Nominee Directors

Between a rock and a hard place

Nominee directors are those appointed to the board of a company to represent the interests of a stakeholder. The stakeholder may be a shareholder, creditor or even an employee.

The question that troubles many nominee directors is, “when, if at all, can I act in the interests of my appointor?”.

Take the following example:

  • George is a director of Good Pty Ltd (“Good”).
  • He was nominated to his position by OK Pty Ltd (“OK”) which is a shareholder of Good.
  • The Board of Good is meeting soon to discuss and vote on a proposed acquisition of another company.
  • OK stands to make significant profit from the acquisition, as it is also a shareholder in the target company.
  • George is unsure whether he can approach the matter with an open mind and wonders whether he should excuse himself from voting.
  • Good Pty Ltd’s constitution does not offer George any guidance about what he can do.

There can be many variations on this theme.  George may be a director of his nominator OK.  He may also be a shareholder of OK, and have a personal interest in the outcome of the proposed acquisition.  There could be a shareholder’s agreement for shareholders of Good which addresses the role of a nominee director, but in the example above it is assumed that there is no agreement.

Duties of a Director

Directors of companies have numerous and substantial duties both under the Corporations Act and at common law (unless common law duties are excluded by the Constitution or other agreement).  Some of the main duties of a director under the Corporations Act are:

  • To exercise powers and discharge duties with the degree of care that a reasonable person would exercise subject to a business judgment rule (section 180).
  • To act in good faith in the best interests of the corporation, and for a proper purpose (section 181).
  • Not to improperly use the position as a director to gain an advantage for themselves or someone else or cause detriment to the company (section 182).
  • Not to use information gained as a director to gain an advantage for themselves or someone else, or cause detriment to the company (section 183).

A breach of any of these duties can give rise to a civil action for damages, or a civil penalty, or can also be the subject of a criminal prosecution (section 184).

The culmination of these duties, particularly the primary duty of a director to act in good faith in the interests of the company, means that above all else, George must have the best interests of Good Pty Ltd in mind when making any decision.  If George considers that the proposed acquisition is in the interests of Good, he should be able to participate in discussions, and vote, without a breach of duty.  However, if George has information gained from OK that the price may be inflated, or that the acquisition would not otherwise be in the interests of Good, he will face a dilemma.

Conflicts of Interest

Issues arise where a nominee director is required to reconcile their primary duty to the overall company and their duty as a representative of a particular class of stakeholder.  At common law, the fiduciary duties of a director include a duty to avoid a conflict of interest.  In the Corporations Act, this is dealt with in section 191 by requiring a director who has a material personal interest in a matter to give notice to the other directors.  This may be given as a standing notice (section 192).  In a proprietary company, if the interest is disclosed, a director may participate in meetings and vote in relation to a matter involving a conflict of interest (this is the effect of the replaceable rule in section 194) unless the constitution of the company provides otherwise.

In the case of a public company, there are prescriptive rules that govern the conduct of directors in positions of potential conflict (section 195). Directors must disclose any personal interests prior to voting on matters and must not vote or participate in discussions on a matter in which they have a conflict, unless the board has approved otherwise.

Wholly Owned Subsidiaries

The picture is a little clearer in the case of a nominee director of a wholly owned subsidiary who represents the interest of a holding company. The Corporations Act states that a nominee director is taken to have acted in good faith in the best interests of the subsidiary if, amongst other things, the constitution expressly allows the director to act in the best interest of the holding company.

If a subsidiary company’s constitution does not deal with the issue of nominee directors, it should be amended to do so to clarify the position of nominee directors.

The Corporations Act does not provide the same protection for nominee directors of non-wholly owned subsidiaries. In fact, there is very little guidance available.

George’s Dilemma

George’s primary duty is to act in good faith in the interests of Good Pty Ltd. There is clearly no way that he could approach the matter with an open mind, free of any competing interests. But that does not mean that George cannot vote. The legal principle is that George may act in the interests of OK Pty Ltd if he honestly and reasonably believes that the proposed acquisition by Good is also in the best interests of the company.

If George has information, likely gained from OK, that the acquisition may not be in the interests of Good, his position is difficult.  He could, in a manner similar to a director of a public company, declare a conflict of interest and refrain from participating in discussions or voting on the matter.  However, if he has information, which may have been gained confidentially from OK, that would be material to the consideration of the matter by the directors of Good, should he disclose this information?  His common law fiduciary duties may require this.  However, if information has been obtained in confidence from OK, this would also be a breach of fiduciary duty.  Because of the competing duties, it would probably satisfy his common law obligations if he does refrain from participating in meetings of directors of Good and voting in relation to the matter.  However, there is some uncertainty.

Company Constitutions and Shareholders Agreements

In the case of a nominee director of a wholly owned subsidiary of a company, two issues are likely to arise.  It would, as noted above, be desirable for the constitution to incorporate the provisions of section 187 of the Corporations Act to allow the nominee director to act in the best interests of the holding company.

In proprietary companies with a number of shareholders, there will always be the potential for conflicts of interest and potential breaches of duty by a nominee director as a director of the subsidiary in relation to disclosure of information etc.  It is possible for these issues to be addressed, at least to some extent, by suitable provisions in the constitution of the company and in a shareholder’s agreement.  These may make provision for:

  • the ability of a nominee director to disclose information to the stakeholder appointing the nominee director;
  • a nominee director to act in the interests of the shareholder appointing the nominee; and/or
  • limiting the duties of directors to those contained in the Corporations Act, and excluding common law duties.

Even with appropriate provisions in the constitution and/or a shareholder’s agreement, there may still be areas of uncertainty for a nominee director. However, appropriate provisions in a constitution or shareholder’s agreement may go a long way to resolving the dilemma in which a nominee director may be placed.

If a nominee director does breach a duty to a company, and is held to be liable in a civil action for consequences of the breach of duty, the company cannot exempt, or indemnify, the director for this liability (section 199A of the Corporations Act).  This is another reason to ensure that the duties of a nominee director are clarified by appropriate provisions in a constitution or shareholder’s agreement.

Taking one consideration with another, like the policemen in The Pirates of Penzance, a nominee director’s lot is not a happy one.

For more information, please contact:
Sandy Donaldson

Sandy Donaldson
Director
p.  +61 8 8124 1954
e.  Email me

This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Should you wish to discuss any matter raised in this report, or what it means for you, your business or your clients' businesses, please feel free to contact us.

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