Every company in New Zealand has at least one director. Most of these companies run small to medium sized businesses. Usually company ownership is recommended by a lawyer or accountant. But do all of these directors understand their obligations? Do these directors know that the Companies Act 1993 (“the Act”) places very specific duties as well as more wide ranging and general obligations on Directors? We have summarised these specific and general duties as follows:
A director in a company must perform the duties and obligations of a director. There is no option to be a “passive” director. You are obliged to perform your role and will be liable for the decisions made by the other director(s) even if you haven’t actually been involved in the decision.
2. Governance and Management
The director(s) govern the company. That means they supervise the management of the company. In most New Zealand companies the directors or one or two of the directors will also manage the company. That means overseeing the day to day activities of the company.
A director has a duty to act with the care, diligence and skill that a reasonable director would in the circumstances. The question may be asked whether the director has complied with this standard when making a decision. Therefore a genuinely held but clearly stupid and reckless belief that a transaction was in the best interest of the company will not satisfy this standard.
3. Good Faith
A director has the duty to “act in good faith” and in what the director believes to be “the best interests of the company”. This means that the company’s interests and that of the shareholders as a whole (who own the company) take priority over the directors individual interests. This means a director:
- must not place his/her own interests over the company’s,
- must take particular care if transacting with the company them self,
- If employed by the company the terms of employment should be no more favourable than a non-director doing the same job (often directors will actually be employed on lesser terms!),
- shouldn’t compete with the company or otherwise place themselves in a situation of conflict with the company,
- should not use the information belonging to the company for his/her own purposes, and
- must exercise their powers for a proper purpose (commonly becomes an issue for a director who issues shares for their own favour or to favour a specific group of shareholders).
4. Reckless or insolvent trading
A director must not allow the company to trade recklessly or if the company is insolvent. Reckless trading is trading as a result of which the company’s creditors face a significant chance of substantial or serious loss. Insolvent trading is when the director allows the company to incur an obligation (to either pay money or perform a service) which the director does not reasonably believe the company will be able to perform.
It is recognised that at various times the directors will take a risk. Risk is acceptable provided the directors have carried out the necessary investigation into the transaction and reasonably believe the company will be able to honour its obligations.
As an example of the questions that a director should ask before entering into a transaction is the following extract from our template director’s resolution
(a) is not aware of any liquidation proceedings which have been commenced or intended to be commenced against the Company, and
(b) believes on reasonable grounds, having made appropriate enquiry, that the Company:
- is able to pay its debts as they become due in the normal course of business,
- is not engaged or about to engage in a business for which it is insufficiently financially resourced,
- will be able to perform its obligations under the transactions when and if required to do so,
- following the transactions it will still be able to pay its debts as they become due and will satisfy the solvency test (as defined in the Companies Act 1993), and
- has assets of greater value than its liabilities (including contingent liabilities).
5. Major transactions
These are transactions in which the company is buying or selling an asset or incurring a debt or a liability (say by an obligation to perform a service) which has a value equal to (or more than) half of the value of the company. For many companies this will be a very common transaction.
The director needs to get the approval of the owners of at least 75% of the shares before entering into such a transaction. Approval must be by a written resolution. The failure to get shareholder approval will mean the director is personally liable if the transaction turns sour.
6. Specific Duties
The director(s) have specific administrative duties contained. These include:
- Maintaining the company register (a record of share ownership, transactions involving the shares and directors’ declarations of interest),
- Declaring personal interest in a transaction (i.e. if the company was giving a guarantee of a directors personal borrowing – which is common with cross guarantees of small companies- the director should make their interest known in the resolution to be approved by the shareholders), and
- Disclosing share dealings (when a director buys and sells shares in the company).
7. Who are duties owed to?
The company itself, the shareholders individually and the shareholders as a group. This means an action can be brought by the company (perhaps by other directors or the receivers) and in some case shareholders on behalf of the company. Also specific obligations to shareholders can be enforced by those shareholders.
If the company is close to operating insolvently there are duties owed to the company’s creditors. This is generally a duty to consider the position of creditors when entering into a transaction and to not unfairly favour any creditor (especially shareholder creditors). The obligation to act in the best interests of the company is overlaid by the duty to its creditors.
Recent court actions against the directors of finance companies have illustrated that a director can become personally liable for his/her actions as a director if they have not satisfied their duties and obligations. The principle of limited liability continues to apply meaning that a director will only become personally liable however if they fail to comply with their duties (or if they personally guarantee the company’s obligations). Care needs to be taken to ensure that you are in fact doing your duty as a director. If you don’t want that responsibility you should avoid being a director.