Directors\' Duties - Lecture note 7 PDF

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Summary

This set of notes explains corporate governance and directors' duties. It focuses mainly on the duty to act in good faith and in the best interests of the company...

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Topic 7: Corporate governance and directors’ duties: Good faith and proper purpose -

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Directors are under both a fiduciary duty and statutory duty to act in good faith and in the best interests of the company. The duty to act in good faith in the best interest of the company means that directors must act in the interests of the general body of shareholders. This includes an obligation to act fairly across different classes of shareholders. The duty to act in the best interests of the company may cause difficulties for nominee directors and directors of a company that is a member of a larger corporate group. In both cases, it may be difficult for a director to reconcile acting in the best interests of the company with acting in the best interests of the nominee director’s appointor. Directors have a fiduciary and statutory duty to exercise their powers for a proper purpose and not for the purpose of conferring an advantage on themselves or someone else. This duty may be breached where directors issue shares for the purpose of preventing a takeover or altering the balance of power among shareholders. Directors who have mixed purpose (proper and improper) for exercising a particular power will breach their duty if the motivating purpose was improper. Shareholders have the power to ratify improper exercises of power by directors.

Duty to act in good faith and in the best interests of the company 

General principles:

Chew v R (1991) 4 WAR 21 (Malcolm CJ) ‘First, the directors must exercise their powers in the interests of the company, they must not misuse or abuse their powers. Secondly, they must avoid conflict between their personal interests and those of the company. Thirdly, they should not take advantage of their position to make secret profits. Fourthly, they should not misappropriate the company’s assets for themselves.’ 

Subjective or objective test?

Bell Group Ltd (in liq) v Westpac Banking Corp (No 9) [2008] WASC 239 While it is not the courts’ role to second-guess directors about management decisions, directors will breach their duty ‘if, on consideration of the surrounding circumstances (objectively viewed), the assertion of directors that their conduct was bona fide in the bests interests of the company and for proper purposes should be doubted, discounted or not accepted’. ASIC v Adler [2002] NSWSC 171 The duty is breached if a director is acting in a way that ‘no rational director would have considered to be in the best interests of the company’. 

Whose best interests?

Darvall v North Sydney Brick & Tile Co Ltd (No 2) (1987) 6 ACLC 154 (Hodgson J) -

The duty requires directors to have regard to both the interests of present and future shareholders as well as the interests of the company as a commercial entity. Directors may act in what they consider to be the best interests of the company as a commercial entity even though this may not be in the short-term interests of shareholders. i.

Individual shareholders

Directors’ duty to act in good faith in the best interests of the shareholders does not mean that they owe duties to particular shareholders. Percival v Wright [1902] 2 Ch 421 Facts: A director of a company was approached by a shareholder wishing to sell his shares. The director agreed to buy them but did not disclose that there was an impending takeover bid at a higher price. The shareholder later sought to rescind the contract for the sale of his shares on the basis that the director breached his fiduciary duty to him by failing to disclose the information concerning the impending takeover even though it did not eventuate. Held: Directors only owe fiduciary duties to the company as a whole and not to individual shareholders. Perkin v Anderson (2001) 19 ACLC 3001. For a director to owe fiduciary duties to an individual shareholder, the director must have been in direct and close contact with the individual member so that the director caused the member to act in a certain way which turned out to be detrimental to them. Coleman v Myers [1977] 2 NZLR 225 Facts: The managing director of a family company arranged for the company to be taken over at an under-value by a new company controlled by him. Held: -

The managing director breached fiduciary duties owed to the minority shareholders of the family company. The managing director failed to disclose material information concerning his potential profits and misled the shareholders as to the true value of the company’s assets

Concept: Factors that give rise to a fiduciary duty to individual shareholders are -

Dependence upon information and advice The existence of relationship of confidence The significance of some particular transaction for the parties The extent of any positive action taken by or on behalf of the director or directors to promote it.

Brunninghausen v Glavanics [1999] NSWCA 199 (special circumstances that depart from general rule that a director does not owe fiduciary to act in best interests of particular shareholders) Facts: -

The company had 2 shareholders who were also its only directors. Glavanics, the minority shareholder, despite being a director, was not involved in the company’s management and had no access to its financial records. After falling out, B (majority shareholder, managing director), entered into negotiations to buy G’s shares However, unknown to G, another person approached B offering to buy all the shares in the

company. Eventually G agreed to sell his shares to B, who subsequently sold all of his shares to the third part for a higher price. G then sued B for breach of fiduciary duty and claimed equitable compensation.

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Held: While a director’s fiduciary duties were generally owed to the company and not individual shareholders, the nature of a transaction may give rise to a director owing fiduciary duties to a shareholder B possessed special knowledge acquired while managing the company which provided an opportunity to sell the company’s business advantageously. A fiduciary duty owed by directors to the shareholders where there are negotiations for a takeover or an acquisition of the company’s undertaking would require the directors to loyally promote the joint interests of all shareholders.

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ii.

Beneficiaries of a trust

Where a company acts as a trustee, directors of the trustee company may owe a duty to act in the best interests of the beneficiaries of the trust. Hurley v BGH Nominees Pty Ltd (No 2) [1984] 37 SASR 499 Facts: The trust carries on business at leased premises. It was argued that the directors breached their duty by acquiring the freehold of the premises for themselves. Held: -

Incorrect to say that directors of a company are entitled in all circumstances to act as though they owe no duty to individual shareholders. In appropriate circumstances, directors of companies that act as trustees owe duties not only to individual shareholders but also to the beneficiaries of the trusts. iii.

Different classes of shareholders

Mills v Mills (1938) 60 CLR 150 Authority for not applying the test of whether director is acting in the interests of the company in circumstances where its shares are divided into different classes. Has to decide on what is fair between different classes of shareholders. S 232 enables a member to obtain remedy if the court is of the opinion that a resolution of a class of members was contrary to the interests of the members as a whole, oppressive or unfairly prejudicial or unfairly discriminatory. -

iv. Nominee directors Appointed to represent sectional interests: Interests of individual shareholders in a joint venture company, majority shareholders, a class of shareholders, creditors, a holding company, employees or government body

Re Broadcasting Station 2 GB Pty Ltd [1964-1965] NSWR 1648

Facts: -

A newspaper publishing company ( Fairfax) gained control of Broadcasting Station 2GB Pty Ltd ( a radio station). One of the directors ( also a shareholder), sought remedy under s 232 alleging that the affairs of 2GB were being conducted in an oppressive manner. The alleged oppression concerned the appointment of the nominee to act solely in the interests of Fairfax and their conduct in withholding information from fellow directors concerning negotiations carried on by Fairfax in seeking the continuation of the radio station’s broadcasting licence.

Held: -

No oppressive conduct. The Fairfax nominee directors would be likely to act, and were expected by Fairfax to act in accordance with its wishes without close personal analysis of the issues. There was no evidence that nominee directors believed that the interests of Fairfax diverged from the interests of the company as a whole. It is unrealistic to expect directors to approach each company problem with a completely open mind. This would put a nominee director in an impossible position.

Concept: Nominee directors are permitted to act in the interest of their appointor provided that they honestly and reasonably believe there is no conflict between the interests of their appointor and the interests of the company. Levin v Clark [1962] NSWR 686 Facts: -

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Levin purchased the majority shareholding in a company and simultaneously mortgaged the shares to the vendor to secure payment of the purchase price. Clark and Rappaport were appointed by the company’s constitution to represent the interests of the vendor and mortgagee Under the sale agreement, the constitution was amended so as to allow Clark and Rappaport to exercise their powers as governing directors only in the event of default in payment of the loan to Levin. ( in this way, they are able to protect the interests of mortgagee/vendor) Levin defaulted and C & R exercised their power as governing director. Levin argued that the primary obligation of C&R is to the company and not the mortgagee

Held: -

The extent of the fiduciary duties of directors depends on the circumstances and these may include the fact that the constitution provided for the appointment of nominee directors. It was implied that C&R were expected to protect the mortgagee’s interests in the event of default by the mortgagor. The fiduciary duties of C&R took into account the agreement of the shareholders even though this was not expressly stated.

Concept: -

A company’s constitution or a shareholders’ agreement may specifically permit the appointment of nominee directors to represent the interests of particular shareholder or creditor.

Scottish Co-operative Wholesale Soc Ltd v Meyer [1953] 3 All ER 66

Facts: The minority shareholders of a subsidiary of the Scottish Co-operative Wholesale Society held slightly less than half the issued shares in the subsidiary. 3 directors of the subsidiary were appointed as nominees of the holding company and the other two represented the minority shareholders. The subsidiary operated a profitable textile manufacturing business using yarn purchased from its holding company. After a time, the holding company decided to operate its own textile manufacturing business and stopped supplying yarn to its subsidiary. The action of the holding company has the effect of preventing the subsidiary’s minority shareholders from participating in the profits of the textile manufacturing business. Held: -

the subsidiary’s directors appointed by the holding company acted contrary to the interests of the shareholders as a whole by failing to defend it from the actions of the holding company. Their failure to act, coupled with the holding company’s conduct, was regarded as oppressive conduct under the English equivalent of a s 232.

Concept: Nominee directors breach their duty where there is a clear conflict between the interests of the company and their appointor. Bennets v Board of Fire Commissioners of New South Wales (1967) 87 WN (Pt 1)(NSW)307 A nominee director must put the interests of the company ahead of the interests of the appointor whenever conflict arises.

v.

Company group

Walker v Wimborne (1976) 137 CLR 1 If there is a conflict between the interests of a subsidiary and the group, nominee directors must act in the subsidiary’s best interests and not in the interests of the group as a whole. Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 32 NSWLR 50 Facts: finds were transferred from two companies in a group to satisfy the debt of a related company. Held: -

The dominant director of the group was justified considering the welfare of the group was intimately tied up with the welfare of the individual companies. The interests of the two companies were considered because provision was made for compensating them for the loss of the funds The transactions were justified because the holding company of the group had guaranteed the debt which was repaid. The alternative was possible disaster for the whole group, including the two companies.

Re Spargos Mining NL (1990) 3 WAR 166; Jenkins v Enterprise Gold Mines NL (1992) 10 ACLC 136

Facts: -

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A minority shareholder (Jenkins) obtained remedies under equivalent of s 232 on the grounds that directors of Spargos and Enterpise Gold Mines had diverted substantial assets that were used for the benefit of other companies in the group. This caused considerable losses to the shareholders not interested in the other companies because the transactions were of no commercial benefit to S and their shareholders

Concept: It may be detrimental to the interests of minority shareholders if directors fail to act in the interests of a particular company and instead treat the company as part of a group. S187 assists directors who serve on the boards of wholly-owned subsidiaries o A director of a wholly-owned subsidiary will be taken to act in good faith in the best interest of the subsidiary where:  The constitution of the subsidiary expressly authorises the director to act in the best interests of the holding company; and  The director in fact acted in good faith in the best interests of the holding company. S 187 is limited to situations where the subsidiary is solvent at the time the director acts and does not become insolvent because of the director’s action ( in order to protect the interests of the subsidiary’s creditors)

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Employees

Parke v Daily News Ltd (1962) Ch 927 Facts: A company that controlled two newspapers sold one of them. The directors intended to distribute surplus proceeds from the sale among its employees by way of compensation for dismissal. A shareholder brought an action to prevent these payments.

Held:

The directors breached their fiduciary duties to act in the best interests of the company because the proposed payments were not reasonably incidental to the carrying on of the company’s business. They were gratuitous payments to the detriment of shareholders and the company as a whole.

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Concept: Directors should not consider the interests of employees at the expense of the interests of the company’s shareholders In most cases, a payment to the employees will be in the interests of the company where their employment continues because its industrial relations may be improved. Pt 5.8A of Corporations Act require directors to consider the interests of employees in certain situations; to prevent directors from stripping the companies’ assets and making the companies insolvent so as to prevent employees enforcing their entitlements.

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Creditors Directors have fiduciary duty to exercise their powers in good faith and in the best interests of their company.

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When the company is solvent, the best interests of the company correspond with the best interests of its shareholders as a collective group. When the company is insolvent, the interests of the company is those of its creditors. Directors have duty to exercise their powers in a way that does not prejudice the company’s ability to pay its creditors....