CORPORATE MANAGEMENT (3)
DUTIES OF DIRECTORS
Directors play a key role in corporate administration. They are the managers of the company’s business. As a result, they are entrusted with a whole lot of key information of the company including the assets and business operations. The duty of directors arises from the nature of this bearing in mind the fact that the company is an artificial entity. Here, we will be looking at the nature of the duties of the directors and to whom are these duties owed? Before now, these issues were regulated by Common Law but the law has helped us to an extent now. Today, most of these duties are contained in the Act.
The essence of these duties is because of the role these directors play in running the affairs of the company. The directors are empowered by law to run the affairs of the company, by so doing they manage the assets and liabilities of the company and the law imposes certain obligations on them. They could be trustees, agents……. Whatever role they play; they are usually in a fiduciary relationship with the company. This relationship also implies certain level of conduct on the part of the fiduciary.
S. 279(1) restates the point that directors are in a fiduciary relationship with the company and they must observe utmost good faith in their dealings with the company or on behalf of the company. In every transaction a director is involved he must exercise this. Furthermore, a director must always act in what he believes to be in the best interest of the company as a whole. These are rules of conduct or general principles with which we understand the role of directors in the course of corporate administration. In the performance of their functions, a director must have regard to the interests of the company’s employees as well as the interests of its members. Sometimes the interest of the company may necessitate the directors to consider more the interest of the employees as against that of the members. Can the shareholders raise an objection in this regard? The key thing to note is that the directors are to act principally in the interest of the company. Where the directors have acted though to benefit the employees more but have done this in the best interest of the company, there’s no violation of the provision of the law. In certain instances, the directors may decide to focus more on the community within which the company is located so as to help the inhabitants. Can the directors be said to have breached their duties in this regard? The issue may be resolved by looking at whether the director has acted in what he believes to be the best interest of the company as a whole. Note the Niger-Delta example as explained in class. Thus, much depends on the circumstances of each case. The provisions we have considered here ambulatory in the sense that they float.
Directors have a duty to exercise their powers for proper purpose(s). How do u determine these proper purposes for which the directors shall exercise their powers? When you determine it and you are applying, all these subsections will come into play. But let’s determine how to determine these proper purposes. In determining these proper purposes, two basic instruments are relevant: The Act and the Articles. This means that there may be some powers in the Act which the directors have been given to exercise specifically for them in which case the powers can’t be taken from them. It also possible for the articles to confer some powers on the directors. Thus, the language of grant must be looked at or considered. Where the instrument of grant gives the directors wide powers and the directors have acted within such grant, the only ground on which such act can be invalidated by the court is where they have not acted in the interest of the company. In the majority of the cases here, the courts have tried to interpret this with regard to the language of the provision. See these cases: Howard Smith Ltd v Ampole.
In Hallows Nominees Property Ltd v Woodside (Lake Entrance) Oil Company, Woodside was engaged in oil and gas exploration and collaborated in its exploration with other companies including B. It had issued share capital. Woodside’s directors were concerned about ‘mystery buyer’ acquiring substantial shareholding in the company through purchasing shares and made allotment to B. Mystery buyer challenged allotment on grounds it was against proper purpose and not in consideration of best interests of company. Contended that as corollary to general fiduciary principle, it could not be suggested that power to issue shared had been exercised bona fide in interests of company unless company had at time an immediate need for capital secured by new issue. It was held that the principle is that although primarily the power is given to enable capital to be raised when required for the purposes of the company, there may be occasions when the directors may fairly and properly issue shares for other reasons, so long as those reasons relate to the purpose of benefitting the company as a whole, as distinguished from a purpose e.g. maintaining control of the company in the hands of the directors themselves of their friends. If the directors have an actual purpose of thereby creating an advantage for themselves otherwise than as members of the general body of shareholders, the allotment would be available as an abuse of the fiduciary power (purpose of ensuring the particular board’s continued power of the company is improper). Here, the allotment was not for improper purpose but to give Woodside greater freedom to plan for future joint operations with B and so ensure its long-term stability rather than defeating mystery buyer.
Teck Corporation v Millar is an important Canadian corporate law decision on a corporate director’s fiduciary duty in the context of a takeover bid. The court held that a director may resist a hostile take-over so long as they are acting in good faith, and they have reasonable grounds to believe that the take-over will cause substantial harm to the interests of the shareholders. The decision is consistent with the duty
In Re Smith & Fonsec Ltd……
In Howard Smith v Ampol Petroleum, two companies, A and B, held 55 percent of the issued shares of company M, which required more capital. A made an offer for all the issued shares of M, and another company, H, announced the intention to make a higher offer for those shares. M’s directors considered A’s offer too low and decided to recommend that the offer be rejected. A and B then stated that they intended to act jointly in the future operations of M and would reject any offer for their shares. H then applied to M for an allotment of 4.5 million ordinary shares; M’s directors decided by a majority to make the allotment and immediately issued the shares. The effect of that issue was that M had much needed capital; A and B’s shareholding was reduced to 36.6 percent of the issued shares and H was in a position to make an effective takeover offer. A challenged the validity of the issue of the shares to H and sought an order in the Supreme Court for the rectification of the share register by the removal of H as a member of M in respect of the allotted shares. M’s directors contended that the primary reason for the issue of the shares to H was to obtain more capital.
The trial court found that M’s directors had not been motivated by any purpose of personal gain or advantage or by a desire to retain their position on the board, that M needed capital, but that the primary purpose of the allotment was to reduce the proportionate shareholding of A and B so that H could proceed with its takeover offer. The judge held that in those circumstances the directors had improperly exercised their powers and he ordered that the allotment of shares be set aside and the share register rectified. On appeal, it was held that although the directors had acted honestly and had power to make the allotment, to offer a majority shareholding was to interfere with that element of the company’s constitution which was separate from and set against the directors’ powers and, accordingly, it was unconstitutional for the directors to use their fiduciary powers over the shares in the company for the purpose of destroying an existing majority or creating a new majority; and that, since the directors’ primary object of the allotment of shares was to alter the majority shareholding, the directors had improperly exercised their powers and the allotment was invalid.
The court noted that a matter such as the raising of finance is one of management, within the responsibility of the directors. It would be wrong for a court to question the correctness of the management’s decision if bona fide arrived at. But, when a dispute arises whether the directors of a company made a particular decision for one purpose or for another……. the court is entitled to look at the situation objectively in order to estimate how critical or pressing or substantial an alleged requirement may have been. If it finds that a particular requirement, though real, was not urgent or critical at the relevant time, it may have reason to doubt or discount the assertions of individuals that they acted solely in order to deal with the matter.
Illustration: A father gives his daughter (a student) a sum of money to buy what she considers to be in her own best interest. Another gives his daughter (a student) a sum of money to buy books in school. The first daughter goes about spending the money on clothing, jewellery, bags, shoes etc. the other one goes around organizing fellowships with this money. The question is whether these two used the money given for proper purpose. To answer this question, we would have to go back to the instruction given to them by their fathers. The first was instructed to use the money for ‘what she considered to be in her best interest’. To this extent, we can say she has used the money properly since she bought things she thought were in her best interest. But with regard to the second daughter, we would see that there was a specific instruction to buy books with the money she was given. Therefore, we can conclude that she used the money for improper purpose. This illustration has been given to help you understand the cases above. Ensure you read and understand them.
S. 279(6) CAMA: A director shall not fetter his discretion to vote in a particular way. He can’t agree either in the articles or agreement with third parties to limit the way he will vote in the course of managing the affairs of the company. If you fetter your discretion with respect of something you will do tomorrow, it may not be in the interest of the company. You must be free at all times so as to act in the best interest of the company. This is why we have this rule to place limit on how a director can decide a company’s business. See Thorby v Golberd; Carba Estate v Fulham football club. But there are cases where distinctions must be made e.g. where one has entered into a particular transaction and the transaction requires certain future actions to be taken by the board so that it will be perfected. The board or director can undertake that when that time comes, you will ensure that transaction is perfected. For a director to create a complete and existing transaction which requires that a particular decision should be taken in future, if he refuses to take that decision, it will not amount to fettering his discretion because that transaction is for the benefit of the company. A transaction could be entered into today that would require a director to undertake an obligation in future to ensure that particular transaction is perfected. It would not amount to fettering of his discretion……
In the Australian case of Thorby v Goldberg, the directors of a company agreed as part of a broader restructuring transaction to allot shares in a particular manner by a certain date. They then failed to do so as they had promised. In a move to compel them to act, they pleaded that the undertaking was an invalid fettering of their discretion. The court rejected their argument, holding that the time of exercising their discretion was when entering into the agreement. The court noted:
“There are many kinds of transactions in which the proper time for the exercise of the directors’ discretion is the time of the negotiation of a contract, and not the time at which the contract is to be performed. A sale of land is a familiar example. Where all the members of a company desire to enter as a group into a transaction such as that in the present case, the transaction being one which requires action by the board for its effectuation, it seems to me that the proper time for the directors to decide whether their proposed action will be in the interests of the company as a whole is the time when the transaction is being entered into, and not the time when their action under it is required. If at the former time they are bona fide of opinion that is the interests of the company that the transaction should be entered into and carried into effect, I see no reason in law why they should not bind themselves to do whatever under the transaction is to be done by the board.”
The Court of Appeal endorsed this approach in the case of Fulham Football Club v Carba Estate.
The issue of delegation of power. Where a director is allowed to delegate his powers under the Act, he can’t delegate his power in such a way and manner as may amount to an abdication of duty. Whether or not a director has abrogated his duties is a question of fact(s). By this we mean that one would have to look at the circumstances to adjudge whether such delegation of power by the director amounts to abdication of duty.
S. 279 (8) reiterates what used to be the practice. Before now, it was possible to use articles to relieve directors form liability incurred as a result of the breach of their duties. Thus, even when directors were liable, they could escape liability because there was that provision in the articles. Lawmakers felt this approach was one for bad governance and encouraged the directors to violate the rules of the company. Today, it is no longer possible for the company to relieve its directors from duties imposed by the Act or from any liability incurred as a result of any breach of the duties conferred upon him under S. 279 CAMA.
Ultimately, any duty imposed on a director under S. 279 is enforceable against the director by the company. Remember the provision of S. 37 which is to the effect that a company may sue and be sued. But you will see in another topic a situation where those who own the company are also in control of the company and they are willing to use the company to sue the directors. Let’s take the case of Salomon as a case study in this regard but this time with a minor alteration. Let’s assume that Salomon, his wife, three of their children and two independent people (not members of Salomon’s family) had formed the company. Salomon still retains the majority. If Salomon (the chairman of the company) engages himself in transactions which undercut the other shareholders and in which he makes a whole lot of money whereas the entitlements which should go to the company were little thereby affecting the dividends of the other members. The law is that the company can sue. The question is who is this company that will sue? How does this company sue to enforce its right? The directors ordinarily are to determine whether to sue on behalf of the company. When you open the Board who should sue for the company, you will find Salomon, his family members and only two independent members. If the issue were to come up at the board, Salomon and his family would outnumber the two independent directors. So Salomon and co can vote that it would not be in the interest of the company to sue. The implication of this is that this particular provision has no life as far as this scenario is concerned. But the GM is also entitled to sue for the company. Again when you look at the members in GM, you would find Salomon and his family outnumbering the other two. Our point is, this provision is not meaningful in all cases. Thus, in a lot of cases, you’d find that the company can sue via the GM or the Board which in most cases are the reason for the breach complained of.
Presently, the minorities such as the one in the case study above are empowered to institute an action for the company. This is made possible by an action called the derivative action which we will find in S. 303 EA. By virtue of a derivative action, an applicant may apply to the court for leave to bring an action in the name or on behalf of a company, or to intervene in an action to which the company is a party, for the purpose of prosecuting, defending or discontinuing the action on behalf of the company. Thus, the minority shareholders can use a derivative action to compel the majority shareholders to account to the company.
Specific Duties Directors Are Expected to Perform
Here, we are concerned with the purely fiduciary duties of directors. The duties we discussed before now are also fiduciary but most of them are just instruments of analysis stating how directors are expected to exercise their powers…. But here we are concerned with the duties the directors have to perform specifically.
A fundamental duty for directors is that directors must not conduct the affairs of the company in such a manner that their duties would conflict with their personal interest. This is a core duty for directors. The reason is not far-fetched. Since the directors are running the business of their principal and not their personal business, there is a likelihood that there would be a conflict between the two interests. A lot depends on the way these directors are treated. But it has been shown that some directors would still have conflicting interests notwithstanding the fact that they are well-paid.
If A is a director of a company having share qualification in the sense that he is both a director and a member of the company, it is quite reasonable that he would do everything within his power to ensure the survival of the company since the downfall of the company would largely affect his dividends from that company. Compare it with a situation where he is just a director without any share qualification. In the latter, his interest is more likely to be conflicted.
A director must not make any secret profit or achieve other unnecessary benefits while in the course of managing the affairs of the company or in the utilization of the company’s property. A breach of this provision would make him accountable to the company.
The fact that the company was unable or unwilling to perform any functions or duties under its Articles and memorandum shall not constitute a defence to any breach of duty of a director under this Act.
A director has a duty not to misuse corporate information. This duty enures even after he has resigned from the company. This means that even after resignation, a director would be accountable to the company in case of a breach of his duties. Such a director may be restrained by an injunction from misusing the information received by virtue of his previous position.
A director who discloses his interest(s) before the transaction and before the secret profits are made before the general meeting, he may escape liability. But he won’t escape liability where discloses his interests after the secret profits are made. In the latter case, he would be accountable to the company.
From the above, there are two specific duties of a director. First, a director owes the company a duty not to misuse corporate information. Secondly, a director owes a duty not to misuse corporate property. See the following cases: Regal (Hastings) v Gulliver, Industrial Development Consultant v Cooley, Canadian Aero Services v Omalley, Boardman v Phipps. You would find that sometimes the cases could work injustice. Please read also the provisions of S. 284-286 CAMA.
S. 287 (1)-(4) CAMA also provides against secret benefits. He must not accept a bribe, gift, commission or a share in profit of any person in respect of any transaction involving his company with such person. A contravention of this provision would entitle the company to recover such gift and sue the director for damages. Where the gift was made to the director after the transaction in a form of unsolicited gift as a sign of gratitude, he may be allowed to keep the gift provided it was disclosed to the board and that fact appears in the minute book of the directors. In an action for breach of duty under this section, the plea that the company benefited or that the gift was accepted in good faith shall be no defence.
S. 288 CAMA is to the effect that the liability of the directors, managers or MD in a limited company may be unlimited if so provided by the memorandum. However, there must be notice in writing informing the director of the extent of his liability before he accepts the office and acts therein. Failure to inform him of the extent of his liability attracts a fine of one hundred naira by the appropriate parties.
Central to this discussion is the duty of disclosure by directors in contracts. A director who is in any way interested in a (proposed) contract must declare the nature of his interest in such contract to the board. This declaration must be made in the board meeting when he becomes interested in such contract. There is sufficient declaration on interest in a contract where he presents in a board meeting a general notice to that effect. Any director who fails to comply with the provisions of this section shall be guilty of an offence and liable to a fine of N100.
Let us also consider substantial property transactions involving directors. The relevant provisions of the law are contained in sections 284-286 CAMA. By virtue of these sections, a company shall not enter into an arrangement whereby a director of the company or its holding company, or a person connected with such a director, acquires or is to acquire one or more non‐cash assets of the requisite value from the company. Also, a company shall not enter into an arrangement whereby the company acquires or is to acquire one or more non‐cash assets of the requisite value from such a director or a person so connected, unless the arrangement is first approved by a resolution of the company in general meeting and if the director or connected person is a director of its holding company or a person connected with such a director, by a resolution in general meeting of the holding company. Where an arrangement is entered in breach of the provision of S. 284, any transaction entered into in pursuance of the arrangement (whether by the company or any other person), shall be voidable at the instance of the company, unless one or more of the conditions specified in S. 286(2) is satisfied.
As noted earlier that the directors are not liable per se for the indebtedness of the company. However, S. 290 CAMA seems to reverse this in some situations. S. 290 CAMA deals with personal liability of directors and officers. The section is to the effect that where a company is loaned a sum of money to be used for the execution of a contract or project and with intent to defraud it fails to apply the money for the purpose for which it was received, every officer of the company who is in default shall be personally liable to the lender. See Public Finance Securities v Jefia and Alade v Alic.
The Duty of Care, Skill and Diligence (S. 282 CAMA)
Directors are also required to exercise skill, care and diligence in the running of the affairs of the company. This duty has its history in case law. See Re City Equitable Fire Insurance. Under Common Law, this case was the locus classicus for the duty of skill, care and diligence required of directors. Then, there were no statutory provisions in this regard. When you read Roman J’s dictum, you’d see that the duties of directors as formulated were porous, large and unhelpful. In fact, the way the formulations were interpreted was such that the directors were hardly liable for a breach of this duty. It was due to the ineffectiveness of the formulation in this case that led to review in so many jurisdictions. Read the Canadian case of People’s Department Stores Incorporated v Wise. This case would help in terms of the standard of how the court goes about the analysis. Also note the case of BCE v 1976 Debenture Holder.
S. 282 (1) CAMA provides:
“Every director of a company shall exercise the powers and discharge the duties of his office honestly, in good faith and in the best interests of the company, and shall exercise that degree of care, diligence and skill which a reasonably prudent director would exercise in comparable circumstances.”
Under normal circumstance, no director is expected to exercise a skill he doesn’t have. But when you look at the provision of S. 282, you’d see that the standard stated therein is an objective one. This particular section talks about a skill which a reasonable prudent director could exercise in comparable circumstances. So it is the circumstance of the case that will define the level of skill, care and diligence that is expected of a director. It is not what the director has. It implies that the director must pay serious attention to the duties of his office. It also implicates delegation. An absentee director, for example, can make no meaningful contribution to the affairs of the company. While he is allowed to delegate, he is not allowed to delegate in such a way as would amount to abdication. Again, we would find that there is no distinction between executive directors and non-executive directors in the application of these duties by the courts and even by law.
S. 282 (2) is to the effect that where the director fails to exercise the required level of skill, care and diligence as stated in subsection (1), an action for negligence or breach of duty may be instituted against him.
S. 282(3) makes each director individually responsible for the actions of the board in in which he participated. The mere fact that he was absent from the board’s deliberations would not relive him of such responsibility unless his absence is justified.
For the sake of emphasis, it is important ot state that if a director doesn’t have the intellectual ability to take up or continue a job, he is expected to reject the offer or resign. He must make up his mind on whether or not to serve on the board. He can’t accept a job he knows he can’t do. The case of Daniels v Anderson epitomises the judicial and legislative activity in Australia. The case established that directors are required to have a real understanding of the company’s business and will not be able to rely on the maxim ‘Ignorance is bliss’. See also: Deputy Commissioner of Taxation v Clark, ASIC v PLYMIN.
S. 283 CAMA states the legal position of directors. They are trustees and agents of the company. Consequently, they must account for all money over which they exercise control and shall refund any moneys improperly paid away.
Please note that the fiduciary duties of directors are owed only to the company and the company alone. However, as a derivative of this application, there must be some consideration. If you accept the principle that a corporation is a distinct person from the shareholders, the interest of the corporation even conceptually is supposed to be distinct and different from the shareholders. However, sometimes there could be some level of co-extensiveness, the interest of the company may not necessarily be co-existent with the interest of the shareholders. What is good for the corporation is not necessarily always good for the shareholders. In some cases, what would be in the interest of the company may not necessarily be in the interest of the shareholders. The directors need not focus on the interest of the shareholders. In determining what is best in the interest of the company, consideration for the shareholders, community, creditors may be had. The decision as to what is best is made by the directors (in what they believe to be) and not what the courts believe to be. Ordinarily, the courts would not override the decisions of the directors (where the directors took such decision in what they believed to be in the best interest) notwithstanding that a different conclusion would have been reached by the court. However, the language of care and skill is an objective standard. The court is at liberty to look at the circumstance and consider the conduct of the director whether a reasonable and prudent director would have acted in such comparable circumstance.
Most of these cases would trigger a S. 311 analysis. The same consideration would apply in alteration of articles. When you take a look at some of the cases with regard to alteration of articles, you’d find out that the interest of the shareholders was lost. The court usually interpreted such cases in terms of the language of the grant. The relevant provision in this regard would be S. 48(1) CAMA. Thus, in any case, it is important to note that the interest of the company is usually paramount.