#3570 - Directors' Duties 1 - Company Law

DIRECTORS’ DUTIES 1

Content of Duties

1. Section 171: duty to act within powers and for a proper purpose

2. Section 172: duty to promote the success of the company

3. Section 173: duty to exercise independent judgment

4. Section 174: duty to exercise reasonable care and skill

5. Section 175: duty to avoid conflicts of interest

6. Section 176: duty not to accept benefits from third parties

7. Section 177, 182: duty to declare interests in transactions

8. Section 188-226: duties in respect of transactions requiring approval of members

   Section 179: the duties are cumulative

   Thus director can be liable for breach of more than one duty at same time

Avoidance of Liability

Ways in which directors can avoid being in breach of duty include:

1. Board authorisation

• Section 175(5)+(6)

2. Consent, approval or authorisation of members

• Section 180

3. Authorisation in articles

• Section 180(4)

4. Ratification

• Section 239

5. Relief from the court

• Section 1157

Remedies

Section 178(1): consequence for any breach of duty is same as would apply if corresponding common law rule or equitable rule applied

To Whom Are Duties Owed?

Section 170(1): Directors owe their statutory duties to the company

Hence only the ‘company’ can

enforce directors’ duties,

or ratify a breach of duty.

Directors may in certain circumstances owe duties to:

1. Shareholders

   only the directors’ statutory duties are owed to company

   thus directors can still come under fiduciary duties to shareholders outside of statute

   directors may come to owe fiduciary duty to shareholders where:

   directors are acting as agents of shareholders

• e.g. for the sale of shares

  there is special factual relationship between directors and shareholders

• even where there is no agency relationship

• e.g. in case of a small family company directors may owe fiduciary duty of disclosure if:

1. they are much more knowledgeable than members

2. members rely on them for advice

   • Coleman v Myers [1977] (New Zealand Case)

2. Creditors

   when company is nearing insolvency, interests of company becomes synonymous with interests of creditors

   director may owe duty to company take into account interests of creditors where company is nearing insolvency

   But cannot owe duty to creditors directly

   Yukong Line [1998]

   thus only the liquidator (as holder of company’s right of action) may sue director for not having regard to interests of creditors

   and not creditors themselves

   Yukong Line [1998]

3. Employees

   Section 172: directors have duty to have regard to interests of employees

   However employees themselves are incapable of enforcing this duty

   i.e. only the company/liquidators can do this

   in addition, must only ‘have regard’ to employees’ interests

   thus in practice, provision hardly ever enforced

By Whom are Duties Owed?

Directors’ duties are owed by:

1. Directors

2. De facto directors

   Directors’ duties may be owed by:

3. Shadow directors

   Concept of shadow directors and de facto directors are usually distinct

   However they have common feature that person in question is alleged to have exercised real influence over company

   Re Kaytech [1999]

   Unclear whether directors’ duties apply to shadow directors

1. One case held they did not

• Ultraframe [2005]

2. Another case seems to support view that they do

• i.e. analogy drawn between de facto and shadow directors suggest that same duties apply to both

• Re Kaytech [1999]

SECTION 171

Section 171: director must exercise powers:

1. In accordance with the constitution

2. For the purpose for which they were conferred

   Thus director breaches his duty in section 171 wherever he acts:

1. outside his powers

   action which is ultra vires the director’s powers

   action which has not been duly authorised by a quorate board

2. or for improper purposes

Former is obvious. Only latter need be analysed in greater detail.

Improper Purposes

External Powers

I.e. use of powers in relation to third parties

Test of improper purposes is objective.

not subjective

Regentcrest plc v Cohen [2001]

Thus test is not one of good faith

i.e. is possible for director to be acting in good faith, but for improper purposes

Regentcrest [2001]

“Nominee/Special Interest Directors”

Sometimes directors are appointed deliberately in order to represent the interests of a particular shareholder, or special interest group.

Nominee/special interest director still has overriding duty to serve interests of board in question

Cannot simply act as representative

Bennetts v Board of Fire Commissioners of News South Wales [1967] (Australian Case)

Can only take into account interests of nominator insofar as this is consistent with his overriding duty

2. Internal Powers

   I.e. use of powers in manner which affect rights of shareholders

   Courts seem much more prepared to interfere where internal powers are involved.

   Whether use of power is proper depends on purpose for which power was conferred

   this ascertained from construction of company’s articles.

   Hogg v Cramphorn [1967]

Relevant Test

Opposing Tests

1. Objective Test

   Supported by some English authorities

   Hogg v Cramphorn [1967]

   Therefore whether directors acting in good faith irrelevant

2. Subjective Test

   More popular in Commonwealth

   Thus is no improper purpose where directors are acting in good faith.

3. Intermediate Test (best view)

   Power is exercised properly where “substantial purpose” for which power was exercised is proper.

   ‘Substantial purpose’: i.e. the dominant or primary purpose

   Howard Smith v Ampol Petroleum [1974] (PC)

   Extrasure Travel Insurance v Scattergood [2003]

   Thus where substantial purpose of exercising power is proper, is irrelevant that an incidental purpose is improper.

   Howard Smith [1974]

   Good faith of directors simply a factor taken into account when determining “substantial purpose” for which power was exercised

   Howard Smith [1974]

   Strength of Shareholders

   where exercise of power affects power of relative shareholders in company, courts also look at whether exercise of power is fair as between different classes of shareholders

   i.e. in addition to interests of company

   Mills v Mills [1938] (Australian Case)

Examples

1. Where directors use any of their powers in order to promote or defeat a takeover, will almost always be improper.

   i.e. as this decision should be left to shareholders

   Howard Smith [1974]

2. Proper use of directors’ powers to issue shares is to raise capital.

   And not to deprive people of majority or create a new majority

   Howard Smith [1974]

   However considerations of fairness as between individual shareholders still relevant

   Mills v Mills [1938]

Nature of Duty

Director owes duty in s.171 to the company

and not to the shareholders

Hogg v Cramphorn [1967]

Thus in theory, members do not have a right of action against directors for breach of s.171

even where improper use was to deprive members of voting power.

This conclusion supported by section 170(1).

Exception

Nevertheless an improper use of power to allot shares has been conceived of as an infringement of members’ contractual rights under Articles.

i.e. so that members have personal right of action

Re A Company [1987] (see supervision 7)

Possible that section 170(1) now precludes duty in s.171 being owed to shareholders?

Consequences of Breach

External Powers

where director acts for improper purposes, lacks actual authority.

however may still have ostensible authority

where contract is entered into without actual authority (due to improper purpose) and without ostensible authority, contract is void.

and not voidable

Jyske Bank

Internal Powers

where director uses power to allot shares for improper purposes, allotment is voidable

thus can be set aside by shareholder

Howard Smith v Ampol Petroleum [1974]

Remedies

section 178: remedy is same as that for corresponding common law/equitable duty

pre-2006, breach of this duty was treated as breach of trust

thus remedies are those for breach of trust (see below)

Remedies For Breach of Trust

1. Liability of Directors

   Remedies available to company against director include:

1. Equitable compensation

2. Recovery of property

3. Account of profits made by director

4. Rescission of contract (for breach of s.177)

Equitable Compensation

Directors are strictly liable to make good any losses their actions caused company

Liability is joint and several for multiple directors.

Recovery of Property

Misapplied company property can be recovered from anyone who holds it (including the director and third parties without a defence)

i.e. this done via:

1. restitution

• where property is still intact

2. tracing

• Where property has been converted to some other form (see Equity)

• Property of company is treated as though it were a trust fund

  • Russell v Wakefield Waterworks [1875]

    Where property is recovered in this way, will be subject to constructive trust.

2. Accessory liability

   Third parties may be liable for

   Dishonest assistance of director’s breach

   Knowing receipt of company’s property

3. Unauthorised Remuneration

   Director ordinarily entitled to take remuneration from company

   Model Article 23 (Plc) permits them to

   director will usually have contract of employment

   However where no such right exists, director must account for unauthorised remuneration

   held on constructive trust for company

   Guinness v Saunders [1990]

SECTION 172

Definition

Section 172

Directors have duty to act in the way which, in good faith, would be most likely to promote success of company for benefit of its members as a whole.

Directors shall have regard to six factors when doing this:

1. Likely long-term consequences of decisions

2. Interests of employees

3. Need to foster good relationship with suppliers, customers and others

4. Impact...