Family business does not equal small business. Many boards of large family companies are comprised of professional family, executive and non-executive directors. However, not all family boards are put together this way. In fact many first generation family businesses will only have one director.
In 1995 the Corporations Act was amended to abolish the requirement for a company to have a minimum of two directors. Prior to this change, the boards of many family companies included a passive director, often a spouse. It is important to note however that a company's constitution (or a shareholder's deed) may still provide that a company requires two or more directors.
Notwithstanding the change in the law, many family companies still have boards which include passive directors. The law relating to directors of large public companies applies equally to directors of family companies. The law provides that directors have a number of duties including a duty of care and diligence. That duty requires a director to be actively involved in the management of a company. This typically involves supervision and oversight of the managers of the company. A director must also understand the affairs of the company so that the director can form an opinion about its financial position. It follows that the director must be able to read and understand the financial reports of the company.
Directors must not be passive. The leading case regarding passive directors relates to insolvency. A director has a duty to prevent insolvent trading by a company. In Deputy Commissioner of Taxation v Clark , the Commissioner brought proceedings against a director of an insolvent company seeking payments for group tax. The director was found personally liable and ordered to pay the ATO $208,000. The facts of the case are worth considering:
Mr Clark and another director were directors of the company. Mrs Clark became a director at the request of her husband when the other director resigned. Her appointment was based on her husband’s belief that the company needed to have two directors.
Mrs Clark lacked any business experience and had never been a director of a company before. As part of her role she often signed company documents that were not explained to her. In her words she would usually have “a frying pan in one hand and be signing with the other”.
Mrs Clark tried to rely on a statutory defence that at the time the relevant debt was incurred she had good reason not to be involved in the management of the company. Her argument was that she relied completely on her husband to conduct the affairs of the company. This argument was rejected and Mrs Clark was found liable.
It would be wrong to think that Clark is limited in its application to wives in family businesses. The director in Mrs Clark’s position could have been the husband or a partner. The principle is the same. A director cannot argue he or she was not involved in the management of a company on the basis that he or she relied completely on another person to conduct the affairs of the company.
As well as spouses and partners, the next generation needs to understand the duties and risks of becoming a director of a family company.
Family members who are appointed as directors of family companies primarily because they are family must understand their legal obligations as directors. Families should support the training of family members taking up board positions - especially in financial matters.
Furthermore, family members should take a professional approach to managing the risk of liability as a director. Common strategies include seeking an indemnity from the company (to the extent permitted by the Corporations Act 2001 (Cth)), and requesting the company maintain directors’ and officers’ insurance. Professional directors will usually insist on a Deed of Access Indemnity and Insurance from the company covering these and related matters.
In conclusion, directors of family companies should ensure they prepare themselves for the responsibilities of being a director, discharge their duties and take steps to mitigate the legal risks of being a director. In the eyes of the law there is no place on the board of a family company for directors who see their role as a mere formality.