Directors' Duties: Duty not to act for an improper purpose

One of the duties Directors have in managing the business affairs of the company is the duty not to act for an improper purpose.  How will you know if you are acting for an ‘improper purpose’? This duty is imposed to ensure that the powers of a Director are confined to the express and implied powers of the company. These powers are granted by:

1. the law;

2. the company’s constitution; and

3. the company’s by-laws.

In addition to promoting the interests of the company, the purpose for which the company was created must also be considered in determining whether or not a particular act is for an improper purpose.

Where a Director acts outside the scope of his or her powers, they will be deemed to be acting for an improper purpose.  An act of the Directors that is within the express or implied powers granted to them, but outside the scope of the powers granted upon them by the company’s constitution (or its by-laws) may be said to be an improper act. Ideally, compliance with this duty requires a Director to act in the interests of the company.  Acting in the interests of the company means acting to further the objectives and the purpose for which the company exists.

A Director must not use their position to obtain a profit or personal business advantage.  Taking a business opportunity from the company for personal gain is a perfect example of breaching the duty not to act for an improper purpose.  Voting for and consenting to a contract which a Director knows to be outside of the power of the company, is also a breach of this duty.

In Punt v Symons & Co Ltd (1903) 2 Ch 506 , the court held that the Directors abused their powers.  The Directors issued new shares to give voting rights to additional shareholders in order to secure the passing of a special resolution.  Similarly, in Howard-Smith v Ampol Petroleum Ltd [1974] AC 821 Directors were held to have abused their powers when they acted for the purpose of defeating the voting power of existing shareholders by creating a new majority, the issuing of shares must be exercised in the interests of the company as a whole.

Court’s intervention

A party with standing may ask the court to intervene and set aside the controversial act that is violating the Director’s duty not to act for an improper purpose.  However, it must first be established that the act violated the Director’s duty not to act for an improper purpose.  The court’s job is to look into the powers granted upon Directors and whether there are any restrictions placed on them.

In Mills v Mills (1938) 60 CLR 15, the Court determined that a transaction may be liable to be set aside dependent upon whether ‘but for’ the purpose, the Directors would have performed the act being challenged.  Essentially, if the act of the Directors was neither for the purpose of promoting the interests of the company nor for achieving the object for which the company was established, then the purpose of the act in question was not proper.  The Court's jurisdiction to intervene is founded on the theory that if the Directors' purpose is found to not serve the interests of the company, but to serve their own personal interests (or that of their friends or of a particular group of shareholders), they can be said to have abused their power Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285.

Effect of Breach of duty

A contract made in violation of a Director’s duty not to act for an improper purpose is voidable. This means that the act of the Directors may be invalidated.  In some cases, an act for an improper purpose may be ratified by the shareholders.  However, keep in mind that ratification may not be available in a meeting called for the purpose if it was entered into by an insolvent company to prejudice the creditors: Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722.

Similarly, an act may not be invalidated where a third party has no notice of the surrounding circumstances of the breach of duty.  If the third party can show that they contracted in good faith, the contract will be binding and operative: Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285. 

Key points

Whether you are a director or one of the shareholders, always remember, when in doubt to consult the company by-laws and constitution; these documents should always be your first point of reference for any questions involving powers and authority of directors.  Our attorneys are always on hand to help you interpret the by-laws, as well as assist you with drafting new ones.

What Should I Do Next?

Contact us if you would like further legal advice on your Duties as a Director.  Our lawyers at You Legal will be happy to assist you in whatever way we can.

* This blog is for general guidance only. Legal advice should be sought before taking action in relation to any specific issues.