When a local government operates a company, the governance structure can be complex, particularly in distinguishing between council decisions and company decisions. The constitutions of council-owned companies are often designed to ensure that the board of directors is predominantly composed of elected councillors, thereby aligning company decisions with council priorities. However, a significant challenge arises when there is a change in elected councillors. During this transition, uncertainty may emerge regarding the appointment and removal of directors. This article explores the governance issues faced by council-owned companies during such transitions.
The role of a company’s constitution
The Corporations Act 2001 (Cth) (“Corporations Act“) establishes the foundational legal framework for corporate governance in Australia. It includes “replaceable rules”, which act as default governance provisions for companies. However, for council-owned corporations, these replaceable rules are often overridden by the company’s constitution. This is particularly evident in provisions relating to the composition of the board of directors, as many council-owned corporations require that some or all board members also be serving councillors. The challenge with this approach arises during election periods when a change in local government occurs, potentially leading to a lack of active councillor directors within the council-owned corporation.
Under section 203AB of the Corporations Act, companies are prohibited from removing the last remaining director, a provision known as the “last man standing” rule. In such situations, if directors attempt to resign or vacate their office before replacements are appointed, the last director cannot step down entirely until a new board is in place, even if they are no longer actively involved in council decision-making. Crucially, the last director remains officially listed with ASIC and continues to bear the core legal duties of the role, including personal liability for the company’s debts and obligations. Therefore, it is essential to promptly establish a new board following any changes in local government to minimise the risks associated with an inactive or incomplete board.
Appointment of New Directors
In typical corporate governance structures, directors are appointed by the board of directors rather than the shareholder. However, when the board is not functional due to vacancies, the constitutions of council‑owned companies are often drafted so that the local government, as the sole shareholder, has the authority to appoint new directors. In this scenario, the local government can usually appoint new councillor directors to re-establish the board, although this depends on the specific wording of the company’s constitution. When there is a change in local government, councillors themselves must decide who will serve on the board.
The Role of Councillors
Councillors who sit on company boards typically have two roles to fulfill:
Councillors of the Shareholder
- A shareholder, also referred to as a ‘member’, is the owner of the company. For local governments holding fully paid shares, there is no further financial liability to the company, meaning the local government is not responsible for the company’s debts or obligations. In the absence of specific delegations regarding shareholder decisions, any decisions related to the shareholding must be made collectively by the full council.
Directors of the Company
- Unlike shareholders, directors bear significant responsibility for managing and overseeing the company. It is essential that councillors understand the considerable responsibilities and potential liabilities associated with serving as a company director. Any decision made by a councillor in their capacity as a director is a personal decision, not one made on behalf of the council. Directors can be held personally liable for actions such as allowing a company to continue trading while insolvent, mismanagement, failing to exercise reasonable care, skill, and diligence, or not acting in the best interests of the company. Councillors should be fully aware of these risks before accepting director roles.
- Councillors who wish to assume director roles must provide written consent to act as a director and must abstain from voting on their own appointment to avoid conflicts of interest.
- All councillors are required to update their register of interests with the Chief Executive Officer by 30 July each year, including positions held as executive officers of a corporation, such as a company director.
Reviewing and Updating Company Constitutions
The constitutions of council-owned companies often specify the composition of the board, including the number of councillor and independent directors. The benefit of having independent directors is that they provide objectivity and external perspectives on strategy, performance, and governance. However, a board with a majority of councillor directors tends to better align with the governance model preferred by local governments, ensuring that council priorities are well-represented.
Councils should review the constitutions of their companies to ensure the governance structure aligns with their desired model. The composition of the board should reflect the intended balance between elected councillors and independent directors. If adjustments are necessary to better align with the preferred model, they should be carefully considered, as such changes may impact the local government’s level of control over the company’s decisions. Changes to the constitution of a company with a sole‑council shareholder can generally be made through a written resolution lodged with ASIC.
Conclusion
Effective corporate governance in council-owned companies requires careful consideration of the relationship between the local government, the company, and its directors. The governance structure, particularly the composition of the board, plays a critical role in ensuring that company decisions align with the priorities of the local government. However, transitions in local government introduce complexities in board composition. Councils must remain proactive in reviewing and updating company constitutions to address these challenges and ensure that the board structure reflects a desired balance between councillor and independent directors. By understanding the roles, responsibilities, and potential risks associated with directorships, councillors can navigate governance transitions more effectively, protecting both the interests of the local government and the long-term success of the company.
At Preston Law, we specialise in navigating the complexities of corporate governance, particularly the interplay between the Local Government Act 2009 and the Corporations Act. If you require assistance with reviewing company constitutions, establishing sound governance practices, or ensuring compliance with standards for transparency, ethics, and stakeholder engagement, our local government team is here to help. We also provide support in preparing documentation, including notices, minutes, resolutions, and ASIC lodgments.