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Brief Counsel

Jail time for serious breach of directors' duties

25 October 2011

​The risks attached to being a director will increase if legislation introduced last week to criminalise serious breaches of directors’ duties is passed by the new Parliament.

The measure is contained in the Companies and Limited Partnerships Amendment Bill, which was among the flurry of Bills introduced this month by outgoing Commerce Minister Simon Power as he cleared his desk before leaving politics.

This Brief Counsel looks at the proposal and discusses its potential implications. 

Directors’ duties

The introduction of criminal offences for serious breaches of directors’ duties has a long and nomadic history.

It was first raised in the June 2010 discussion document to launch the Securities Law Review and featured briefly in the exposure draft Financial Markets Conduct Bill before being transferred to the Companies and Limited Partnerships Amendment Bill.

This Bill is primarily concerned with tightening the rules around company registration, Chapman Tripp’s commentary on which is available here

The directors’ duties provisions amend the Companies Act 1993 by inserting a new section which provides for criminal sanctions.  Those criminal sanctions will apply only to a breach of two of the existing duties in the Companies Act:

  • the duty to act in good faith and in what the director believes to be the best interests of the company, and 
  • the duty not to agree, cause or allow a company to carry on business in a manner likely to create a substantial risk of serious loss to the company's creditors.

A director will be criminally liable if he or she knows that conduct in breach of those duties is either seriously detrimental to the interests of the company or will result in serious loss to the company’s creditors.

Penalties are up to five years’ imprisonment or a fine of up to $200,000.

Chapman Tripp comments

The policy papers leading up to the introduction of the Bill recognise the tension between deterrence of intentional dishonest behaviour and the need to avoid deterring people from taking directorships and boards from taking legitimate commercial risks. 

As we said in an earlier publication, Directors’ duties – how much stick is too much stick?:

Clearly there will come a point at which the march toward criminalisation in the boardroom will deter people from becoming directors and will deter boards from making rational business decisions or will mean that they become so focussed on looking behind their backs and seeking expert independent input that they miss out on opportunities.

To address that concern, the government is proposing to criminalise only “knowing” and egregious conduct. 

This will mean that any prosecution will have to prove, beyond a reasonable doubt, that a director had actual knowledge (or wilful blindness) that his or her conduct was definitely causing or would definitely cause a particular effect.  This is a high threshold for any prosecutor to meet.  Liability will therefore be difficult to establish.

By requiring knowledge (tantamount to proving intention), we believe that the Bill strikes the right balance between deterring inappropriate conduct while at the same time avoiding discouragement for the right people from taking up directorships.

This balance is further enhanced by the fact that the government has not proposed “civil penalties”, such as those which apply in the securities context, for less serious breaches. 

Such penalties would lead to a sliding scale of culpability, which the Minister considered would then “put the regulator in the position of second-guessing the soundness of directors’ business decisions”.

Finally, the Bill excludes introducing any new criminal sanction for breach of a director’s duty not to agree to the company incurring an obligation unless the director believes, on reasonable grounds, that the company will be able to perform that obligation when it is required to do so. 

Criminalisation of the duty was proposed in the Minister’s February 2011 Cabinet Paper, but was omitted from the draft Bill because the Companies Act already contains criminal provisions for carrying on business fraudulently.

Our thanks to James Burt, Principal, for writing this Brief Counsel.

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