Written by Richard Wee & Jacob Wong
Introduction
A director can be an individual or member from a company that is elected to be in the company’s board of directors. The main responsibilities of the board of directors are to be in charge of the management, business, policies and bylaws of the company. Therefore, with such powers conferred upon directors, they also owe a duty of care to the company in order to act in the best interest of the company. A failure to perform their duties as a director may bring legal consequences.
This article will illustrate several fundamental duties of directors including the duty to act in the best interest of the company, business judgment rule and duty to avoid and disclose conflict of interest.
Apart from the generally appointed director, there are also individuals who act as a director without being appointed as a director. According to Section 2 Companies Act 2016 (CA 2016), it states that ‘director’ also includes any person occupying the position of director of a corporation by whatever name called and includes a person in accordance with whose directions or instructions the majority of directors of a corporation are accustomed to act and an alternate or substitute director.
Examples for individuals who act as a director but not officially a director are de facto director and shadow director. De facto director is a person who acts as a director but is not formally appointed whereas a shadow director is a person who gives directions and instructions to the formally appointed director.
In the case of Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180, Millet J explained and distinguished the difference between de jure (validly appointed), de facto and shadow director by stating that “I need not recite the proviso to that definition. Directors may be of three kinds; de jure directors, that is to say, those who have been validly appointed to the office; de facto directors, that is to say, directors who assume to act as directors without having been appointed validly or at all; and shadow directors who are persons falling within the definition which I have read…….
….. A de facto director, I repeat, is one who claims to act and purports to act as a director, although not validly appointed as such. A shadow director, by contrast, does not claim or purport to act as a director. On the contrary, he claims not to be a director. He lurks in the shadows, sheltering behind others who, he claims, are the only directors of the company to the exclusion of himself. He is not held out as a director by the company.”
Therefore, de facto directors or shadow directors are also under legal responsibilities to act in the best interest of the company and failure to do so would breach the duty of care that they owed to the company. This principle is further affirmed in the recent high profile case of Pendakwa Raya v Dato’ Sri Mohd Najib bin Hj Abd Razak [2020] MLJU 1254 where the court stated that “Having regard to the totality of the evidence I think it is abundantly clear that the accused could in essence and substance be construed as a shadow director of SRC or as its director as defined in Section 402A of the Penal Code. And as such a director, the accused must at all times like any duly appointed director, act in the best interests of the company, and be subject to the same duties and obligations of a director under the law.”
According to Section 213(1) CA 2016, a director is required to act in the best interest in the company. By doing so, the director has to exercise reasonable care, skill and diligence, this is laid down in Section 213(2) CA 2016. Furthermore, Section 213(2)(a) and (b) CA 2016 suggests that a director has to act with the knowledge, skill and experience which may reasonably be expected of a director having the same responsibilities and any additional knowledge, skill and experience which the director in fact has.
In order to determine whether a director has acted in accordance with the Act, the test has been laid down in the UK case of Re Smith and Fawcett Limited [1942] 1 CH 304. In that case, Lord Greene MR was of the view that the duty to act in interest of the company means the director must act bona fide in what they consider, not what a court may consider. This view has been affirmed by the Federal Court in the case of Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd and another appeal [2017] MLJU 1976.
However, the Federal Court further made a judgment that the test should be a combined test consisting of objective and subjective tests. By making the judgment, Azahar Mohamed FCJ referred to the case of Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] 1 CH 62 where the court highlighted that the test should be whether an honest and intelligent man in the position of a director of the company concerned could, in the whole of the existing circumstances, have reasonably believed that the transaction was for the benefit of the company.
There is a sanction attached in Section 213(3) CA 2016 where failure to comply with Section 213 CA 2016 may be liable to imprisonment for a term not exceeding five years or to a fine not exceeding three million ringgit.
A director when making a business judgment rule is required to make the judgment in accordance to Section 214(1) CA 2016. Section 214(1) reads as follow:
(1) A director who makes a business judgment is deemed to meet the requirements of the duty under subsection 213(2) and the equivalent duties under the common law and in equity if the director
- makes the business judgment for a proper purpose and in good faith;
- does not have a material personal interest in the subject matter of the business judgment;
- is informed about the subject matter of the business judgment to the extent the director reasonably believes to be appropriate under the circumstances; and
- reasonably believes that the business judgment is in the best interest of the company.
‘Business judgment’ is defined under Section 214(2) CA 2016 as any decision on whether or not to take action in respect of a matter relevant to the business of the company.
Section 214(1) indicates that a director has owed a duty of care to the company when making a business judgment. The question here is how the courts determine whether a director has breached the duty of care.
In the case of Petra Perdana which was mentioned above, the court referred to the case of Howard Smith v Ampol Petroleum Ltd [1974] UKPC 3 to determine whether the defendants had acted in the best interest of the company when making a business judgment. The main principle from the case is that when in the absence of fraud, breach of fiduciary duty and conspiracy, the courts do not undertake the exercise of assessing the merits of a commercial or business judgment made by directors. This shows that courts will not substitute its own decision against business and management decisions merely because the decision was made poorly.
A director of a company is not allowed to be involved in making a business decision if the decision involves personal material interest of the director. The established principle in this area was laid down in the case of Aberdeen Railway Co v Blaikke [1854] 1 Macq 461. Lord Cranworth held that it is a universal application that no one having fiduciary duties shall be allowed to enter in engagements in which he has or can have a personal interest conflicting or what possibly may conflict with the interest of those whom he is bound to protect.
Generally, a director is allowed to act as director for several companies. However, the director is not allowed to act as director for 2 different companies that consist of conflicting interest between them. Besides that, personal conflicting interests such as becoming the supplier to your own company is also not allowed.
Nonetheless, a director can still continue an act with potential conflicting interest by having the company’s board members granting an approval. However, as a director, it is important to recognise the duty to always promote the best interest of the company. Therefore, even with the approval of the board members, the director still has the responsibility to prevent causing losses to the company for personal interest.
There is also a duty to disclose a potential conflicting interest to the company’s board of directors. These areas are governed under Section 221 and 222 CA 2016. Section 221(1) outlined that a director needs to disclose the conflict of interest as soon as practicable after the relevant facts have come to the director’s knowledge, declaring the nature of his interest at a meeting of the board of directors.
Furthermore, the declaration of conflicting interest is required to be recorded in the minutes of the meeting as stated in Section 221(8). This is further affirmed in the case of Sysmex (Malaysia) Sdn Bhd v Sia Kee Chow [2013] 8 CLJ 120 where Suraya Othman J said that, “As the first and second defendants had not disclosed or made any such declarations of their interest nor did they record it in any minutes of meeting, prima facie, the defendants are in breach of their fiduciary duty.”
In Section 222, it states that a director with conflict of interest is allowed to attend the meeting that discusses the subject matter but not allowed to discuss or vote in that matter.
Conclusion
Directors are the main operators of a company and thus regulations are needed to be in place to make sure their actions are taken to ensure the best interest of the company. However, by putting too much legal burden on directors may the freedom to exercise their powers. Therefore, the law on governing the directors has to be proportionate to develop the corporate field.
Published on 1 October 2020
Photo by Benjamin Child on Unsplash