Company Law: Directors Duties - Case Study Example

Directors Duties

Introduction

Company law remains an evolving area as changes, and further development of concepts continue now and then. The Sources of Company Law over time has been case Law and Corporations Act. Corporations are regulated by the state law formed under the Companies Act as well as the Insolvency Act as well as court decisions that form precedents.

Statute and Case Law

The Statute law developed through a legislative process imposes various obligations on companies and their directors separately. The Common Law or general duties includes determining the company’s name, cause company registration, prepare prospects amongst others. The Companies Act also provides key documents necessary for the formation of the company such as the memorandum and articles of association. The courts in the exercise of their duties adhere to the provisions of the act as was illustrated by Penrose v Martyr where the plaintiff claimed not having knowledge that the company was limited. The statute provides guidance also on specific areas of company law such as the number of directors, their appointment, and restrictions. In Latchford Premier Cinema Co v Ennion it was held that verbal resignation notice given and accepted by the general meeting remains effective and can’t be withdrawn as guided by the company articles of association. Case law, on the other hand, originates from court decisions that relate to companies operations

Company Law interactions

Company Law interactions with business start from the inception of the business, its day to day operations and lastly on winding up. The main difference between a company and other business organizations is based on two fundamental company law principles. Firstly is the Legal personality of a company and secondly the limited liability theories. The principle identifies a company as a separate legal entity from the memorandum subscribers and thus has own rights and duties in a manner similar to human beings rights. In Salomon v Salomon & Co Ltd, the Company was considered a different legal person from Salomon who was a subscriber to the memorandum even when where such companies are a one man company. In Lee v Lee’s Air Farming Ltd, the Council reasserted Salomon case proposition of separate legal entity such that a director could, in a company solely owned by him, enter into an employment contract.

The theory of limited liability explains to what extent a person may, in the event of winding up, be called upon to contribute own assets to the company as was the case in Adams v Cape Industries Plc. This is made possible and necessary due to the separate legal personality of the company from shareholders. Companies can be Limited or un-limited. A Company is formed after a lawful registration. However, promotion precedes registration where promoters take necessary steps towards the company incorporation and ensure sufficient capital for operations commencement. Different judges have used varying terminologies to define a promoter. In Twycross v Grant, the jury interpreted a promoter as one who undertakes to form a company, set it going and takes steps necessary to the purpose accomplishment. The Lord in Erlanger v New Sombrero Phosphates Co Ltd differentiates a promoter from an agent, about a company he promotes, not as an agent since a non- existent principal cannot have an agent but rather acts in a fiduciary duty as an agent has a fiduciary relationship with his principal. The relationship is equitable and based on trust, good faith, and confidence. The rule as such imposes certain equitable duties on promoters. Before the company law concept, Promoters would sell their company to another newly formed company at inflated prices as well as acquire assets for the company on commission from the seller. The court on fiduciary duty concept insisted that promoters must disclose profits or potential conflict of interest to an independent board of directors or shareholders both existing and intended. In Erlanger V New Sombrero Phosphate Co, for instance, the court decided that where a promoter sells personal property to a company without disclosing, the company has a right to rescind the contract and full purchase price recovered.

Director’s Fiduciary Duties

The artificial personality of a company dictates that it cannot be in a position to manage its affairs and as such the provisions of company law that the duties and powers are delegated to a natural being. A director as such runs the affairs of the said company. A breach of duties assigned leads to legal action being taken if collective measures cannot provide a suitable remedy. The first directors are decided on a subscription to the memorandum with subsequent ones appointed by members at a general meeting. Some restrictions to the appointment of directors exist such as age factor, qualification shares, bankruptcy amongst others. The law also guides on persons may cease to be directors both voluntarily and involuntarily as well as addressing compensation issues amongst others. The duties of a director can either be fiduciary duties or common law duties of care and skill.

A fiduciary relationship that is based on trust and confidence occurs when someone undertakes to act in a particular manner and circumstances for or on behalf of another company. The loyalty obligation is distinct in a fiduciary relationship. The fiduciary duties of a director are owed to the company alone and not to the individual shareholders or members as was the case in Percival v Wright. In Allan v Hyatt directors’ duties were considered in circumstances of the directors representing the company in purchase and selling purchases. The fiduciary duties of directors includes duty to avoid conflict of interest, disclosure, to act bonafide or otherwise in good faith in the interests of the company as a whole and use powers only for proper purposes and on grounds for which they were conferred

On conflict of interest, the law disallows a director putting himself in a position where the duties and personal interests conflict. In Aberdeen Rly Co v Blaikie Brothers this rule was adopted when directors were restricted from having any interests on company contracts. In the presence of such interests, the director should declare it at a board meeting and as a matter of fact at the very first board meeting at which discussion of the contact are held. In case the director didn’t have interests at the first board meeting that discussed the contract then the disclosure should be at the consequent board meeting of the director's interest arise. On such scenarios the director is prevented from voting on the matter, the vote nullified in case he votes or the director presence on the board meeting nullified by missing on the quorum of present directors as was the case in Re North Eastern Insurance Co Ltd.Interest by a director arose in Industrial development consultants’ Ltd v Cooley on a contract that he was to negotiate on behalf of the company but instead opted to resign and take the contact personally. The court observed a breach of duty since the opportunity was by his position in the company and as such was held accountable to the company for the benefits derived to the company. In Cook v Deeks also the directors diverted a contract meant for the company to themselves. The Court held that the benefits derived from the contract be surrendered to the company. A conflict between the law and equity principles arose as to whether the company was formed for the purpose of getting the contract of whether the contract belonged to the intended company. Lord Herschel in Bray v Ford noted the possibility of interest swaying persons holding fiduciary positions to prejudice the same people they are bound to protect.

Directors are bound not to make personal profit secretly as a result of company connection and by so doing the profit is accounted to the company. In Boston Deep Sea Fishing Co v Ansell the principles governing employee dismissal on the grounds of misconduct came up. Ansell, the managing director of a company, obtain commissions from clients he had awarded contracts was required to pay back the commissions to his employer. Similar principles apply to principal-agency relationships. The Issue of secret profits was also illustrated in Regal (Hastings) Ltd v Gulliver and in Industrial Development Consultant Ltd v Cooley where the jury brought an aspect of Shareholders allowing a director to keep the profit through voting unless fraudulent to the minority. On disclosure duty the justification is on two approaches of usage, the shareholders can sue for violation of the fiduciary duty and secondly can help them deter completion of transactions they deem not beneficial or contain conflict of interest issues. A possible remedy to this duty violation depends on the stage of discovery where corrective disclosure is done if that’s done at an early stage detection but if discovered late after completion of the decision and outcomes felt or obtained then possible remedies becomes complicated. This is because no proof can be made as to whether full disclosure would have changed the outcome and secondly holding directors liable may seem harsh where the concealment was not intentional, determination of which is further complicated.

The director duty to act bonafide or otherwise in good faith in the interests of the company as a whole dictates that directors promote the company objectives for the benefit of all company stakeholders. In Australian Metropolitan life Assurance Company Ltd v Ure the courts held that the director must exercise good faith in their decisions and not on their absolute will. The issue of goodwill determination came up in Whitehouse v Carlton Hotel Pty Ltd where the court held that this was a subjective test and as such circumstances present in each case guides on the determination of honesty and good faith. For instance, if a director enters a contract whether good outside the company purpose may be regarded bad faith by the circumstance at hand. On assenting to a contract knowingly and willing which is against the law, such acts may be interpreted to be in bad faith

In exercising their powers, the purpose for conferment of such powers need be considered. In Howard Smith v Ampol Petroleum, the directors used powers motivated by their personal interest of retaining control by diluting the voting power. The powers on allotment of shares in the case were noted to have been for purposes other than for which it was granted.

Directors Standards of care

The director’s standards of care are embodied in their duty of care and skill under Company law. The duty relates to their competence and skills in company affairs management. The directors are expected to pay attention and make good decisions. Greater degree of skills is expected from a director that may be expected reasonably from a person with similar experience and knowledge. Previously the directors were judged according to their skills, knowledge, and experience as found in Brazilian Rubber plantations & Estates. Substantial loss resulted from a company investment made by directors lacking qualifications and business acumen. The director with no special rubber related qualification required could undertake managerial duties without incurring responsibility from ignorance related mistakes. The same proposition was held in City Equitable Fire Insurance Co Ltd where it was decided that director’s standard of care duty is based on what is reasonably expected from a person in their position. However, in recent cases, the courts have introduced submission to certain standards of skills that are reasonability expected to be possessed by persons undertaking certain levels of duties. The Lord in Hoffman in Norman v Theodore Goddard argued that court requirement on director standards be raised to reach a higher standard than in previous judgments setting a new precedent. In Dorchester Finance, Co Ltd v Stebbing, for instance, the professional qualification of the accountants rendered them, liable for negligence since they failed to exercise care in issuing blank cheques despite their qualifications and experience

The rationale in determining whether decisions were made with care becomes complex especially in the absence of conflicting interest. For instance, courts may use guesswork on poor decisions, Investments made on the decision basis may flop due to many factors other than the decision, at times risky decisions work well for the company and others terribly and as such directors held liable. Unlike professional jobs qualifications such as education and mature age, such factors are not considered for one to become a director. In Marquis of Bute’s case, a six months old baby became a director by inheriting the office from his deceased father.

The law dictates that a director does not necessarily to need give a day to day attention to the company affairs but otherwise his duties are intermittent in nature performed for instance during periodical meetings. He has a duty to attend such when in a reasonable state to do so though not bound to attend such meetings in totality. Having attended only a single board meeting over a period of 38 years, a director in Marquis of Bute’s case was exonerated from liability on an alleged negligence basis. The jury sought to distinguish meeting attendance with the performance of duties that ought to be performed from the meetings a similar holding in the case of Denham Company Ltd. To avoid ambiguity, companies have rights to impose a duty to attendance and prescribe consequences for breach of the duties. On notice period the law dictates that no prescribed period exists the meeting notice period should be reasonable as held in Homer District Gold Mines where a board decision was revoked on the basis of inadequate notice. The court revoked the decision to allot shares due to notice inadequacy. The notice issue is subsequently discussed in other cases such as Browne V La Trinidad and Shaw v Tati Concessions Ltd

The law dictates that in the dispersion of his duties, a director should act in honesty and justified in trusting an employee or officials of the company with a delegated task. A director in Dovey v Cory was not held liable for negligence on failing to verify false information given by a manager and the Managing Director with the jury stating that business cannot be carried on the basis of distrust principles.An employee or company officials holding responsible position need be trusted by people above and below them in the absence of a reason for distrust. However, prudence and care involve no distrust.

Conclusion

Company law is developed from two main sources that are case law and statues. The law is critical to company operations. The law serves the importance of emphasizing adherence to good corporate governance norms and principles by enabling smooth business set up, protecting stakeholders’ interests, ensuring effective and efficient operations, regulating competition and encouraging co-operation between different business set ups. One main contribution of the law is the field of directorship. The duties of a director are continuously been elevated as a corporate governance norm improvement that seeks to ensure correct decisions are made for the company at all times. Breach of duties bestowed on them or negligence can result in them being held legally liable.

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