Macrossans Lawyers Brisbane law firm

What is Corporate Governance?

Presented by:
Bill Hickey, Partner
Thursday 8 June, 2006

Corporate Governance is the system by which companies are directed and controlled, encompassing:

• How a company is managed by a board
• The powers, duties and obligations of the directors and officers of the company to ensure accountability to shareholders and other stakeholders (employees, consumers, creditors and community at large).

A company is separate and distinct from its shareholders (the owners), with a division of power between the directors (the board) and the shareholders. The board is charged with the responsibility to manage the company and the directors owe their duties to the company rather than the shareholders.

• There are different types of directors: executive, non-executive, independent, shadow etc.
• The shareholders cannot instruct the directors as to how they should exercise their powers of management. Subject to any shareholders' agreement, shareholders' rights are limited to powers which can be exercised at general meetings of all shareholders of the company and relate to matters such as the makeup of the board, directors remuneration etc.
• The board can delegate authority and powers but not responsibility. There should be a clear distinction between circumstances where the board is making the decision and circumstances where the board has delegated its decision-making role to management. This distinction can become very "grey".
• How the company is run and the powers and duties of the directors are shaped by:
  - The Corporations Act and a myriad of legislative provisions that impose specific obligations on directors (eg Income Tax Act, workplace legislation, environmental legislation)
  - The constitution of the company, which is simply the rules by which the company is run (number of directors, provisions as to meetings, etc.
  - Structures set in place by the board to provide for effective delegation as well as creating some checks and balances. For larger companies this may include setting up committees.

Director/s' Duties

There is a specific statutory obligation on a director to exercise powers and perform duties:

• With due care and diligence
• In good faith and for a proper purpose.

As business has become more complex, more is expected from directors in the way they govern the affairs of companies to which large sums are being committed by way of equity or loan. Whilst it is acknowledged that people have different skills and therefore their duties may vary, ignorance and a failure to make appropriate enquiries does not protect a director against liability.

A classic small company situation is where a husband and wife are shareholders and directors. The case Deputy Commissioner of Taxation -v- Clark, dealt with the liability for insolvent trading of a wife who was a director of her husband's building company. The wife said she "signed what he asked her to sign with a pen in one hand and a frying pan in the other".

This was no protection for the wife as the Court held there was a core requirement of skill involving an objective test of ordinary competence or reasonable ability.

• Directors cannot use the position improperly to advantage themselves or to cause a detriment to the company
• Delegation - the board can delegate powers and authority but that delegation must be reasonable having regard to the reliability and competence of the delegate
• When acting and making decisions, the board relies on information that is supplied to them by consultants and employees. This reliance does not totally absolve them in that their role requires them to form an independent assessment as to the reliability of the information.

Shareholders Agreements

Consider who are the shareholders and what capital contribution are they making?

• If the venture may need further funding, on what basis will the shareholders contribute these funds - equity or loans?
• Set out the terms of any ongoing funding by shareholders:
  - Include the interest rate that is applicable by reference to a bank rate
  - When or what circumstances does the loan become repayable
  - If not established in the initial agreement between shareholders, it needs to be recorded at the time of the transaction.

The benefits of a shareholder agreement are:

• Financial obligations of the parties are made clear
• Other obligations and duties of the parties, such as work to be performed and assets such as IP to be supplied, are made clear
• In the event of a dispute, a mechanism can be provided to resolve deadlock
• Avoids problems that arise when these matters have not been agreed upon and recorded when the company starts up.

Insolvent Trading

The Corporations Act has provision by which a director can become personally liable for debts of the company.

Elements which give rise to personal liability for company debt include:

• A debt is incurred by the company
• A person is a director when the company incurs that debt
• The company is insolvent when the debt is incurred or becomes insolvent because the debt is incurred. Insolvency is the inability of the company to meets it's debts as and when they fall due
• When the debt is incurred, there are reasonable grounds for suspecting the company is insolvent or will become insolvent by incurring the debt.

Factors determining solvency:

• Determine debts due and payable
• Relevance of cash flow
• Asset position
• Arrangements with lenders (if this is being used as a defence, evidence of a third party source to advance monies needs to be strong).

If, after making appropriate enquiries, a director(s) suspects the company is or will become insolvent, he/she needs to take action.

For further information please contact:
Bill Hickey, Partner
Ph: (07) 3292 9723