In some cases, non-executive directors remain passive, taking no active role in the management of the organisation. This type of non-executive director is sometimes referred to as a 'sleeping' director. What is often misunderstood by non-executive directors, particularly in smaller or family run organisations, is that regardless of their status, both executive and non-executive or 'sleeping' directors must comply with the legal requirements and statutory duties pursuant to the Corporations Act 2001.
The duties
The Corporations Act 2001 requires that directors must:
- use the care and diligence of a reasonable person in the corporation's circumstances, in the same position and with the same responsibilities as the Director (s180);
- act in good faith in the best interests of the corporation and for a proper purpose (s181);
- not use their position improperly to gain an advantage for themselves or someone else or cause detriment to the corporation (s182); and
- not use improperly information obtained as a result of being a director to gain an advantage for themselves or someone else or cause detriment to the corporation (s183).
Actual cases
From a historical point of view, there was some acceptance by the Courts for the position of passive non-executive directors relying on their lack of specific knowledge of the corporation as a protection against breaches of directors' duties.
This position has changed in the economic fallout of the recession in the late 1980's with a number of insolvency cases during the 1990's leading to the current view on the role of non-executive directors.
In Morley v. Statewide Tobacco Services Ltd [1993] 1 VR 451 a husband and wife (both directors) owned a chain of tobacconists. When the husband died, the wife asked her son to carry on running the business. Under the son's control the business rapidly deteriorated and ended up in liquidation. The wife was sued by the main creditor for allowing the company to trade while insolvent, breaching her duty to act with care and diligence. Even though she was a passive or 'sleeping' director having no involvement in the running of the company, she was found personally liable for the debt to that creditor.
In Deputy Commissioner of Taxation v Clark [2003] NSWCA 91 the New South Wales Court of Appeal also considered the position of a housewife 'sleeping' director attempting to rely on non participation in the management of the company to avoid liability under the insolvent trading provisions of the Corporations Act. The Honourable James Spigelman, AC in his judgement referred to the trend in legislative development and case law with respect to the increasing expectation that directors will participate in the management of a company.
The judgement highlighted the point that the complete failure to participate in the management of a company, regardless of the reason, is inconsistent with the basic duty of a director to share in the management of a company and, furthermore, cannot be relied upon in defence of liability for insolvent trading.
Although, The Honourable James Spigelman acknowledged that Mrs. Clark became a director of her husband's company because there had to be two directors and that she relied on her husband completely to manage the company, he concluded that 'there is no justification for a doctrine, which would hold sleeping directors to be `de facto non-directors', who should be relieved of their liabilities'. The Court of Appeal allowed the appeal against her.
Non-executive directors are reminded that their role is a serious undertaking with legal responsibilities and consequences. The Courts have clearly indicated a willingness to impose high standards on directors' conduct and will not provide any leniency for non-executive directors or 'sleeping' directors where breaches of directors' duties occur.
The Courts expect non-executive directors to apply an independent and enquiring mind to the information provided to them by executive directors and officers of the organisation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.