Business and Corporation Law Research - Essay Example

Business and Corporation Law Research Name: Subject & Code: Instructor: Date: I. Introduction People mostly regard the director’s position on a board of corporation on the basis of their commitment to the endeavor while paying little regard to the legal responsibility that attaches to the same.1 Yet, as directors focus on these responsibilities, it is important for them to note that they owe other parties tangible legal responsibilities. Such parties include governments, creditors, members, shareholders and employees.2 Warthog’s scenario presents the challenges that directors face in their duties and responsibilities to the company and the legal consequences of their actions or inactions toward the company. This paper deals with the various legal issues arising from the fact pattern presented in Warthog’s case. The first part of the paper answers the question of whether Warthog is legally bound to repay Cheatem Bank the funds advanced for the loan. Secondly, this paper seeks to investigate Scar’s extent, if any, of the breach of his duties as a director of the company. Lastly, this paper seeks to investigate the extent, if any, of Simba’s breach of his responsibility as a director. II. Whether Warthog Is Legally Bound To Repay Cheatem Bank The Funds Advanced A general overview of a borrower’s principle objectives include ensuring that the funds will be available in the most palatable financial terms possible and repaying the loan over a period unburdened while ensuring that it complies with all the terms of the loan agreement.3 Among the salient expectations of a lender for the loan agreement include setting out the conditions for disbursement of the funds, monitoring the financial situation of the borrower and providing itself with legal remedial procedures in the case of default on the part of the borrower.4 A lender’s ability to enforce a loan agreement in the case of a default by the borrower is largely dependent, regulated and determined by the underlying document.5 The document referred to is the loan agreement document. Therefore, in Warthog’s case, the general rule would be for the loan agreement, if any, to be the instrumental in the repayment terms. A. Duties and Responsibilities of Directors In determining whether to take up a loan, a company is required to consider certain key things. In Australia, for instance, directors of companies have duties and responsibilities under both common law and statute to act in good faith and in the company’s best interest.6 Therefore, in determining the beneficial interest of a particular loan transaction, both direct and indirect benefits should be considered. For instance, the shareholders’ approval and consent needs to be sought before making a decision to take up a loan.7 The foregoing would be considered in determining whether the Company is liable to repay the loan. Corporate benefit rules allow for the reduction of the risks of a transaction (a loan transaction for example) and such a way is by obtaining shareholders’ approval for that transaction.8 From a director’s point of view, a company’s constitution may be amended in order to allow for the directors of a subsidiary company that is wholly owned to act in the parent company’s best interest. This would be a way of protecting he directors from legal consequences of defaulting on a loan transaction. However, the present case of Warthog Company presents a slightly different scenario. The actions of the directors of Warthog Company are what have led to the Company becoming insolvent and as such the question is whether the Company can incur liability on account of the actions of its directors. This question is answered in the following paragraphs. B. Piercing the Corporate Veil To begin with, preventing fraud and promoting justice are the major objectives of the doctrine of corporate veil.9 It is noteworthy that in corporate veil cases, fraud is accorded a wider meaning than in its general usage. When the courts interpret fraud, it usually appropriated to mean misrepresentation. Accordingly, courts have been found to oftentimes lift the veil of incorporation in cases where a fraud has been perpetrated. An example of the illicit conduct is the misappropriation of corporate funds and other fraudulent conduct.10 Warthog Company’s case reveals that the directors got involved in fraudulent conduct. One of the directors executed the loan documents, deposited the money into an offshore account and fled the country. The other director was disinterested in the daily running of the affairs of the company and these situations led to the Company becoming insolvent. One of the leading cases on piercing the corporate veil is the Re Darby, Brougham case.11 In that case, the Liquidator sought to pierce the corporate veil in order to recovers certain sums that had been acquired by fraudulent means. Therefore, although a company is a separate legal personality capable of being sued in its own name, the directors thereof, in certain instances may be held personally liable for the company’s debts. Corporate law and common law statutes place many requirements upon directors to which they must adhere. One of these duties is a fiduciary one which involves good faith and honesty, and they require directors not to use their position for personal benefit.12 There is a rebuttable presumption that directors have acted honestly, in good faith and for the best interest of a company especially where good information has been sought.13 Therefore, directors are required to make all the necessary investigations and inquiries before venturing into a transaction. Directors are absolved from personal liability when they can prove that they acted in good faith during the transactions.14 Basing the argument on this understanding, then Warthog Company would be liable for the default and as such, it would be required to repay the loan. However, in this case, it was the misdeeds of the directors that led to insolvency and the eventual default in repaying the loan. Cheatem Bank will be required to prove that the directors acted in bad faith in order for the veil to be pierced. C. The Business Judgment Rule Integral as risk is to a business, this principle draws a line between risk taking and actions taken without due care and diligence.15 The Business Corporations Act envisages a definition of the BJR and the rule ultimately aims at providing a safety net for businesses in ensuring that directors act in the best interest of the company.16 The Canadian Supreme Court clarified as a general rule that even after the eventuality of insolvency, the directors of a corporation do not owe the creditors a fiduciary duty.17 However, the Honorable Court acknowledged that directors owe a duty that extends beyond that to the corporation, which duty is owed to creditors. In essence, therefore, where a director makes a decision that is adverse to those of the creditor to the creditor’s detriment, then such a director may be sued personally for breach of duty of care.18 In the South African case of Philotex (Pty) Limited and Others v Snyman and Others and Braitex (Pty) Limited and Others v Snyman and Others, the Court established the principle that penalizes directors who recklessly conduct the affairs of a corporation with the intention of defrauding creditors.19 The courts have interpreted recklessness to mean gross negligence. The other requirement for directors to be held personally liable is if the particular director executed the documents in an individual capacity.20 According to the facts of the case at hand, one of the directors executed the loan agreement but deposited the money into an offshore account. This may be interpreted to mean that the director signed the document in an individual capacity and not in his capacity as the Company’s director. It is important to note that a company’s directors may, nevertheless, be sued in their individual capacity for their tortious deeds even if they were acting as the company’s agents or officers. This was the holding in the American case of Florida Specialty, Inc. v. H 2 Ology, Inc.21 In summary, a company is a juristic personality separate from its shareholders, officers, agents and directors. This means that a company is capable of entering into transactions in its own name, incur debts and be sued in its own name. The directors of a company do not necessarily incur liability whenever a company is in default. However, there is an exception to this general principle. This is the rule that was established in the famous case of Salmon vs. Salmon. By piercing or lifting the corporate veil, individuals in a company are able to incur liability, civil or criminal. There are certain considerations that courts will look at in order to lift the veil of incorporation, some of which have been discussed in the foregoing paragraphs. Directors owe certain duties to the company and to creditors, most of which if breached, may cause them to be personally liable. The instance presented by the fact pattern in Warthog is a similar one. The inactions and breach of statutory duties by the company’s directors caused it to enter into financial ruin thereby defaulting in its repayment of the loan. The question was whether it was liable to repay the loan. According to the above discourse, the company would not incur liability but the directors would personally. D. Enforceability of Contractual Obligations The fact pattern in the Warthog case reveals that one of the directors was appointed as managing director by contractual agreement for a period of four years and has yet to renew the contract. The managing director’s name also has yet to be lodged with ASIC. Under the requirements of the Corporations Act of 2001 in section 201A (1), a proprietary company is required to have a minimum of one director. As such there seems to be no breach of statutory terms, which if had been breached, would attract sanctions from the ASIC.22 The issue that remains is the one of the contractual appointment of managing director that is yet to be renewed. Scholars agree that parties’ respective idiosyncratic knowledge of their own contract is of considerable importance.23 This means that courts can rely on both the law and the evidence of the behavior of contractual parties in determining and understanding their contracts. Applying this understanding to Warthog Pty, a conclusion may be drawn that if the contract of appointing Nala as director of the company was to be looked at in the above manner, then the decision to take up the $300,000 loan is void. If the decision to take up the loan was void, and further if Nala was not the legally recognized managing director of the company, then the company will not incur liability in repaying the loan. Nala would incur liability personally. III. The Extent of Scar’s Breach of Duty as Director The duties and responsibilities of company directors are far-reaching and diverse. The duties that were previously the subject of common law are increasingly being encoded into statute.24 The following paragraphs discuss in brief Scar’s extent of breach of his duties as director. A. Duty not to Misuse the Position of Director Under this duty, a director is precluded from making use of his position to make personal profit or benefitting another person or to place the company in jeopardy. If a director has access to either property or information, it is important for them to consider that they belong to the company and are not individually owned. As such, the assets of a company are not to be used elsewhere. In case of doubt, the director is required to disclose to the board or to fellow directors and get their approval before proceeding with any arrangement.25 A good example of misusing the position of director is where one appropriates a business opportunity. When a director identifies a business opportunity, he is required to bring it to the attention of the company and not take advantage of it in order to use it for personal benefit. In light of the foregoing, it is clear that Scar breached the duty not to misuse his position as director when he induced the company into entering an agreement which he knew would profit him personally. Furthermore, the Corporations Act contains provisions that discourage directors from engaging in deceptive or misleading conduct.26 Deliberately holding information and silence generally has been considered to amount to misleading conduct. It is important to note that this duty ties in closely with the duty of loyalty.27 IV. The Extent of Simba’s Breach of Duty as Director The problem question reveals that Simba is a very skilled pilot and has extensive knowledge in the aviation industry but does not concern himself with the financial condition of the company. In the period ensuing the executing of the contract, Simba did not make any enquiry about the fate of his fellow directors or concern himself with the running of the company. Consequently, as a result of this inaction and neglect, the company to breach its contract with Gold Digger and eventually ran into insolvency. The following part discusses the extent of breach of Simba’s duties as director. A. Duty of Care A director is obliged to undertake all the tasks that pertain to the company, howsoever they arise, with due care and diligence.28 According to the jurisprudence of the Supreme Court of Switzerland, a corporate director has the obligation of exercising the level of due care requisite for the management of a company. The standard of comparison of corporate director is that of a “good director”, that is, a conscientious and reasonable individual acting in the same position. Moreover, in the event of a director being in possession of an above-average skill within a particular realm, a higher standard is expected of him.29 For example, if a director is a very skilled pilot with above-average expertise in the aviation industry, then the applicable standard of care shall be that of a person who is above average as such. A director cannot be exonerated from liability in the name of being a mere ‘straw man’.30 The fact that one accepts corporate directorship, despite knowing his shortcoming in discharging the requisite obligations, breaches his duty of care. Furthermore a corporate director cannot such subjective grounds as lack of time, knowledge and professional skill to escape potential liability.31 Particularly, the duty of care requires directors to keep themselves abreast with the affairs (and especially the financial condition) of the company. A director must ensure that he is informed regularly of the financial situation of the company and seek the intervention of an expert if need be. The duty of care is said to be more than an ordinary duty since it sets out the standards of how obligations are to be performed. It is noteworthy that the duties and responsibilities of a director may not be delegated to anyone else. Summarily, a company’s directors require a high degree of competence and apt business judgment and enough time remain abreast with the company’s situation. Based on the foregoing, it is clear that Simba is in gross violation of his obligation as a director. V. Conclusion In conclusion, directors play a critical role in the management, running, supervision and overseeing of a company’s affairs. Therefore, directors need to understand that in the event of neglect of their duties and responsibilities, they may incur financial liability in case the company experiences loss or failure. 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