Legal Battles on Fiduciary Duties of Directors - Essay Example

Legal Battles on Fiduciary Duties of Directors Introduction In the context of company law, directors act as agents of corporate governance on behalf of shareholders. Directors execute duties of their offices in accordance with business objectives of a corporate organization. In most cases, numerous directors under the Board of Directors umbrella deliberate on important issue of an organization. Board of Directors usually meets annually or after a relatively long period. Frequent convention of directors’ meetings is not practically possible. This is the reason why often, an organization’s managing director makes decisions and executes organizational duties alone. Competitive business environments necessitates swift decision making. Certain issues in commercial environments may not allow head directors to convene a meeting. Such immediate issue calls for correspondingly immediate decision making processes. Consequently, a director is solely responsible for everyday decisions in an organization. Occasionally, the director calls for help from shareholders when a matter under consideration has dire consequences. Such matters may require collective deliberation. According to Smith (2010), decisions made within a director’s office may have either negative or positive impacts on an organization. Some decisions made by a director may yield immense profits, while others may be detrimental to an extent that the organization may become bankrupt. Inasmuch as directors ought to have shares within an organization, directors are usually not the major shareholders of a company. In case of loss, certain shareholders may incur more loss compared to the directors. Immense loss resulting from poor decision making by a director calls for legal deliberation (Smith 2010). Facts surrounding a detrimental decision must ascertain whether a director acted or failed to act professionally. In their duties, directors must preserve business interests of shareholders. A director’s decision that compromises on shareholders’ interests deserves legal evaluation. Theoretical Background Under the doctrine of incorporation, directors act as agents of a company. All financial transactions and business contracts of a company are performed by the directors on behalf of shareholders. As agents, directors must operate within the scope of their authorities. Legally, authorities and duties of directors are explicitly spelled out within a company’s Articles of Association (Davies & Lyndon 2010). The spelled authorities demarcate boundaries in which a director may perform his or her office duties. In order to foster objectivity, directors are required to operate independently. Shareholders have limited influence on decisions made by a director while in office. Despite the limited influence, shareholders are confident of a director’s role in a company because the Articles of Association exists (Sheinfeld & Pippitt 2004, p. 121). Breach of authorities spelled out in the Articles usually attracts punitive acts which may include but not limited to replacement of a director. However, a director cannot be punished when he or she acted within the scope of the office duties. Regardless of the outcomes from a director’s decisions, shareholders are not at will to intervene as long as such decisions fall within the scope of a director’s office. As a means of ensuring objectivity, directors employ the business judgment rule in decision making (Mangal 2005). Theoretically, the business judgment rule requires directors to act as trustees of authorities entrusted to them by the Articles of Association. In this case, directors are protectors of a company’s property and business interests. At any time, shareholders may require a director to account for money and assets of a company. This means despite being independent in decision making, a director cannot impropriate a company’s properties. Directors must honestly exercise the powers and duties of their offices in the interest of shareholders (Davies & Lyndon 2010). Admittedly, directors are not perfect like computers. Their decision making processes may be influenced by subjective factors. Based on the number of times that directors make decisions on a daily basis, it is highly likely that one or more of those decisions may cause negative impacts to an organization’s business. Some stakeholders may not tolerate negative impacts resulting from directors’ decisions. In such cases, directors find themselves in court. The court process will require the directors, who in this case are defendants, to prove that their ill-fated decisions were made out of shareholders’ interests (Neal 2006). Based on the degree of detriment caused by their decisions, the shareholders as plaintiffs are committed to win their case against the directors. Shareholders usually assert that directors made decision contrary to provisions of the business judgment rule. In this case, the court will need to determine whether a director under accusation maintained provisions of the business judgment rule, especially the provisions pertaining to duty of loyalty and duty of care (Beate 2009). Literature Review: Madoff Securities International Ltd Vs Raven & Others Recently, an English High Court passed a landmark decision on duties of a company’s director. The legal proceedings of Madoff Securities International Ltd Vs Raven & Others clarified the scope of a director’s authorities. In addition, the legal process also clarified on when a director can be regarded as having acted intelligently and in good faith for the interests of a company. After the case’s final judgment in 2013, directors and shareholders obtained guidance on legal and commercial duties of a director. The decision on this case gave directors freedom to execute their duties without fear of eventual vindication by the shareholders (Royal Courts of Justice 2013). Additionally, the court’s decision emphasized on the scope of directors duties in relation to commercial decision making. Madoff Securities International Ltd Vs Raven & Others was a case between a company’s shareholders and its directors. For approximately 4 decades since 1960s, Bernard Madoff grew his financial investment business in the New York securities market. By 2008, Bernard Madoff was regarded as one of the few self-made billionaires in the world. By that time, Madoff had a subsidiary company operating in London under the name Madoff Securities International Ltd, MSIL. As a chief shareholder of the MSIL, Madoff employed other directors which included Mr. Raven, Mr. Flax and Mr. Andrew among others. During the course of business, Madoff Securities International Ltd liquidators brought forward claims of fraudulent activities in MSIL (Royal Courts of Justice 2013). MSIL liquidators accused the company’s directors led by Mr. Raven of fraudulent business undertakings currently known as the Ponzi scheme. At first, MSIL liquidators accused Mr. Raven and other directors of dishonestly and fraudulently making payments amounting to $27 million to an Australian business woman. Mr. Raven and other directors were accused of making reckless decisions contravening interests of shareholders (Royal Courts of Justice 2013). In this case, Mr. Raven & Others were charged of breach of duty. Apparently, Mr. Raven and other directors made subjective business decisions with reference to requests from the chief shareholder, Mr. Bernard Madoff. Based on reputation and integrity that Bernard Madoff held in global financial markets, Mr. Raven & the other directors honestly had no reason to suspect Madoff of fraudulent intentions. During judgment, Justice Popplewell reiterated that the directors acted in the interest of the company in a similar manner that any honest and intelligent man in their position would act (Royal Courts of Justice 2013). Consequently, the court maintained that MSIL liquidators brought not only unfounded but also serious allegations of dishonesty against the directors. In 2013, the case was dismissed. Independency in Fiduciary Duties of Directors In company law, directors are persons appointed or elected by the shareholders or any other relevant body to govern an organization. Criteria for acquiring a director vary from one company to another. For instance, Articles of Association in some companies require directors to acquire a minimum number of shares from that company. Contrarily, other companies may omit the shareholding requirement when selecting directors (Creighton 2008). Despite the difference in requirements, one thing remains constant; the Articles of Association contains interests of shareholders. Professionally, directors operate within the scope created by a company’s Articles of Association. With respect to a company’s Articles of Association, a director assumes the positions of an agent, an employee, a trustee and an officer. Duties of all these positions are cumulatively given to a director as fiduciary duties. In practical contexts, a director either acts alone or with the help of other officers in decision making. With respect to the Madoff Securities International Ltd Vs Raven & Others case, it emerged that decisions made by dependent directors are not objective. Bernard Madoff used his public reputation to manipulate Raven and other directors in making fraudulent business decisions. According to Robinson (2012), Mr. Raven and other directors relinquished their independency in decision making, and relied on the influence of the major shareholder. Raven and other directors made payments to Madoff because as the chief shareholder, Madoff approved of the payments. The decision to make payments to business parties was not arrived at unanimously but through influence from Madoff as the major shareholder. Inasmuch as Raven and other directors were aware of the false invoicing of the payments, they were not able to intervene. Consequently, the lack of directors’ independency in task execution led to an unprecedented fraudulent scheme. Hypothetically, directors must act independently. Shareholders are business people with the sole interest of accumulating wealth through profit maximization (Kraakman & Reinier 2009). Shareholders may not necessarily give regard to legality of transactions within an organization. As long as a transaction generates money, most shareholders will prefer profit maximization at the expense of ethical business practices. On the contrary, directors are professionals. Directors have the requisite academic and professional qualifications for business management (Clive & Dave 2005, p. 83). In addition, directors are thoroughly conversant with the legal framework of business environments. Inasmuch as shareholders need huge profits, directors must adhere to legal business provisions. In this context, a director cannot aim at profit maximization at the expense of legitimate business practices. In case of business opportunities, a director must objectively evaluate the legitimacy of an underlying business transaction (Earle & Filiberto 2008). With respect to Madoff Vs Raven case, it emerges that Bernard Madoff realized that by lending money to MSIL, he would make profits in from of interest from the loan. In 2000, Bernard Madoff lent MSIL US$62 million. The loan agreement was processed by the Financial Services Authority in London. Interest for the loan was set at 0.5% higher than the commercial rate. Seven years later when the loan was capitalized, MSIL paid US$14 million as interest. Apparently, MSIL did not need the loan in the first place. Mr. Toop, who was the director at the time, was aware of the company’s financial status. However, Mr. Bernard Madoff influenced Mr. Toop to acquire the loan from the Madoff Company in New York. According to Calder (2013), the decision to apply for the loan made the director liable for any consequences of the capitalization. In this case, the director was not independent, hence his decision was subjective. When Can a Director Act Alone? At this juncture, one may ask several questions regarding to independency of a director. Is it possible for a director act alone? And if it is possible, then how free can a director act alone? What if a director’s decisions contravene those of shareholders? Questions regarding to a director’s independency can be endless. However, the fact remains that an independent director enhances objectivity of decision making processes (Black 2001, p. 35). The first instance where a director is free to act alone is during situations requiring company’s credibility. A director must ensure that a company meets accounting standards. At any time, a company’s director must be able to provide evidence of an organization’s financial accountability. All accounting transactions must be transparent and financially objective (Borrowdale & Schenone 2011). In the case of Madoff Vs Raven, the director failed to maintain sound accounting standards when he applied for a loan. Financial records for MSIL indicated that the company did to require such a huge loan. However, Mr. Toop and other directors failed to act freely in making the decision regarding to the loan. Another instance when a director is free to act alone is during resolution of competing interests between stakeholders. According to Griffiths and Loose (2011), stakeholders like government agencies, liquidators and shareholders may have conflicting interests. In such instances, a director should act as an objective mediator. Practically, a director will be split for choice. Admittedly, a company’s director did not emerge out of the blue and assumed governance of the company. A director is usually appointed by shareholders from within a company’s workforce. After appointment, the appointing body assumes the role of a boss. Directors are usually subject to manipulation from shareholders. This explains why directors easily side with major shareholders when resolving conflicting interests (Smith 2001). In order to foster professionalism, directors must remain indifferent to selfish wishes of major shareholders. A high level of indifference sustains objectivity. Therefore, directors should act independently in resolving conflicts of parties within an organization. Duties and Obligations of Directors With respect to the independence recommendation, it is acknowledgeable that decisions made by directors have direct impact on a company’s business progress. The office of a director bestows direct powers of influencing a company to a director. At all times, independency is instrumental in ensuring objectivity of decision making (Saxe 2002, p. 1254). Despite being independent, directors must bear in mind certain duties and responsibilities of their offices. A director assumes fiduciary duties within a company. Shareholders are the principals of the fiduciary relationship. In this regard, a company’s director assumes all duties and obligations pertaining to the fiduciary position. Technically, directors have duties to ensure diligence and compliance in a company’s business undertakings. In addition, directors are obliged to be responsible for any consequences of breach and business liabilities arising from their role as a sole decision maker (Lorenz, Australia, & Victoria 2010, p. 56). With respect to the case of Madoff Vs Mr. Raven, Mr. Raven and the other directors held fiduciary positions while MSIL liquidators were principals of the relationship. Diligence is one of the most important duties of a director. With respect to the case of Madoff Vs Mr. Raven, it emerges that Mr. Raven and the other directors tried to exercise diligence in decision making. For instance, Mr. Bernard Madoff wanted to raise MSIL capitalization by 25% to US$200 million. However, as a director Mr. Raven realized that the increase in capitalization by 25% was financially unnecessary. Mr. Raven exercised diligence when he advised Mr. Madoff to reconsider his capitalization decision. Allegedly, the capitalization would cause a burdensome overhead on MSIL. As a result, Mr. Madoff reduced the capitalization to US$62 million. Theoretically, diligence as a directors’ duty involves performing tasks in good faith and towards the benefits of a company (Jersild 2001, p. 99). A director should not maintain silence concerning the material facts of a company. Regardless of the shareholder’s wishes, each decision made by a director must reflect a spirit of professional prudence. Another duty of a director is strict compliance with prevailing commercial standards. Business undertakings do not happen in isolation. Stakeholders like government agencies, international monetary bodies and even shareholders influence the manner in which a director makes decisions. For example, Mr. Raven and the other directors made decisions that eventually affected the MSIL liquidators. Mr. Raven and the other directors approved and processed payments that later turned out to constitute fraudulence. In this context, the company’s directors failed to comply with business standards of safeguarding stakeholders’ interests. In case a director is not in a position to change decisions made by influential shareholders, that director must inform the other shareholders and any other relevant stakeholder of the company’s affairs (Schenone 2013). However, silence of a director on non-compliant business transactions cause detrimental impacts in a company. This act of blowing the whistle is the last remedy in ensuring sustainability of compliance within an organization. In an event of negative consequences resulting from poor decision making, directors are required to be responsible and account for all consequences of breach and subsequent liabilities. Consequences of breach arise from neglect of duties. According to Willis (2004), directors must always prioritize diligence and compliance in business management. As an ambitious business manager, some directors may collude with influential shareholders to fraudulently rip the company of funds. For example, Mr. Raven and the other directors were thought to have colluded with Bernard Madoff in the Ponzi fraudulent scheme. Neglect of duty is usually perceived by shareholders as intentional mistakes; hence directors must be liable for damages. In legal suits against directors’ liability, the court must establish that the mistakes constituting neglect of duty were made unintentionally. Otherwise, intentional mistakes will necessitate the responsible director to pay for any loss incurred by the company. Payments for the loss incurred will be made not from a company’s finances but from the funds of individual directors (Willis 2004). Conclusion In conclusion, it is evident that directors have direct influence on affairs of a company. Directors’ decisions can either bring positive or negative impacts to an organization. In addition, it is acknowledgeable that independence of directors in paramount in ensuring management professionalism. However, directors must adhere to certain provisions outlined a company’s Articles of Association. Moreover, directors must perform his duties and obligations in a responsible manner, or else face consequences resulting from neglect of duty. In court battles between stakeholders and a company’s directors, facts must support allegations of neglect of duty. Otherwise, the court will dismiss a case when it is proved that irrespective of the outcomes, a director made decisions in good spirit and at the best interest of a company. Reference List Beate, S. (2009) Towards a Sustainable European Company Law: A Normative Analysis. Geneva: Kluwer Law International. Black, B. S. (2001). The Core Fiduciary Duties of Outside Directors. SSRN Electronic Journal, Vol. 62, No. 2, pp. 34-39. Borrowdale, A. & Schenone, S. 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The Fiduciary Duty of Corporate Directors to Protect the Environment for Future Generations. Environmental Values, Vol. 84, No. 3, pp. 1253-1274. Schenone, S. (2013) Duties and Responsibilities of Directors and Company Secretaries in United Kingdom. 4th Edition. London: CCH Limited. Sheinfeld, M. M., & Pippitt, J. H. (2004). Fiduciary Duties of Directors of a Corporation in the Vicinity of Insolvency and After Initiation of a Bankruptcy Case. Business Lawyer, Vol. 12, No. 7, pp. 120-136. Smith, D. (2010) Company Law. London: Butterworth-Heinemann Press. Smith, J. (2001) Reports of Cases Argued on Fiduciary Duties of Directors. New York: SAGE Publishing. Webster, M. (2007). The Director’s Handbook: Your Duties, responsibilities and Liabilities. London: Kogan Page Publishers. Willis, W. J. (2004) A Practical Treatise on the Duties and Responsibilities of Trustees. New York: John Wiley & Sons. Read More