Assignment Company Law - Directors' Fiduciary Duties...

UNIVERSITI TEKNOLOGI MARA MALAYSIA BACHELOR OF LEGAL STUDIES (HONOURS) 2009/2010 SESSION

DIRECTORS’ FIDUCIARY DUTIES ASSIGNMENT OCTOBER 2009

BY KHAIRUL IDZWAN BIN KAMARUDZAMAN / 2006146311

PREPARED FOR: BACHELOR OF LEGAL STUDIES (HONOURS) LAW 580 | LAW OF ASSOCIATION II | GROUP D ASSOCIATE PROFESSOR S.T. LINGAM

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Question: Critically discuss the fiduciary duties of company directors with reference to relevant case law and the provisions of the Companies Act 1965. Company directors are persons who are conferred with responsibilities to manage a company. Although in practice a company is run by its two organs namely the general meetings and the directors, most affairs and business of a company are managed by the directors who are empowered with several powers and duties to ensure that the company is run smoothly and ethically by the directors. One of the duties that company directors need to comply with is fiduciary duties. This is so as company directors are said to be in a fiduciary relationship with the company. When directors are in a fiduciary relationship with the company, they are prohibited from doing any acts deemed prejudicial to the company. In other words, by applying the judgment in Hospital Products Ltd v United States Surgical Corpn, directors cannot and should not use his position to receive personal gains. The traditional view is that the directors owed a fiduciary duty to the company. This is the reason why directors are prohibited from receiving personal gain from their status as directors in a company. The nature of the relationship i.e. fiduciary relationship between directors and a company rendered the directors to act for the best interest of the company. This point can be supported by looking at Section 132(1) of the Companies Act 1965 which states that a director must act in bona fide when exercising his powers for a proper purpose and that he must act in the best interest of the company. Nonetheless, there is an issue of whether the directors also owed fiduciary duties to other persons besides their fiduciary duties to the company. In relation to shareholders, the court decided in the case of Percival v Wright that the directors did not owe any fiduciary duty to disclose the negotiations made when they intended to purchase shares. However, this case also did not lay down any rules that directors of a company can never be in fiduciary relationship with shareholders.

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For instance, in Allen v Hyatt, the court held that the directors in the case had placed themselves in fiduciary relationship with some of the shareholders in an agency capacity. This case shows that even though in Percival v Wright the directors did not owe any fiduciary duties to the shareholders, the possibility that there exist a fiduciary relationship between directors and shareholders of a company cannot be denied. Apart from shareholders, the directors may also have a fiduciary duty to the employees. However, the situation in Malaysia as to the directors’ fiduciary duty to the employees is still unclear as according to Chan and Koh on Malaysian Company Law, the Companies Act 1965 ‘does not expressly provide that the directors of a company are to have regard to the interest of the company’s employees’ in the performance of their functions’. In exercising their fiduciary duties to the company, there are scopes that the directors need to act in accordance with. The scopes of the fiduciary duties are yet to be codified by the Malaysian legislators but the principle founded in cases based on the common law can be applied by virtue of Section 132(5) of the Companies Act. Section 132(5) of the Act reads, ‘this section is in addition to and not in derogation of any other written law or rule of law relating to the duty or liability of the directors or officers of the company’ and the word ‘rule of law’ can be interpreted as including the rule under the common law. Firstly, the directors are in a duty to act in the best interest of the company. This means that in exercising their powers as directors of the company, they must put the company first in all acts that they intend to do. Section 132(1) of the Companies Act reaffirms this duty as it states, inter alia, that a director of a company must exercise his powers in the best interest of the company. To illustrate this point, the case of Re Smith and Fawcett Ltd can be referred to. In this case, Lord Greene M.R. held in his judgment that the directors must act in good faith in what they consider is in the interest of the company. What his Lordship tried to say is that the director must act for the best interest of the company and what is deemed as the best interest of the company is for the directors to consider and not for the court.

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Another case that can be looked into is Re W & M Roith Ltd. In this particular case, Roith, a company director, had entered into a service contract with his company for the purpose of providing a pension for his wife in the event of his death and without taking into consideration whether the contract was for the benefit of the company. The court held that the whole object of the contract was not to be binding on the company as it was to benefit Mrs Roith and not the company. By analyzing this case, it can be seen that as Roith did not act for the best interest of the company as he acted for the interest of his wife, he had breached his fiduciary duty that is duty to act in the best interest of the company. That is why in this case, the court held that the contract was not binding to the company. Next is the duty to act for a proper purpose and not to act for a collateral purpose. Again, by looking at the provision of the Companies Act namely section 132(1), it states that a company director must act for a proper purpose. This duty is mainly concerns on the power of directors to issue new shares in an attempt to avoid takeover bids. However, the power of directors to issue new shares is restricted under section 132D. The provision provides that directors may issue new shares only with prior approval of the members in general meeting. In Hogg v Cramphorn Ltd & Ors, the articles of the defendant company empowered the directors to allot or dispose of the shares to persons on several terms and conditions and at times which the directors think fit. When there is an attempt to takeover the company, the directors worked out a scheme whereby 5707 new preference shares were allotted to a trust newly established for the benefit of the company’s employees. The board of directors made a loan of £5705 out of the company’s funds free of interest to the trustees to enable the trustees to subscribe and pay for the shares. The votes attached to the new shares coupled with those of the directors and their friends were sufficient to constitute a majority of the general meeting and as an outcome, the takeover was defeated. A shareholder of the company challenged the validity of the allotment. The court held that the directors had acted for an improper purpose and added that the power to issue shares was a fiduciary duty of directors. So, 4

when the issuance of shares was done for an improper purpose, the shares issued can be set aside. Similarly, in Howard Smith Ltd v Ampol Petroleum Ltd, the Privy Council held that those directors who use their fiduciary duty to issue shares for the purpose of destroying an existing majority or creating a new majority which did not previously exist had done so unconstitutionally and had breached their fiduciary duty to act for a proper purpose. In short, as long as it can be proved that the directors had acted for an improper purpose, the directors are said to have breached their fiduciary duty. Another duty of the directors is the duty not to fetter discretion. Under this duty, the directors are obliged to decide objectively and not to restrict their discretion in exercising their duties as directors. As there are neither statutory provisions nor case law pertaining to this duty in Malaysia, the principle under the common law can be applied. Under the common law, the rule regarding this duty of directors not to fetter discretion and to exercise independent judgment is governed by the case of Fulham Football Club Ltd v Cabra Estates plc which follows the decision in the Australian case of Thorby v Goldberg. In that case, it was held that directors may fetter their discretion if they had entered into an agreement and when the agreement was made, they had considered thoroughly that what they did was bona fide and it was done in the best interest of the company. Still, it remains unsure as to whether the Malaysian courts will follow the rule set in Fulham Football Club case. Besides duty not to fetter discretion, company directors also have a duty to avoid conflict of duty and personal interests. One of the main parts under this duty is the rule not to contract with the company. As a general rule, directors must not put themselves in a position where their duties to the company conflict with their personal interest. This prohibition subsists due to the fiduciary relationship existed between the directors and the company. As such, a director who breached his fiduciary duty by entering into a contract with his company still remains accountable to the company for any profit that he gained 5

from the contract even if the contract is not avoided either because the company chooses to affirm the contract or because of any other circumstances. This duty can be seen in the case of Aberdeen Railway Co. v Blaikie Bros where Lord Cranworth L.C. was quoted as saying that: “… And it is a rule of universal application, that no one having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting or possibly may conflict with the interest of those whom he is bound to protect. So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into.” However, this rule of not to contract with the company, or the non-conflict rule, can be modified by the company in accordance with statutory requirements. Section 131 provides that a director is not prevented from entering into a contract with his company in which he has an interest if the requirements of section 131 are complied with. Section 131 requires every director of a company to disclose to a meeting of the directors any interest which they may have in a contract or proposed contract with the company. To supplement this requirement, article 81 of Table A of the Fourth Schedule provides that the article of a company may prohibit a director from voting on any contract or proposed contract with the company in which he is interested. In addition, article 72(h) states that the office of a director shall become vacant if he fails to declare the nature of his interest as required by the Act. It shall be noted that failure to disclose by a director is an offence under section 131(8) of the Companies Act. Another rule under the duty to avoid conflict of duty and personal interests is the rule not to compete with the competing company. In common law, it seems that a director may engage in competing business as long as there is no express prohibition in the memorandum, articles or agreements of the company. This can be found in the case of Bell & Anor v Lever Brothers Ltd & Ors which referred to the case of London & Mashonaland Exploration Co Ltd v New Mashonaland Exploration Co Ltd. 6

However, in Malaysia, section 132(2)(e) provides that a director shall not engage in business which is in competition with the company except with the consent or ratification of a general meeting. This means that a director may involve in a competing business activity with the consent of the general meeting. In addition, any involvement in competing company must be declared at a meeting of the directors by virtue of section 131(5) of the Companies Act. The last rule is the rule not to make secret profits from the use of corporate assets, information or opportunities. This is due to the fact that as directors are in a fiduciary relationship with the company, they are prohibited from obtaining any profit out of their position. The rule is very strict in which although the company did not suffer any losses, they could still get all the profits received by the director. In Boston Deep Sea Fishing & Ice Co v Ansell, a director of a fishing company was asked to enter into a contract to purchase fishing vessels for the company. He entered into such contract with a third party which rewarded him with a commission. The director did not report to the company about the commission. Later, when he was asked to order some ices for the company, he ordered it from an ice company of which he was a member. The ice company had a policy of giving bonuses to members who order ices from them. So, the director received the bonuses but was found out by the fishing company later. The court held that the director must give both the commission and bonuses to the fishing company as he had made secret profits out of the contract made on behalf of the company. Another case that can be referred to is Regal Hastings v Gulliver. In this case, the court ordered the directors to pay back all the profits that they had made by selling the shares to the new board of directors of the company as the opportunity for them to make the profits come from their position as the director of the company. The court further held that without their position as directors, they will never have the opportunity to gain such profits. Similarly, in Industrial Development Corporation v Cooley, a Mr. Cooley who was a director as well as the architect of Industrial Development Corporation (IDC) was asked to negotiate a contract with the Gas Board. During the negotiation, Mr. Cooley 7

found that the Gas Board was not prepared to give the contract to IDC instead they were prepared to give the contract to him personally. So, he went back to IDC and said that the negotiation had failed. Soon after, Mr. Cooley resigned from IDC on the ground of ill-health. Subsequently, he successfully obtained the contract from the Gas Board and made a substantial amount of profit. IDC was informed on this matter and sued Mr. Cooley for the profit that he had made to himself from the Gas Board’s contract. The court held that Mr. Cooley must return all the profits he received to the IDC as although IDC did not suffer any losses, Mr. Cooley gained the profits by his position as a director for IDC when he negotiated the contract with the Gas Board. So, Mr. Cooley had breached his fiduciary duty by making secret profits out of his position as a director. Nevertheless, in Peso Silver Mines Ltd v Cropper, the court held that the directors are free to keep the profits that they received out of their position as directors if the company itself rejected the offer made by the third party who give the profit to the company’s directors. In conclusion, being directors of a company, there are several fiduciary duties that they need to adhere to. This duties can be found by following the principles in common law and where applicable, the Companies Act 1965. All the fiduciary duties of the directors as has been discussed above must be obliged by them and any nonobligation will render the directors breached of their fiduciary duties.

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