Article Summary
We explore the legal distinction between directors’ duties and shareholders’ rights, highlighting why ownership does not equate to control. It outlines how clear governance structures can reduce risk and prevent disputes in closely held companies.
In family-owned and closely held businesses, it is common to assume that those who own the company are also the ones in control.
Directors carry significant legal responsibilities under (The Act) and under the common law. While most directors have a general awareness of these duties, the practical divide between director authority and shareholder power is often misunderstood.
This is particularly true in closely held and family-owned companies, where ownership and control are commonly treated as interchangeable.
That assumption can be risky.
When governance boundaries are unclear, disagreements can escalate quickly. Directors may find themselves exposed to personal liability, while companies can face internal conflict, regulatory scrutiny and expensive disputes that could have been avoided with clearer structures and expectations in place.
Directors’ Duties: What the Law Requires
Directors’ duties arise under statute and common law. The statutory duties in the Act largely codify existing common law principles rather than replace them.
Duty of Care and Diligence (Section 180)
Section 180 of the Act requires directors to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise in the same position and circumstances.
Directors must be active and informed participants in decision making. They cannot simply approve proposals without proper consideration or defer unquestioningly to management, advisers or dominant shareholders.
In Australian Securities and Investments Commission v Rich (2009), the Court emphasised that directors are required to make properly informed decisions, which includes appropriate scrutiny and verification of material information.
The ‘business judgment’ rule in sections 180(2) and (3) provides a defence where a director makes a business judgment in good faith, for a proper purpose, without a material personal interest, and on an informed basis. However, the rule does not protect directors who fail to turn their minds to the decision at hand.
Duty to Act in Good Faith and for a Proper Purpose (Section 181)
Directors must act honestly in what they genuinely believe are the company’s best interests, and exercise powers for their intended purpose.
This duty mirrors the common law fiduciary obligation of loyalty. Acting to advance the interests of a particular shareholder, family member or related entity at the expense of the company may constitute a breach, even if the director believes they are acting pragmatically.
In DTM Constructions Pty Ltd (t/as QA Developments) v Poole (DTM v Poole), the Court reinforced that directors must exercise independent judgment and cannot subordinate the company’s interests to external influences, including shareholder pressure.
Improper Use of Position (Section 182) and Information (Section 183)
Sections 182 and 183 prohibit directors from improperly using their position or information obtained through their office to gain an advantage for themselves or another person, or to cause detriment to the company.
These duties continue to apply even after a director ceases to hold office. In DTM v Poole, the Court reaffirmed that directors must not leverage their role to prefer personal or associated interests.
Criminal Liability (Section 184)
Conduct involving dishonesty, recklessness or lack of good faith can attract criminal consequences. The Act distinguishes between civil obligations and more serious dishonest conduct requiring proof beyond reasonable doubt.
Duty to Prevent Insolvent Trading (Section 588G)
Directors must prevent a company from incurring debts while insolvent, or when there are reasonable grounds to suspect insolvency. Breach of this duty can result in personal liability for company debts, civil penalties and disqualification.
Directors vs Shareholders: Why the Distinction Matters
A recurring point of confusion arises around who makes what decisions in a company.
Section 198A of the Act is a replaceable rule stating that the business of a company is to be managed under the direction of the directors. In practice, this means directors control the day-to-day management, strategic direction and operational decisions of the company.
The role of shareholders is different in both function and scope. Their role is to exercise specific rights through the legal and governance framework of the company.
This distinction is often misunderstood in companies where ownership and control are seen as interchangeable. Many disputes arise because shareholders assume they can direct outcomes simply by virtue of their shareholding.
How Shareholders Exercise Power
Shareholders exercise their authority primarily through resolutions passed at general meetings. Their key statutory powers include:
- Appointing and removing directors;
- Amending the constitution by special resolution; and
- Approving major corporate changes such as winding up or significant structural transactions.
Outside of these specific areas, shareholders generally cannot interfere with day-to-day management. If shareholders are unhappy with how the company is being run, their remedy is usually to change the board, not to override board decisions directly.
The scope of shareholder power can also depend on several factors, including the class of shares held, the company’s Constitution and any Shareholder Deed.
Why Governance Documents Matter
Good governance is built on more than good intentions, it depends on clear documentation that defines how decisions are made. A company’s Constitution and Shareholder Deed do more than set expectations, they set the foundation for accountability and effective decision making.
If a company does not adopt a Constitution, all replaceable rules under the Act apply by default. A company may replace all or some of those rules by adopting a Constitution.
A Constitution can clarify how directors are appointed, how decisions are made and which matters require shareholder approval. However, Constitutions are often relatively high level.
A Shareholder Deed plays a more detailed role. It governs the rights and obligations of shareholders and often regulates:
- Exit mechanisms and transfer restrictions;
- Deadlock and dispute resolution processes; and
- The relationship between shareholders and directors.
Critically, a Shareholder Deed should clearly distinguish matters reserved for the board from those requiring shareholder approval, and specify the level of majority required to pass particular resolutions.
Need Assistance?
If you have any questions about the above, or would like assistance drafting or reviewing your Constitution or Shareholder Deed, please contact our Business and Corporate Advisory team.
For further information contact Managing Director Ben Gouldson.
The assistance of Lawyer Melanie Sharpe in researching this article is gratefully acknowledged.
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