 237(2)(d)); and

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the applicant gave written notice to the company of the intention to apply for leave, and of the reasons for applying, at least 14 days before making the application, or circumstances are such that it is appropriate to grant leave in any case (proposed paragraph 237(2)(e)).

6.32 These criteria are aimed at preventing potentially vexatious or unmeritorious actions that would be detrimental to the company on whose behalf the action was taken. The criteria are based on recommendations of the CSLRC and were endorsed by CASAC and the House of Representatives Standing Committee on Legal and Constitutional Affairs.

6.33 The criteria seek to strike a balance between the need to provide a real avenue for applicants to seek redress on behalf of a company where it fails to do so and the need to prevent actions proceeding which have little likelihood of success.

Inaction by the company

6.34 As a practical matter, the companys response to any notice of intention to apply for a grant of leave would provide evidence relevant to this criterion. An applicant might also seek to discharge this criterion by demonstrating that the alleged wrongdoer has a dominant influence on the board of directors.

6.35 Ratification by the general meeting of any wrong committed against the company would be a matter for the Court to take into account under this criterion although it would not necessarily be decisive.

Applicants good faith

6.36 In assessing whether an applicant is acting in good faith, the Court could be expected to have regard to whether:

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there was any complicity by the applicant in the matters complained of; and

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the application is being made in pursuit of an interest other than that of the company.

6.37 The good faith requirement is designed to prevent proceedings being used to further the purposes of the applicant, rather than the company as a whole.

Best interests of the company

6.38 This criterion would allow the Court to focus on the true nature and purpose of the proceedings. It would recognise that a company might have sound business reasons for not pursuing a cause of action open to it and that its management might legitimately have decided that the best interests of the company would be served by not taking action. For example, a decision may be taken in a case where, although it may be clear that there has been a breach of duty by a director, the loss to the company may only be nominal. In this case, the costs of taking proceedings may outweigh any benefit to the company.

6.39 The inclusion of this criterion would allow the Court to refuse to grant leave in these circumstances because the applicant for leave would not be able to show that to do so would be in the best interests of the company.

Third party actions

6.40 It is proposed that where the proceedings are by the company against a third party or by a third party against the company, it will be presumed that unless the contrary is proved, granting leave is not in the best interests of the company (proposed subsection 237(3)).

6.41 Decisions regarding arms-length transactions by the company are appropriately made by the board of directors, and generally it is not in the interests of a company for other persons to interfere in the smooth decision making processes of the board. The assumption is that such interference is not in the best interests of the company and it must be proven on a balance of probabilities that granting leave will, in fact, be in the best interests of the company.

6.42 It will therefore be presumed (unless the contrary is proven) that granting leave is not in the best interests of the company if:

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the company has decided not to bring or defend proceedings, or has decided to discontinue, settle or compromise the proceedings (proposed paragraph 237(3)(b)); and

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the directors who participated in that decision:

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were acting in good faith for a proper purpose (proposed paragraph 237(3)(c)(i));

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did not have a material personal interest in the decision (proposed paragraph 237(3)(c)(ii));

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informed themselves about the subject matter of the decision to the extent they reasonably believed appropriate (proposed paragraph 237(3)(c)(iii)); and

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rationally believed the decision was in the best interests of the company (proposed paragraph 237(3)(c)(iv)).

6.43 It will be assumed that the directors belief that the decision was in the best interests of the company is rational, unless it is a belief that no reasonable person in their position would hold.

6.44 For the purposes of proposed subsection 237(3), a person will be a third party if:

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the company is a public company and the person is not a related party of the company; or

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the company is a proprietary company and the person would be a related party of the company if the company were a public company.

6.45 A related party is defined in proposed section 228.

Serious question

6.46 The serious question to be tried test is familiar and regularly employed by the Courts in the context of interim injunction applications. The serious question to be tried test was preferred to the alternative of requiring the applicant to show a prima facie case. It is important in this regard that the application for leave to take proceedings is not turned into a trial of the substantive issues, without the applicant having the usual plaintiffs right to pre trial discovery and interrogatories. The applicant is simply required to show that proceedings should be commenced. On the other hand, this criterion would prevent the proceedings being abused by further frivolous or vexatious claims.

6.47 It is considered unnecessary as a precondition for relief for a shareholder to have to bring the matter before a general meeting of the company as the proposed provisions already require the Court to be satisfied that it is probable that the company would not itself bring the proceedings or take responsibility for them. In any case, this criterion would be difficult to establish without the applicant showing that it had in fact tried to gain the support of the company by at least attempting to convene a general meeting. There are also practical obstacles facing an applicant in requisitioning a general meeting. Unless the articles provide otherwise, the Law currently requires five per cent of total voting rights of all members to convene a meeting of the company.

6.48 Similarly, limiting derivative actions to those cases where a dominant shareholder is affecting the interests of the company could exclude from the application of derivative actions cases where directors have acted in breach of their duties to the company, unless those directors were also a dominant shareholder. It would also preclude the situation where several shareholders who held the balance of power acted in concert. In addition, it could be argued that the question of dominance is already addressed in the majority of cases under the oppression remedy, while the statutory derivative action is specifically designed to go beyond instances of strict oppression.

Notice of proceedings

6.49 The requirement on the applicant to set out in a notice the reasons for applying for leave and requiring the applicant to give 14 days notice, allows the company time to address the applicants concerns prior to the hearing date. Failure by the company to take action would, after notice is given, support the Court arriving at a conclusion that it is probable the company would not itself take proceedings.

6.50 The applicant does not need to meet the requirement of 14 days notice where it is not practical or expedient, thus allowing for an ex parte hearing where there is a need for urgent litigation.

Substitution of another person for the person granted leave

6.1 Proposed section 238 will allow for substitution of another person for the person who has already been granted leave to commence or intervene in the proceedings. Substitution might be required if later events compromise or negate the ability of the person to whom leave has been granted, to take responsibility for the proceedings.

6.2 The class of persons who may apply to be substituted under this provision is the same as that specified under proposed subsection 236(1)(a) in respect of making an application for leave.

Ratification or approval by members

6.3 Proposed section 239 will give the Court flexibility in dealing with the effect of ratification or approval by the members of the company of an alleged breach of a right or duty owed to the company.

6.4 The provision is designed to overcome restrictive rules associated with the common law derivative action, which effectively prevent a shareholder from taking a derivative action in respect of a ratifiable breach of duty. One of the reasons the common law action has been used so infrequently is that a member of a company may be precluded from bringing an action if the conduct about which redress is being sought against directors of the company is capable of being, or has been, ratified by the general meeting of members.

6.5 The approach adopted in the draft provisions is intended to avoid the need to determine what are ratifiable and what are non-ratifiable decisions/actions, and whether a decision/action has been effectively ratified.

6.6 In some circumstances judicial action may be preferable to action by the shareholders and the applicant should be permitted to commence litigation irrespective of shareholder approval.

6.7 To ensure that this can occur, proposed subsection 239(1) will state that the law relating to the effect of ratification or an approval of conduct does not apply to either the application for leave or the proceedings in respect of which leave has been granted.

6.8 Proposed subsection 239(2) will provide that the Court may take into account a ratification or approval of conduct in deciding what order or judgment (including as to damages) to make. However, the provision will make it clear that the Court may only have regard to ratification if it is satisfied that the ratification was effected by the companys fully informed independent members.

Leave to discontinue, compromise or settle derivative proceedings

6.9 An important aspect of the new provisions will be that the person having charge of the conduct of the proceedings will not be permitted to discontinue, compromise or settle the proceedings without the Court being able to consider if that is in the best interests of the company. This has the added benefit of enabling the Court to prevent any collusion between the person conducting the proceedings and the defendants, which might benefit that person but not the company (proposed section 240).

General powers of the Court

6.10 In addition to the usual orders which a Court may make pursuant to relevant Court rules, the Court will be able to make an order directing the company or an officer of the company to do or refrain from doing any act (proposed paragraph 241(1)(c)).

6.11 Pursuant to proposed paragraph 241(1)(d), the Court will also be able to make an order appointing an independent person to investigate and report to the Court on:

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the financial affairs of the company;

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facts surrounding the circumstances which gave rise to the cause of action; and

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funds expended by both sides during proceedings.

6.12 To enable an investigation to be effectively carried out, the Court appointed investigator will be provided with a right to inspect the books of the company provided the inspection is for a purpose connected with their appointment and reasonable notice is given to the company (proposed subsection 241(2)).

6.13 As the Court appointed investigator will effectively be an officer of the Court, they would be required to protect the confidentiality of any information obtained in the course of their investigation except as provided by the Court.

6.14 The proposed provision is principally designed to ensure that where an action is being funded by the company, the Court will be able to find out independently of the parties whether shareholders funds are being expended in a reasonable manner and whether a complaint constitutes a good cause of action.

Costs orders

6.15 Under the rules of Court, the Court has power to make orders in respect of the costs of the parties. However, in proceedings brought or intervened in with leave pursuant to proposed section 237, the company will be the party to the proceedings, not the applicant. Accordingly, it is necessary to include a specific provision dealing with costs in relation to proceedings on behalf of a company.

6.16 Proposed subsection 242 gives the Court a broad discretion to make any orders it considers appropriate about the costs of the applicant, the company or any other party to the proceedings or the application.

6.17 Orders can be made in respect of the application for leave or the proceedings, and can include requiring indemnification for costs.

6.18 Where an independent investigator is appointed pursuant to proposed paragraph 241(1)(d), the Court may make or vary an order under proposed paragraph 241(3)(c) stating whom out of the parties to the proceedings, or the company itself, is liable for the remuneration and expenses of the person appointed. Where two or more persons are to be liable for the costs of the investigator, the Courts order may also determine the nature and extent of each of those persons liability (proposed paragraph 241(3)(d)).

6.19 The Courts discretion regarding the allocation of costs is aimed at providing an additional safeguard in respect of use of company funds. In particular, the Court would be able to protect a bona fide shareholder against liability for costs indemnifying them out of company funds while at the same time allowing the Court a further means of discouraging unmeritorious or doubtful action. This reflects the position that the company itself is the beneficiary in a successful derivative action.

6.20 In addition, if a shareholder were successful in an action, the costs would not necessarily fall on the company but on the defendants to the action. If the action was not successful, the applicant may have costs awarded against them, especially if the action was ultimately considered frivolous. The exercise of the Courts decision in this regard would probably depend on the merits of the case.

Duties of Officers and Employees

6.21 The draft provisions rewrite the duties of officers and employees in current section 232 of the Law to make it easier for company officers to know what is expected of them.

6.22 The draft provisions define officer to include a director or secretary as well as certain other persons who may manage the company, but not employees (proposed subsection 179(2)). Where an obligation imposed by the Law applies to employees, as well as officers, the Law will state this.

Care and diligence

6.23 The duty of care and diligence in current section 232(4) will be rewritten to clarify the standard of care and diligence required of an officer (proposed section 180).

6.24 Current section 232(4) was inserted by the Corporate Law Reform Act 1992 to provide that an officer of a corporation must exercise a degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporations circumstances. The explanatory memorandum indicated that the words in a like position were intended to allow consideration of the special background, qualifications and management responsibilities of a particular officer in evaluating their compliance with the standard of care.

6.25 However, doubt has been expressed about whether current section 232(4) enables the Courts to have regard to the circumstances of the particular officer as well as their position in the corporation. The draft provisions have been rewritten to clarify that whether the officer has breached the standard of care and diligence is determined both by regard to the corporations circumstances and the officers position and responsibilities within the corporation (proposed subsection 180(1)).

Civil penalty

6.1 It is proposed that a breach of the duty of care and diligence will only give rise to civil sanctions and will no longer provide a basis for an offence under the Law. Under subsection 1317FA (1) of the Law, a breach of the duty of care and diligence in subsection 232(4) undertaken with a dishonest intent amounts to an offence punishable by a maximum fine of $200,000 or five years imprisonment, or both. However, the concept of negligence is inconsistent with dishonesty, in that dishonesty suggests an active awareness of wrong doing, rather than a failure to exercise sufficient care and diligence. Criminal liability will continue to apply to breaches of the duty to act honestly.

Good faith

6.2 Current section 232(2) requires officers to act honestly. The draft provisions will rewrite section 232(2) to require officers to exercise their powers and discharge their duties in good faith in what they believe to be in the best interests of the corporation and for a proper purpose (proposed section 181).

6.3 There have been different views about what constitutes a contravention of current section 232(2). One view was that a contravention occurred when a person exercised their powers for a purpose that the law considered improper, regardless of whether the person considered they were acting in the best interests of the corporation: Southern Resources Ltd v Residues Treatment & Trading Co Ltd (1990)
3 ACSR 207 . The alternative view was that a contravention required knowledge that what was being done was not in the interests of the company, and deliberate conduct in disregard of that knowledge: Marchesi v Barnes
[1970] VR 434 . This was based on the assumption that, as a contravention could have criminal consequences, a person should only be liable if they had a criminal intent.

6.4 The civil penalty provisions were intended to overcome these difficulties by clearly stipulating that a contravention constituted a criminal offence only if accompanied by the fault elements set out in section 1317FA. The civil penalty provisions were also intended to make it clear that for a company to recover compensation or profits from a director as a result of a contravention it is not necessary to establish a fault element.

6.5 The draft provisions will reinforce the distinction between civil obligations and criminal offences, and the intent that each requires, not only in respect of the duty to act in good faith etc, but also other duties in the Law, by clearly distinguishing each in the relevant sections. For instance, the draft provisions divide the duty of honesty into a civil obligation (proposed section 181) and a criminal obligation (proposed section 184). A contravention of the requirements concerning good faith, use of position or information will be criminal offences only if dishonest and committed intentionally or recklessly. The offence relating to an officers duty of care and diligence will be repealed.

6.6 However, there are other difficulties with the current provisions. In particular, it is difficult to reconcile the use of honestly as an element of the duty in current section 232(2) with the inclusion of dishonestly as one of the fault elements in current section 1317FA. The provisions were described as extremely complex and arguably unworkable by the Model Criminal Code Officers Committee of the Standing Committee of Attorney Generals in its June 1996 discussion paper, Conspiracy to Defraud.

6.7 The draft provisions overcome these difficulties by rewriting section 232(2) to mirror the fiduciary duty of a director to act in what they believe to be in the best interests of the corporation and for proper purposes.

Restrictions on indemnities and insurance for officers and auditors

6.8 The draft provisions clarify the legal costs exception to the statutory prohibition on a company or related body corporate indemnifying or exempting an officer or auditor of the company, from liability incurred in that capacity.

6.9 It is proposed that the provisions concerning indemnification be rewritten to state all circumstances in which indemnification and exemption of officers or auditors is not permitted. As is currently the case, it is proposed that exemptions in respect of officers or auditors by the company, for a liability owed to a company, will not be permitted at all. Indemnification will be permitted in circumstances other than those expressly prohibited.

No exemptions

6.10 There are proposed to be no exceptions to the rule that a company or related body corporate must not exempt a person (whether directly or through an interposed entity) from a liability to the company, incurred as an officer or auditor of the company (proposed subsection 199A(1)).

Prohibition on an indemnity for liability (other than for legal costs)

6.11 Proposed subsection 199A(2) sets out the circumstances in which it is proposed to prohibit an indemnity by the company, for a liability owed to the company. The proposed provision does not apply to a liability for legal costs.

6.12 A company or related body corporate will not be able to indemnify a person:

•

for any liability owed to the company or a related body corporate, where the liability is incurred as an officer or auditor of the company (proposed paragraph 199A(2)(a)); or

•

for a civil penalty order made under proposed section 1317G or a compensation order under proposed section 1317H (proposed paragraph 199A(2)(b)); or

•

for any liability owed to someone other than the company or a related body corporate, that did not arise out of conduct in good faith (proposed paragraph 199A(2)(c)).

6.13 An indemnity of this type will be prohibited whether it occurs through an agreement or by making a payment and whether directly or through an interposed entity.

Prohibition on an indemnity for legal costs

6.14 An officer or auditor of a company will not be able to be indemnified by the company or a related body corporate against legal costs incurred in defending an action for a liability to the company if the costs are incurred:

•

in defending or resisting proceedings under which the officer or auditor is liable, for a liability for which they cannot be indemnified pursuant to proposed subsection 199A(2) (proposed paragraph 199A(3)(a)); or

•

in defending or resisting criminal proceedings in which the person has been found guilty (proposed paragraph 199A(3)(b)); or

•

in defending or resisting proceedings brought by the ASIC or a liquidator for a court order, if the grounds for making the order are found to have been established (proposed paragraph 199A(3)(c)); or

•

in circumstances where the Court has denied relief sought by the person (proposed paragraph 199A(3)(d)).

6.15 It should be noted however that proposed paragraph 199A(3)(c) does not apply to costs incurred in responding to actions taken by the ASIC, or a liquidator, as part of an investigation, before commencing proceedings for the court order. Legal costs incurred in these circumstances will be able to be indemnified, even if grounds for making orders in proceedings later taken by the ASIC or a liquidator, are found by the Court to have been made out.

6.16 One of the concerns about the operation of the indemnity provisions has been that a person is not entitled to an indemnity until the outcome of the relevant proceedings is known. Substantial liability may be incurred (for example, on-going legal costs) during the course of a proceeding, which are unable to be paid to the indemnified officer, until the outcome of the proceedings is known. To address this, as indicated in Note 2 to proposed section 199A, the company may be able to give a person a loan or advance in respect of legal costs. Once the outcome of the proceedings is known, the person would be either obliged to pay back the loan or advance, if not entitled to an indemnity, or may retain the loan moneys as the indemnity to which the person is now entitled.

Clarification of the liability of directors in situations of conflict of interest

6.17 Proposed section 187 clarifies the issue of conflict of interest faced by directors where they are a director of two or more companies and to permit directors who serve on wholly owned subsidiaries, to take into account the interests raised by the nominating company, in addressing their tasks.

6.18 The proposed new provision is designed to give directors some certainty in the performance of their obligations as the problem of conflict of interest is potentially one that will increase given the growing complexity of corporate groups and the limited pool of people from which directors are drawn in Australia, resulting in many directors of public companies taking on multiple directorships.

6.19 The proposed provision is based on S.131(2) of the New Zealand Companies Act 1993 and gives legislative expression to the current state of the common law in this area.

6.20 Proposed section 187 provides that a director of a wholly owned subsidiary is taken to act in good faith in the best interests of the subsidiary where the constitution of the subsidiary expressly authorises the director to act in the best interests of the holding company, and the director has acted in good faith in the best interests of the holding company.

6.21 The proposed section limits the operation of the provision to where the subsidiary is solvent at the time the director acts and does not become insolvent because of the directors action. The purpose of this limitation is to protect the interests of creditors of the subsidiary.

Reliance on Information Provided by Others and the Delegation of Responsibilities

6.22 Doubts have been expressed about the extent to which it is permissible for directors, non executive directors in particular, to delegate functions to, and rely on, advice and information provided by others. Uncertainty about the circumstances in which it is appropriate for a director to delegate to, or place reliance on the advice of others could lead to an overly conservative approach to management and could impede the decision-making processes within a company. This is a less than optimal outcome and is not conducive to the development of sound corporate governance practices such as putting in place appropriate board committee systems. To remedy this, it is proposed to provide specific legislative authority for delegation and reliance by directors.

Reliance by directors on information and advice provided by others

6.23 Under proposed section 189, in determining whether a director has fulfilled their duties as a director in relying on information, professional or expert advice, provided by others, it will be presumed that reliance by a director is reasonable if the director:

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acted in good faith (proposed paragraph 189(b)(i)); and

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made proper inquiry if the circumstances indicated the need for inquiry (proposed paragraph 189(b)(ii)).

6.24 The protection afforded by the proposed provision to a director in relying on information or advice provided by others will be limited to proceedings brought to determine whether a director has performed a duty under the proposed Part, or an equivalent general law duty.

6.25 The presumption that the directors reliance is reasonable, is rebuttable the directors reliance on the information or advice is taken to be reasonable in the circumstances set out above, unless the contrary is proved.

6.26 Proposed subsection 189(a) will provide that in exercising their powers or performing their duties under the proposed Part, or the equivalent general law duty, a director may rely on information or professional or expert advice supplied by:

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an employee of the corporation whom the director believes on reasonable grounds to be reliable and competent in relation to the matters the subject of the employees advice (proposed paragraph 189(a)(i)); or

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professional advisers or experts where the director believes on reasonable grounds that the relevant matters are within the persons professional or expert competence advice (proposed paragraph 189(a)(ii)); or

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another director or officer in relation to matters within the directors or officers designated authority advice (proposed paragraph 189(a)(iii)); or

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a committee of directors on which the director did not serve in relation to matters within the committees designated authority advice (proposed paragraph 189(a)(iv)).

Delegation

6.1 Proposed section 190 provides specific legislative authority as to the circumstances in which the board of directors may validly exercise their powers or perform their duties by delegating to others.

6.2 Under proposed subsection 190(1) a director will be responsible for the exercise of the power by the delegate as if the power had been exercised by the directors.

6.3 However, under proposed subsection 190(2), a director will not be responsible for the acts of the delegate if the director believed:

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on reasonable grounds at all times that the delegate would exercise the power in conformity with the duties imposed on directors of the company by the Law and the companys constitution; and

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that the delegate was reliable and competent in relation to the power delegated. The directors belief must be based on reasonable grounds, arrived at in good faith and after making proper inquiry, if the circumstances indicated the need for inquiry.

6.4 If the delegate acts fraudulently or outside the scope of their delegation, provided a director has fulfilled the above requirements, they will be taken (in so far as they have relied on the delegate) to have fulfilled their duty as a director.

Right of Access to Company Books

6.5 Proposed section 198F is designed to ensure that directors (and former directors) will have sufficient legally enforceable rights of access to company documents.

6.6 At common law, a director has a right of access to all company information necessary to enable the director to discharge his or her fiduciary or statutory obligations ( State of South Australia v Barrett (1995)
13 ACLC 1369 , 1372, 1376; Kriewaldt v Independent Direction Ltd (1995)
14 ACLC 73 , 75). However, such information may only be used by the director for the purposes of the company (Barrett, supra, at 1372, 1376; Kriewaldt, supra, at 76). For example, if a director is being sued by the company for an alleged breach of duty owed to the company, it can be difficult for the director to demonstrate that access to documents (perhaps crucial to their defence) would be for the purposes of the company. This can particularly be a problem for retired directors.

6.7 Proposed section 198F will allow current and retired directors a legally enforceable right of access at all reasonable times to the books of the company in which they are or were a director (proposed subsections 198F(1) and (2)). The right of access is to continue for a period of 7 years after a person ceases to be a director of the company (proposed subsection 198F(2)).

6.8 The right of inspection (other than for financial records) is limited to where the director requires access for the purposes of a legal proceeding to which the director is a party, or proposes in good faith to bring, or has a reasonable belief will be brought against them (proposed subsection 198F(1).

6.9 A person authorised to inspect the books of the company for the purposes of a legal proceeding may make copies of the books for the purposes of the proceedings (proposed subsection 198F(3)). The company must not refuse access to a person in the exercise of their rights to inspect or take copies of the books (proposed subsection 198F(4)).

Rewrite

6.10 The draft provisions will rewrite without substantial change the existing provisions of the Law about Officers (Part 3.2), Related Party Transactions (Part 3.2A), Oppression (Part 3.4) and Civil Penalties (Part 9.4B). The following paragraphs outline the more significant changes proposed to be made to these provisions in the course of rewriting them.

Material personal interests

6.11 Current section 231 requires a director of a proprietary company to disclose at a directors meeting interests in contracts and proposed contracts in which the director is either directly or indirectly interested and offices or property held by the director which might give rise to future conflicts of interest. It does not seem appropriate to confine this disclosure obligation to contracts, proposed contracts, offices and property. Other conflicts may be just as prejudicial to the companys interests. Subject to the exceptions set out below, it is proposed to apply the disclosure obligation to any material personal interest a director has in a matter relating to the affairs of the company.

6.12 Under current section 232A, a director of a public company must not vote on a matter in which the director has a material personal interest, and must not be present when the matter is being considered by the board. The board or ASIC may permit the director to vote or participate in the boards consideration of the matter. However, the director is not required by the Law to disclose that they have an interest in a matter before the board. It is proposed to remove this anomaly by requiring that the directors of public companies must always disclose matters in which they have a material personal interest.

6.13 These two changes would bring into line the basic disclosure obligation of directors of public and proprietary companies.

6.14 Proprietary company directors are currently able to fulfil their disclosure obligation in relation to any future contracts between the company and other companies or firms in which they have an interest by giving the other directors a general notice setting out the nature and extent of their interest in those other companies or firms (current section 231). It is proposed to make this procedure available to both public and proprietary company directors and in relation to all matters, not just contracts. The notice will expire if a new director is appointed to the board and the new director is not given the notice. The notice will have effect again as soon as it is given to the new director.

6.15 Current section 231 does not apply to a directors interest in certain contracts. Similarly, under current section 232A, a director is taken to not have a material personal interest in certain insurance contracts. It is proposed to apply each of the current exceptions in sections 231 and 231A to the directors duty to disclose conflicts of interest and, in the case of public company directors, absent themselves from certain board meetings.

6.16 In recognition of the closely held, often family, nature of many proprietary companies, a director of a proprietary company will not be required to give notice of conflicts of interest where the other directors are aware of the nature and extent of the directors conflict of interest.

Company secretaries

6.1 The First Corporate Law Simplification Act 1995 allowed the registration of proprietary companies with one director and one member. The requirement for proprietary companies to appoint a company secretary is an unnecessary regulatory burden. It is also inconsistent with the goal of allowing the registration of single-person companies (unless the same person is appointed as both director and secretary). New Zealand and Canada no longer require companies to appoint a secretary. It is therefore proposed to remove the requirement for proprietary companies to appoint a secretary. However, public companies will continue to be required to appoint a secretary in light of the importance of the corporate governance function played by the secretary in these companies.

6.2 It is proposed to amend the rules about when a secretary will be liable for a companys failure to comply with its statutory obligations to:

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maintain a registered office;

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keep its registered office open to the public during certain hours (the Company Law Review Bill will repeal this obligation for proprietary companies);

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lodge an annual return with ASIC; and

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lodge notices about the personal details of its directors and secretaries with ASIC.

6.3 Current subsection 83(2) provides that a secretary is deemed (unless the contrary is proved) to be knowingly concerned in and party to any contravention by the company of these obligations. The secretary will be guilty of an offence unless they can show that they were not knowingly concerned in the companys contravention.

6.4 It is proposed that current subsection 83(2) be replaced by a requirement that the secretary ensure that the company complies with these obligations. The secretary will have a defence if they can show that they took all reasonable steps to ensure that the company complied with the obligation. In the case of a proprietary company that has not appointed a secretary, each director will be guilty of an offence, and have available the same defence, if the company fails to comply with its obligations.

Related-party transactions

6.5 Part 3.2A of the Law regulates related party transactions involving public companies. It is proposed to make minor policy changes in the following areas:

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definition of related party;

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reasonable remuneration; and

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consequences of contravention.

Definition of related party

6.1 The definition of related party includes entities which control the public company. However, control is currently defined by reference to the accounting standards. It is therefore necessary for users of the Law to refer to external material to understand their obligations under the Law. It is proposed to overcome this by inserting into the Law a test for control based on the accounting standards.

Reasonable remuneration

6.2 The Law currently exempts reasonable remuneration given to an officer from the related-party provisions.

6.3 The reasonable remuneration that may currently be given to an officer includes an indemnity or insurance premium in respect of a liability incurred as an officer. In the light of suggestions that it is not appropriate to count these indemnities and insurance premiums as remuneration, it is proposed to include a separate section exempting from the requirement for shareholder approval a reasonable indemnity or insurance premium given to an officer who is a related party. The reasonableness of the indemnity or premium would also be assessed as at the time the company agrees to make the payment, not when the payment is actually made under the indemnity or insurance contract.

Consequences of contravention

6.4 Currently, a related party who is given a financial benefit in contravention of the prohibition contravenes the Law even though they may not have sought the benefit. It is proposed to provide instead that a related party contravenes the Law only if they are involved in the contravention of the related-party provisions.

Civil penalty provisions

6.5 The draft provisions contain a rewrite of the civil penalty provisions in Part 9.4B of the Law. The civil penalty provisions apply to contraventions of certain specified sections (such as the duty on directors to prevent insolvent trading). If a person has contravened these provisions, the Court can make the following orders:

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a declaration that the person has contravened the provision;

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an order disqualifying the person from being a director or officer of a company for such period as it thinks fit; and

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if the contravention is serious, a pecuniary penalty payable to the Commonwealth of an amount up to $200,000.

6.6 A contravention of a civil penalty provision may also give rise to a criminal offence, if the contravention is accompanied by dishonesty. The civil penalty provisions currently include a number of complex provisions designed to address the situation where a prosecution for the criminal offence has failed, but the court is satisfied that there has been a contravention of the relevant civil penalty provision. In these circumstances the court is currently able to make a civil penalty order. It is proposed to repeal these provisions. Instead, where a criminal prosecution has failed, ASIC would have to commence fresh proceedings to obtain a civil penalty order.

6.7 Currently, the commencement of proceedings for a civil penalty order is a bar to a subsequent prosecution for the corresponding criminal offence. This is intended to prevent evidence obtained in the course of the civil proceedings being used in subsequent criminal proceedings. However, the rule does not operate as a bar to commencing criminal prosecutions under other Acts (for example, the Crimes Act ). It also provides a significant disincentive for ASIC to commence civil penalty proceedings.

6.8 It is proposed to repeal the bar and provide instead that evidence given in the course of proceedings for a pecuniary penalty order is not admissible against the person in a prosecution for a criminal offence constituted by substantially similar conduct. This is designed to prevent the evidence being used in the prosecution of any offence involving substantially similar conduct, not merely in the criminal prosecution of offences established by the civil penalty provisions. It will also allow a later prosecution to commence where this would be appropriate, without prejudice to the defendants right to a fair trial because of the earlier proceedings for a pecuniary penalty order.

6.9 It is proposed to remove the power of a criminal court to make a compensation order against a defendant who has not been found guilty. This will make it necessary for ASIC to begin fresh civil proceedings if it wishes to pursue civil remedies following an unsuccessful prosecution.

Oppression

6.1 It is also proposed to rewrite the oppression remedy without making any significant change. It is proposed to make three minor changes to the oppression namely:

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to make it clear that the Court will be able to make orders even if the act, omission or conduct complained of has yet to occur or has ceased;

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if the Court orders the company to be wound up, the provisions relating to a company being wound up by the court under section 461 of the Law are to apply; and

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to repeal the existing prohibition on making a winding-up order where that would unfairly prejudice the oppressed members, because this is an unnecessary fetter on the Courts discretion.

Consequential Amendments to the Commonwealth Authorities and Companies Act 1997 (the CAC Act)

6.1 The reforms to directors duties and corporate governance introduced by CLERP will apply to Commonwealth companies (defined in section 34 of the CAC Act as Corporations Law companies in which the Commonwealth has a controlling interest). The CAC Act will be amended to apply the reforms, where appropriate, to Commonwealth authorities (defined in sections 5 and 7 of the CAC Act).

6.2 For example, directors of Commonwealth authorities will be able to rely on a statutory business judgment rule which will offer them a safe harbour from personal liability for breaches of the duty of care and diligence in relation to honest, informed and rational business judgments. In the case of Commonwealth authorities a business judgment is one which relates to a matter concerning any of the operations of the authority.

6.3 Other modifications to maintain alignment with Corporation Law reforms include clarification:

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of the standard of care and diligence in relation to the circumstances of an officer;

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that a breach of the duty of care and diligence will only give rise to civil sanctions;

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that directors may rely on a delegation of their functions (where appropriate under a Commonwealth Authoritys enabling legislation) and on the advice of experts;

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of the existing duty of honesty to reflect the fiduciary nature of directors duties.

6.4 Various amendments are proposed to the CAC Act to align its provisions (where appropriate) with the proposed rewrite of the Law about Officers, and Civil Penalties. In relation to the disclosure of, and voting upon, material personal interests, the following consequential amendments are proposed to the CAC Act:

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a director who has a material personal interest in a matter will be able to give the relevant board a standing notice of the nature and extent of the interest;

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where a board is unable to form a quorum because of conflicts of interest and a matter is urgent, or there is some other compelling reason for the matter to be dealt with at the directors meeting, the responsible Minister will be able to resolve the matter by authorising directors to vote on the particular matter despite their conflict of interest; and

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the responsible Minister will be able to make a class order in respect of a specified class of Commonwealth authorities, directors, resolutions or interests to enable directors who have a material personal interest in a matter to be present while the matter is being considered at a directors meeting, to vote on that matter, or both be present and vote.