Question

OzFarm Pty. Ltd. would also like to raise finance to fund the purchase of a block of farm land to expand its business. It is proposing to borrow $2 million from Big Bank using the building as the security for the loan. The two directors, Mitch and Match are in oblivion to the fact that the company is experiencing a downturn in demand for organic produce due to the increasing unemployment as a result of the economic recession in the COVID crisis. OzFarm already had existing debts to the tune of $300,000 owing to a large supplier, Pallet Pack. In order to reduce this debt, the directors are using the line of credit worth $50,000 (similar to using the credit card). A few months down the track, it is becoming clear to the directors that they would be running out of cash shortly, given the demand for their products have decreased significantly.

Advise whether the directors have breached any of their required directors’ duties and if so whether they can rely on any defence?​​

Answer 1

The law has attached certain duties upon the directors. Among them is the duty of care. This duty means that the directors should act carefully while taking business decisions and act as if a prudent men will act. In case of duty of care, the directors must have full knowledge of the business, its liabilities, risks and other corporate affairs. In the above case the directors are very well aware of the financial position of the firm which i not at all healthy. The economic recession has further deteriorated the business activity. The firm is already short on cash and will soon run out of any cash available. This situation needs due care by the directors in making a decision about not to purchase a building by taking loan. There are clearly no resources available to pay off the loan. The firm is already having a liability towards a supplier which it will not be able to pay. Taking a look under these circumstances the directors are clearly violating their duty of care towards the company. They are acting with gross negligence when it comes to taking loan.

Now as regards the availability of any defense available to directors from incurring personal liability, we can say that yes they have some defense. The court cannot held them liable personally just on the ground that they breached the duty of care. There is no such model of perfect behavior or decision making present for the directors. The states have enacted laws which to some extent can limit or eliminate the personal liability. So we can say that yes there is some relief available to directors even if they breach duty of care.