Week 4 Directors Duties Handout PDF

Weeks 4 LAW559 Lecture Handout DIRECTORS DUTIES 1. DIVISION OF COMPANY’S POWERS BETWEEN THE BOARD AND GENERAL MEETING Originally the division of corporate powers lay with the collective will of the membership, i.e. the company in general meeting. The board of director...

Weeks 4 LAW559 Lecture Handout DIRECTORS DUTIES 1. DIVISION OF COMPANY’S POWERS BETWEEN THE BOARD AND GENERAL MEETING Originally the division of corporate powers lay with the collective will of the membership, i.e. the company in general meeting. The board of directors were viewed as the co’s agent to act on behalf of the general meeting. If conflict arose usually the will of the general meeting prevailed. However, during this century the growth and expansion of the corporate form has led to a decline in the general meeting’s supervision and determination of corporate policy. Growth, in both monetary terms and membership numbers have contributed to the demise of the general meeting. Particularly in relation to larger companies there will usually be a clear demarcation between ownership and control, and this results in the need for a centralised body i.e. the board of directors to administer corporate policy. Articles of Association: gradual reduction in the powers afforded to the general meeting. Articles determine the division of powers between the board and the general meeting - see Automatic Self-Cleansing Co v Cunninghame. Duty of General Meeting: To act for the benefit of the co as a whole (similar to the duty owed by directors). Decided on the objective basis of whether or not the general meeting’s powers were exercised for a proper purpose. Confusion has arisen over the ‘benefit of the co’ test - see Clemens v Clemens Bros Ltd. GM must take into account the interests of creditors insofar as they fall within the interest of the company as a whole - see Re Halt Garage (see also duties of directors). 2. DIRECTORS DUTIES Directors are usually viewed as agents of the co with delegated powers to run the co. Financial scandals in the 1980s caused the government to set up the Cadbury Committee in May 1991 with the aim to tighten corporate control mechanisms. e.g. Code of Best Practice. Attracted severe criticism - Dine ‘The governance of governance’ stresses the need for further debate and a rethink on some of the crucial issues such as the Code of Best Practice e.g. will self-regulation ever be strong enough to ensure high standards of corporate governance? Role of non-executive directors etc. the Law Society in its response to the draft report of 1992 stated that the ‘law relating to directors’ duties should be reviewed as part of the exercise of raising standards of corporate governance’. (Mem No 271 July 1992). 1 This whole area is ripe for debate and increasingly over the years we have seen articles calling for increased competence and higher standards of care to be exercised by the profession. You do not need to be qualified to be a director - you just need to be nominated/elected. In the case of small private companies, individuals may have limited or no experience (see later disqualification). Vanessa Finch (MLR 1992) claims that ‘the common law operates to give directors a remarkable freedom to run companies incompetently. Provided that their behaviour falls short of the grossest negligence they are unlikely to be held to account. As a result, directors’ duties of skill and care have long been low on their list of concerns’. This however is changing and in recent years expectations of more rigorous duties have grown - look at the common law and the expectations placed on directors. What are the problems with trying to impose one standard of care on all directors? differences in co’s differences in directors differences in decisions Before looking at the duty of care and skill it is necessary to establish to whom directors owe their duties: Traditional interpretation has been that they are owed only to the providers of capital BUT was qualified by statute CA 1985 s309. To whom is the duty owed? To the company? - Percival v Wright 2 Ch 421 To the members? To the employees? CA85 S309 ‘the matters to which the directors of a company are to have regard in the performance of their functions include the interests of the company’s employees in general as well as the interests of its members’ S 309 repealed and replaced by CA 2006 s 172(1) – Duty to Promote the Success of the Company for the Benefit of its Members as a Whole. Creditors: In normal circumstances it seems no duty is owed to creditors BUT Lord Diplock ‘it is the duty of the board to consider...the best interests of the company. These are not exclusively those of its shareholders but may include those of its creditors’ Lonhro v Shell Petroleum 1 WLR 627, at p.634 2 Nourse LJ - the interests of the company is synonymous with the interests of the creditors where the company is insolvent or ‘doubtfully solvent’ Brady v Brady BCLC 20 Sliding scale - not sure at which point interests of creditors become paramount. No clear principle but S214 IA86/Art 178 I(NI)O 89 makes it clear that directors must take steps to minimise the loss to creditors where they ought to know the co will not avoid going into insolvent liquidation. May be made personally liable. See now CA 2006 s 172(3) DUTY OF CARE AND SKILL: Leading case is Re City Equitable Fire & Insurance Co Ltd. Romer J in what has become the classic exposition of director’s duties of care and skill set out 3 propositions: Re City Equitable Fire Insurance Ch 407 - Romer J Rule 1: A director need not exhibit in his performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. Subjective test - low standard expected initially but some change in the law is occurring: Influence from 5th EC Directive - Art 14 - liable for all damage sustained by co as result of breaches of duty by the members of the board of directors in carrying out their functions. Dorchester Finance Co v Stebbings (1989) (decision reached some ten years before it was reported) - Foster J held duties owed by non-executive directors and exec directors were the same. EX d and non-ex d’s all had accounting experience, 2 non-ex signed blind blank cheques which ex d used to further his own ends. Held all 3 directors had been negligent. S214 IA86 (art.178 I(NI)O 89)- objective standard of care introduced - Norman v Theodore Goddard (1991) BCLC 1028 Hoffman J accepted that the standard in s214 applied generally in relation to directors and that the relevant yardstick was what could be expected of a person in the position of the director carrying out those functions. The standard may well be different from what could be expected of that particular director. See also Re D’Jan of London (1993) BCC 646 - for commentary of these cases and implications see A. Hicks article on list - concludes that the courts may not be prepared to accept the minimalist standard of competence tolerated in early years of this century - need for certainty and development in this area of law. 3 Australian developments - Daniels v Anderson (1995) (the AWA case) - board let inexperienced foreign exchange dealer carry on job with little or no supervision - inaccurate corporate records kept, deals not supervised etc. Management held to be negligent in their supervision of the dept - court went on to say, obiter, that: 1. Every director has a duty to become familiar with the every day running of the co 2. directors should take steps to familiarise themselves with current state of the co and board meetings should be at regular intervals 3. Ignorance could no longer be a shield to negligence 4. directors should give sufficient time to overseeing the cos affairs. Re-iterates same approach as Finch ‘A plea for competence’ and I would suggest that in accordance with developments in the UK English courts will follow the Australian lead. Subjective test is on its way out - the excuse of incompetence is on its way out! Rule 2: A Director is not bound to give continuous attention to the affairs of his company. His duties are of an intermittent nature to be performed at periodical board meetings....He is not bound to attend all such meetings, though he ought to attend whenever…he is reasonably able to do so. Stark example is the Marquis of Bute’s case (1892) - appointed president and director of Cardiff Savings Bank at six months old. Little could be expected form him in terms of corporate control. In the next 38 years he attended only one board meeting and massive frauds had been perpetrated by another director. Held not liable for breach of duty in failing to attend board meetings since he had not undertaken to do so. Higher standard set in disqualification cases e.g. Re Continental Assurance Co of London plc (1997). Rule 3: In respect of all duties that , having regard to the exigencies of business and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly. Delegation to experts allowed. Change evident - under City test directors had nothing to fear so long as they acted honestly - low standard of care. Rapid expansion of negligence in recent years and changes in judicial attitudes mean that this may no longer be the case. 4 Fiduciary Duties - Directors must act bona fide in the interests of the company Categories of behaviour most likely to be in breach of the fundamental duty: - misappropriation of company property - conflict of duty and interest Misappropriation of co property: Cook v Deeks - co involved in series of contracts - directors resigned and formed new co and took contracts for themselves - held to account for money made. Issue that has caused the most controversy has been the conflict of duty and interest: Conflict of interest cases: Bray v Ford (1896) Regal Hastings v Gulliver (1942) Boardman v Phipps (1967) IDC v Cooley (1972) Canadian Aero Service Ltd v O’Malley (1973) Bristol and West Building Society v Mothew (1998) Bhullar v Bhullar (2003) Framlington Group plc v Anderson BCC 611 - Blackburne J - conflict of interest rule was deemed to be inapplicable to a situation which prima facie appeared to be similar to the one in Cooley. Facts: 2 directors (A&B) of holding co (F) were appointed to board of F’s wholly owed subsidiary (S). S was subsequently sold by F to R. The directors of S (A&B &C) were subsequently employed by R to continue the management of S’s business. During negotiations for sale it was understood by all parties that AB&C would be employed by R to manage the business but unknown to F was that they had been paid considerable sum in form of shares in R. It was alleged that the three directors had made a secret profit as a result of F’s sale of S to R. Cooley case distinguished on basis that in Framlington the directors who were accused of breach of conflict had never sought to divert themselves a business opportunity which had belonged to the co. The said business opportunity was available to the co i.e. sale of S and was exploited by the co. 5 Although the directors impliedly benefited from the opportunity they did so independently, without prejudice to the co’s own interests. If board of directors consider a proposed activity or transaction and turn it down bona fide and then an individual director takes it up and exploits it, it is clear that this is not exploitation corporate opportunity. - see Peso Silver Mines case. In Island Export Finance v Umunna (1986) - ex-director will not be deemed to misused corporate opportunity where he merely obtains an advantage by reason of past association with the co. He must exploit information which came into his possession while holding office. Question of timing - Umunna had been MD of co and when he resigned the co had hopes of doing business with the Cameroon authorities to supply postal boxes. It was not signed and sealed and when U resigned, he bid for the contract and got it. It was held that he could take the contract on his own account since no specific corporate opportunities existed at the time of his resignation although it was held that the duty could continue after resignation. What can we conclude from the cases? See slide See John Lowry ‘Regal Hastings fifty years on: breaking the bond of the ancien regime?’ (1994) 45 NILQ 1 Peso/Umunna - more flexible approach breaking from the rigidity of the Regal principle. Large co’s – UK Corporate Governance Code - monitoring duty on non-ex directors (alternative to the expense of requiring a shareholders meeting) but non-exs may be reluctant to perform this role. Redefine role of non-ex (Bean ‘Corporate Governance & Corporate Opportunities’). Also notes that smaller cos may have difficulties in implementing the management structures contained in the Code and costs may be too great. Also, if shareholders of small co not managers/directors there is greater potential for directors to usurp corporate opportunities without shareholder knowledge. Therefore, for shareholder protection Regal should be vigorously applied i.e. directors of such cos should seek shareholder approval. However vast majority of cos are small cos managed by their shareholders - where ownership and management fused then no need for elaborate corporate governance system. Shareholders should be fully informed. Lowry argues that Regal appears to have been a case of owner/managers whose informality of procedure caused the problem. Their failure to formally consent as shareholders to their own actions led to the unfair consequence that the new shareholders of Regal could sue them and gain a windfall. 6