Directors Duties Case - Assignment Example

Qn 1 Directors’ Duties The case has been discussed at end after the analysis legal position in the matter. The Companies Act 2006 retains much of the substantive law of its previous versions since 1856. Hence it is still relevant to draw from common law the principles relating to directors’ duties.1 The statutory statement of directors’ duties in the Act is in fact a codification of common law regarding their duties and common law is a necessary ingredient when the directors’ duties are discussed.2 Chapter 2 of Part 10 A of the Act lays down duties of the directors under various heads such as duty to act within powers, to promote success of the company, to exercise independent judgement, to exercise reasonable care, skill and diligence, to avoid conflict of interest, duty not to accept benefits from third parties and duty to declare interest in a proposed transaction.3 As these duties are owed to the company, the company alone can bring actions against the directors for breach of these duties through the board, liquidator or a derivative action.4 Directors may be executive, non-executive or shadow directors but the extent and degree of their duties are not necessarily the same. In other words, the general duties of the directors do not differentiae duties between them.5 These duties are imposed by law as the shareholders have limited control over them at the general meetings and they cannot participate in the day to day management of their companies.6 Foremost is the fiduciary duty under which duty of care and skill, duty to act bona-fide in the interest of the company and the rule of proper purpose have developed as a common law from judicial decisions. Duty to act bona fide (Section 171) When the directors act within the powers conferred by the constitution of their company, they are expected to act for the benefit of the company. They must act bona fide always what in their opinion is in the best interests of the company. 7 Directors are permitted to exercise their discretion in their decision making provided they act bona fide as held in Re Smith & Fawcett Ltd 8 This case involved directors’ absolute discretion in registration of share transfers. Court refused to interfere with the refusal to transfer of shares saying that it cannot draw an inference that directors refused to transfer shares with mala fide intention. By virtue of articles of association, the directors had enjoyed unlimited discretion to decide on the registration of transfer of shares. The directors acted within the powers conferred by the constitution and there was no way a court could interfere. This was despite the fact that directors insisted that the transferor who sought to transfer the shares in his name on the death of his father should sell 2001 shares out of 4001 shares to one of the directors. 9 In Rolled Steel Products (Holdings) Ltd v British Steel Corporation10, one of the two directors of Rolled Steel Products had borrowed from British Steel Corporation through his own company. But he did not disclose the fact when Rolled Steel Products made an agreement of guarantee with the British Steel Corporation for any debt owned by the directors of the former. Since the director concerned did not disclose of the fact at the board meeting at which the guarantee was made, it was held that guarantee was invalid. The British Steel Corporation also did not disclose of the money owed. The director concerned had not acted bona fide. The British Steel Corporation as a third party might have had actual notice or constructive notice of the Rolled Steel’s director who was agent of the company. Therefore, the company was not bound when the third party knew that its representative either had no authority or exceeded it.11 Browne-Wilkinson LJ observed A third party who has notice- actual or constructive- that a transaction, although intra vires the company, cannot enforce such transaction against the company and will be accountable as constructive as constructive trustee for any money or property of the company received by the third party 12 The above act of the director was clearly in breach of his fiduciary duty which the third party was aware of and the company might avoid the transaction. The case actually is concerned with the abuse of power by the directors. However it was well within the power of the company to ratify since the contract was not void but voidable.13 Teck Corp. Ltd. v. Millar,14 a leading Canadian case law involved fiduciary duty of the director to oppose takeover bids. The director must be acting in good faith since the takeover will cause harm to the company. This draws a parallel to the above quoted case Re Smith & Fawcett Ltd.15 Duty of care and skill (section 174) The directors of a company have a duty exercise their powers with their skill and care so that the company does not suffer for want of it. Just as in fiduciary duty in common law, exercise of skill and care relate to equitable rules in common law. The exercise of skill and care should be consistent with their knowledge and experience as held in Re City Equitable Fire Insurance Company Ltd 16 The standard of care and skill is subjective since it is individualistic with the director concerned and there is no objective standard common to all directors under English law. The director is not required to have exercised greater skill that what is appropriate for his knowledge and experience but if he is a qualified professional, he ought to act with the skill and care expected of the profession he belongs to, as held in Dorchester Finance Co ltd and Another v Stebbing and Others17 Thus, if a director is a qualified accountant, he is expected to use greater skill and care than his co-director not having similar qualification. Further, an executive director who is well conversant with the day to day affairs of the company is required to show greater skill and experience than a non-executive director 18 A non executive director is not required to take active part in the business as held in Re Brazilian Rubber Plantations and Estates 19 But he must attend board meetings as far as possible 20 but it is not compulsory and will not amount to breach of duty if he fails to attend as held in Re Cardiff Savings Bank 21 This position stands changed in Companies Act 2006. Further, a director is not required to bestow attention continuously to the conduct of the business. Besides, he is free to leave the business to be looked after by his fellow directors whom he is entitled to trust if there is no apparent reason to suspect their honesty.22 Duty to promote the success of the company (Section 172) The Companies Act has, through section 172, introduced the concept of enlightened share holder value with effect from 1st October 2007. It replaces the old duty to act in the best interests of the company and instead it requires that directors must act to promote long term interests of the company including corporate social responsibility factors including all the stake holders apart from shareholders such as employees, suppliers, consumers and environment. Directors are liable to the company for breach of duty.23 In this connection, Lord Goldsmith of the House of Lords observed that this section meant that the director should act in good faith in the way that would result in business success of the company for the benefit of its members. The Government has said that this section removes doubts in the minds of the directors as to what constitutes the best interests and this precludes them to form their own opinion on best interests. It has removed the confusion between the interests of other stakeholders who depend on the company and those of the shareholders who are the members. Alistair Darling of the House of Commons observed that this enlightened share holder value constituted the directors’ functioning in a such way that would promote success of the company in the best interests of the shareholders while at the same time considering the interest of other stakeholders. 24 The earlier pluralistic approach has been abandoned so as to avoid the situation of the directors being accountable to no one as there is no objective measure of gauging their performance.25 Duty to exercise independent judgment (section 173) This is traditionally known by the principle that “directors must not fetter their discretion”. A director is not breaching this duty if he acts according to any agreement which restricts his discretion in future. This duty does not confer power on him to delegate but if the constitution of the company so provides, he can do so. This applies to nominee directors who shall not be guided by those who appointed him. They can rely on any advice but they must make their own judgement. 26 Duty not to accept benefits from third parties (Section 176) This is in substitution of the equitable principle that those in fiduciary relationship should not accept secret commissions as held in Attorney General for Hong Kong v Reid 27 Though ‘benefits’ has not been defined in the Companies Act 2006, the Solicitor-General has said that it has the dictionary meaning. This duty is different from the no-conflict of interest rule in section 175. There is no board authorisation provided for the benefit under section 176 unlike in Section 175. Wrongful trading: This applies when the directors knowingly have allowed the company to function even after the stage of insolvency as per section 214 of Insolvency Act. A director can defend himself if he could prove that he took every step to avoid loss to the creditors of the company.28 Disqualification of directors A director who defaults the provisions of Companies Act especially in respect of duty of directors, he has to face civil as well as criminal liabilities and remain disqualified to become a director in any company for maximum 15 years. Persistent breach of the act’s provisions, and conviction for fraud would attract disqualification. The Company Directors’ Disqualification Act attracts when a company becomes insolvent. Ignoring the disqualification order will render a director liable for imprisonment up to two years. The companies Act further prohibits un-discharged bankrupts, people disqualified under CCDA 1986, and people below the age 16 from being directors. Further the articles of association can also make provisions for disqualification.29 For example all directors must hold shares in the company. The Act of 2006 has lifted the ban on people aged 70 and above to be directors. This is subject any provisions in the articles to the contrary. Case discussion and conclusion. Almost all the directors of ADM Ltd have exercised their duty of care and skill and complied with the general duties of the directors as per Companies Act 2006 at all stages except where specifically stated below. George, Michael and Vanessa were the founder directors until Yasmeen Ali was nominated to the board by WYVL when it invested in 50 % of the ordinary share capital besides preference shares. Yasmeen Ali was nominated for the benefit of her professional accounting knowledge to be made available for the company’s board. Yasmeen not only failed to attend board meetings but also failed to exercise her skill and care by analysing the financial statements of the company. Hence she is in breach of duties owed to the company especially after Ray was appointed as a director to look after the newly acquired business. All the other directors have taken necessary care and skill consistent with their qualifications and experience and out of mutual trust among one another, relied on the rest of the directors’ conduct. Michael also had no occasion to disbelieve Ray when his part of the business was flourishing although he had knowledge of his bad antecedents. But he ought to have disclosed it to the company’s board when he was appointed. Hence Michael has not exercised his duty of care and skill. The nominee director Yasmeen Ali also failed to detect the irregularities in the operations of Ray. Ray on his part not only defrauded the company by showing inflated figures but also knowingly allowed the company to do wrongful trading. In the new property business started at the instance of George, Michal and Vanessa did not object even though they had reservations. The company made a blunder by dispensing with the services of the professional valuer but that was in the ordinary course of business and they did not knowingly do it. In view of the foregoing discussions regarding the directors’ duties, it can be concluded that Yasmeen Ali did not use her professional knowledge to detect the irregularities in Ray’s valuations. Vanessa who was finance professional did not bestow her full attention towards financial results of the company. Ray who knew of wrongful trading also and defrauded the company by false accounts has breached his duty. Michael who failed to disclose Ray’s past records is considered to have failed to exercise duty of care. Thus Yasmeen Ali, Vanessa, Micahel and Ray are liable to be disqualified as directors for appropriate periods. Ray is additionally liable for criminal offences under Insolvency Act and the Company Act. Qn 2 One of the general duties of the directors of a company is to avoid conflicts of interest. Conflicts may come in many forms. The question is whether a director should avoid all kinds of conflicts. Under section 176, directors cannot accept benefits from third parties. This is mandatory. The duty under section 175 is subject to board’s ratification or authorization. The director should in such cases declare his interest if it is likely to conflict with the interest of the company. Sealy and Worthington30 state that while conflict of interest in a tangible property can be easily identified, intangible ones in the form of opportunities are difficult to assess. A brief recap of what section 175 says is necessary at this stage. A director is required to avoid a situation where it might conflict with the interests of the company directly or indirectly. This may apply to situations which might become beneficial to the company in future or even while he pursues. However, if it relates to a transaction or arrangement with the company, it is exempted. There is no violation of this section if such a situation is not likely to result in a conflict of interest or where it has been authorized by the directors. If it is a private company and its articles do not prohibit or in case of a public company where its articles have a provision to authorize by the directors, the conflicts can be pursued. Authorization should conform to any quorum requirement without inclusion of the director involved. Lastly, the conflict of interest and duty and a conflict of duties would also come under the purview of conflict of interest.31 Conflicts of interest therefore need to be declared and not necessarily approved by the board in case of directors’ transactions with the company. This amounts to a tacit approval of transactions with the company.32 For example, the director may buy goods from his company and resell on his own. Or he may supply goods to his company. It must be noted that as per section 170 (2), an ex-director must avoid conflicts of interest even after he has left the company as a director in matters relating to the exploitation of property, information or business opportunity to which he was privy during the time of his directorship.33 Subsection 1 is a reformulation of the rule in Aberdeen Railway Co v Blackie Bros34. The essence of section 175 is that it prohibits unauthorised conflicts of personal interest with that of the company. Prior to 2006 Act, the law was that any conflict of interest must be authorized by the members except where an alternative procedure had been in place. 35 The Department for Business Enterprise and Regulatory Reform (DTI) states that the new rules of conflicts of interest represent a cultural change. In its eight point guidance, DTI advises the directors to (1) always act in the best interests of the company by taking everything into account , (2) adhere to company’s constitution and rules formulated thereunder, (3) to keep in mind that company’s property is owned by the company and not them or shareholders.,(4) to be diligent enough to be aware of the affairs of the company, (5) to ensure that all their decisions are recorded by the company, (6) to be conscious that they are responsible for works given to others (7) to avoid situations of conflicts interest and always disclose if there is any and (8) to seek external advice in case of financial difficulties for the company.36 It would be clear now that 'conflicts of interest' is a potential area of trouble for the directors if not properly taken care of. The view of Sealy and Worthington is that conflicts of interest cannot be stretched too much. If this to be strictly to be adhered, then private enterprises will be stifled and personal ownerships will be in jeopardy leading to the dependence on corporate enterprises forever and to be under their mercy. The Act already provides that conflicts of interest are allowed under express authorisation by the other directors. In fact, Companies Act 2006 has a made departure from its previous stand in the 1985 Act in keeping with the cultural changes and to promote free enterprise. The proposition of L Sealy et al “for the law, therefore, the difficult task is to draw the line between opportunities that can be pursued privately and without censure, and those that are regarded as ‘corporate opportunities’ where pursuit should, and will, attract legal sanctions and liability to the company which the director is supposed to be serving.”37, is therefore quite misplaced. There could be conflicting situations of any kind but they are not prohibited. They just need to be declared. Declaration is not necessary when the directors happen to engage in transactions with the company itself. The act is silent as to whether an ex-director is forever prohibited from availing business opportunities conflicting with his ex-company. The prohibition must therefore be for a limited period just as in the case of restraint of trade for a prescribed period or within certain spatial limits. In case of making use of or diversion opportunities coming in his way by virtue of his being a director or in a potential post, the act is liberal enough to require the director to just declare and get approval by the other directors. Members are excluded in the 2006 version of the Act. This could even result in collusion among all the directors to the detriment of the company‘s business. Yet, the act is knowingly being liberal. The long departure from the previous position is in keeping with the cultural change and enhanced productivity of a nation. The conflicts of interest rule is in fact unduly favouring the directors at the cost of the company. Hence, there could be no case for any misgiving as Sealy and Worthington have voiced. The opportunities that come in the way, may not be actually capable of being utilised by the company for variety of reasons such as financial limitations, company’s current policy or lack of experts to make use of the knowhow. It could be even due to viability limitations. Therefore, for imaginary reasons a company director, an ex or current, could not be prevented from pursuing or exploiting conflicting business opportunities. It is for this reason, the declaration is required and therefore, it can be concluded that the directors in no way stand to lose personally because of the mildest possible prohibition against conflicts of interest. Bibliography Books Bourne Nicholas, Bourne on Company Law (Taylor & Francis, Oxon 2010) Campbell Christian, International Liability of Corporate Directors, Volume (Yorkhill Law Publishing 2006) Hicks Andrew, Goo S.H., Cases and materials on company law (Oxford University Press, Oxford, 2008) Mantysaari Petri Comparative corporate governance: shareholders as a rule maker (Springer, Heidelberg 2005) Morse Geofrey, Palmer’s company law: annotated guide to the Companies Act 2006, Volume 2006 (Sweet & Maxwell, London, 2007) Sealy L and Worthington Sarah, Cases and Materials in Company Law (Oxford University Press, Oxford, 2007) Sheik Saleem, A Guide to the company’s Act (Taylor & Francis, 2008) Webster Martin, IOD The Directors Handbook: Your duties, responsibilities and liabilities (Kogan Page Publishers, London 2007) Websites ICAEW, Modernising UK Company Law. Companies Act 2006 Enlightened Shareholder value (s172) < http://www.icaew.com/en/technical/legal-and-regulatory/modernising-uk-company-law> accessed 7 May 2011 Finlayson Sandy, Henry Stuart and Mumford Kenny, General Duties Of Directors Under The Companies Act 2006 (The “2006 Act”) And Fiduciary Duties 2010 accessed 7 May 2011. Read More