Directors' duties

Following on from recent posts, this week's post is again extracted (with thanks) from the Chairman's Red Book.

Shareholders have pooled their funds for a common purpose - to conduct an enterprise that they presumably could not afford to conduct on their own. The role of a company director is to guide and grow the business, observing the duties described below.

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Chairman have a particular role to lead the board and to establish an environment in which executive management can successfully execute the strategy set for the company by the board.

As those ultimately responsible for the company's actions and the shareholders' funds invested in the company, directors are subject to a strict set of duties, reflecting the position of trust they hold.

An ability to fulfil these duties while successfully growing the business is the mark of a good company director; a clear understanding of risk versus reward is essential.

In summary, directors have the following duties:

1. act in good faith in the best interests of the company
2. act for a proper purpose
3. act with care and diligence
4. not misuse information they receive in their role, or misuse their position, for their own or someone else's personal gain
5. avoid conflicts of interest, and
6. prevent insolvent trading.

Directors' duties have evolved over time. The above duties are now set out in statutes (primarily the Corporations Act), however, a body of case law expands upon the underlying legal and equitable principles. A company's constitution generally also sets out additional duties and obligations of the directors of the company.

As a general rule, directors owe their duties to the company, not the shareholders or creditors of the company. However, there are provisions in the Corporations Act under which a director can be liable to these stakeholders (e.g. liability for insolvent trading).

You might also be interested in The Chairman’s Red Blog, which is a supporting resource for the book.

Until next week.

Things to consider in relation to indemnities

Following on from recent posts, this week's post is again extracted (with thanks) from the Chairman's Red Book.

© Stuart Key | Dreamstime.com

The courts have recently applied a restricted view on the use of indemnities and in some cases, have failed to acknowledge the validity of broad, all-encompassing indemnities.  Notwithstanding this, claims under clearly expressed indemnities are generally upheld.

The following issues should be considered by anyone providing an indemnity -

1. the limitation of the loss (i.e. direct loss only and not consequential loss);
2. the scope of the indemnity (e.g. 'loss in connection with' compared to 'loss caused solely by');
3. excluding liability under the indemnity where the liability arises as a result of the indemnified party's default or negligence, or limiting it to the extent it has been contributed to by the party;
4. making the indemnity subject to any exclusions or limitations of liability within the agreement;
5. requiring the indemnified party to mitigate its loss; and
6. including a right for the indemnifying party to defend any claim for which it will be liable as a result of the indemnity.

It is common practice for a buyer to request a separate tax indemnity in share sale agreements.  This is primarily so that the respective obligations of the parties in relation to tax, including as to timing, are clearly and specifically identified. 

It is also common for 'gross up' provisions to be included in these indemnities which account for the tax payable in respect of warranty payments.  Consideration should be given to whether it is appropriate for the parties to agree contractually that any warranty payments are to be treated as a reduction of the purchase consideration.

You might also be interested in The Chairman’s Red Blog, which is a supporting resource for the book.

Until next week.

Indemnities

Following on from recent posts, this week's post is again extracted (with thanks) from the Chairman's Red Book.

© Stuart Key | Dreamstime.com

An indemnity is an undertaking to meet a specific potential liability, or to hold someone 'harmless', on the happening of a particular event, similar to the obligations of an insurer on the happening of an insurable event.  Indemnities provide a clear allocation of risk in respect of an event.

The scope of the indemnity provided under an agreement should be carefully considered by the indemnifying party and the trigger for the indemnity clearly understood.  Depending on the wording of the indemnity, the amount that is claimable under an indemnity may not be limited by the usual common law requirement of remoteness, or any requirement of the indemnified party to mitigate loss. 

Similarly, the indemnity may be open ended and not subject to any limitation or exclusion under the agreement, and in some cases the event need not have been caused by any wrong of the indemnifying party.

Next week’s post will look at some of the issues to consider in relation to indemnities.

You might also be interested in The Chairman’s Red Blog, which is a supporting resource for the book.

Until next week.

What is a warranty?

Following on from recent posts, this week's post is again extracted (with thanks) from the Chairman's Red Book.

A warranty is essentially a guarantee that a factual statement is correct.  Parties will often negotiate to allocate liability for loss between them if the statement turns out to be incorrect.

In a merger and acquisition context, warranties are generally required where a party (often the buyer) makes an assumption when entering into an agreement, and wants to be able to sue the seller if that assumption is incorrect. 

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For example, where a buyer has determined the purchase price of the target company or business on the basis of its reported earnings, the buyer will usually require the relevant financial statements to be warranted by the seller so that the seller bears the risk of the financial statements being inaccurate.

Warranties are usually 'given' within the sale agreement by the warranting party at the time of entering into the agreement, and repeated at completion.  It is also common to see a statement to the effect that the warranties are taken as being repeated each day during the period between signing and completion.

‘Standard’ warranty limitations include -

1.  Seller's knowledge

2.  Disclosure

3.  Exclude future performance

4.  Buyer's knowledge

5.  Recovery from 3rd parties

6.   Specific (ie provided in the accounts; buyers action post completion; law changes; matter of public record)

7.  Insurance

You might also be interested in The Chairman’s Red Blog, which is a supporting resource for the book.

Until next week.