DIRECTORS’ DUTIES IN A VASTLY DIFFERENT CORPORATE LANDSCAPE
Extensive codifications of corporate governance principles and common law precepts under the new Companies Act 71 of 2008 serves to highlight the markedly different corporate landscape in which South African companies are now required to do business
In Da Silva v CH Chemicals (Pty) Ltd (2009) 1 All SA 216 (SCA), the Supreme Court of Appeal was required to pronounce on whether the exploitation of various corporate opportunities constituted a breach of fiduciary duties contemplated by both common law and the Companies Act of 1973. The alleged breach occurred after the resignation of the appellant as managing director to establish and head a distribution agency in competition with the respondent.
In the Da Silva case, the respondent successfully instituted proceedings against the first appellant, as well as two employers of the first appellant in the Pretoria High Court, for the disgorgement of profits and, in the alternative, payment of damages arising from alleged breaches of a director’s fiduciary duties.
The first appellant, while occupying the position as managing director of the respondent, allegedly exploited business opportunities that should have been exploited for the respondent’s benefit.
In addition, action was instituted against the second and third appellants for damages arising from alleged unlawful competition with the respondent.
While the court a quo found in favour of the respondent in all of its claims, on appeal – save for damages suffered by the respondent arising out of its linear low-density polyethylene transaction – the court held that the respondent’s claims should have been dismissed with costs.
Scot JA held that it is a well established rule of company law that directors have a fiduciary duty to exercise their powers in good faith and in the best interests of the company. It follows that they are not entitled to make a secret profit or otherwise place themselves in a position where their fiduciary duties conflict with their personal interests. The court held that a director must acquire an economic opportunity for the company, if it is acquired at all.
Should the opportunity be claimed from the delinquent director, the company may sue for any profits which the director may have made as a result of the breach or for damages it may have suffered.
The court maintained that a corporate opportunity was one which the company had been actively pursuing or which fell within the company’s existing business activities and involved in each case a close and careful examination of all relevant circumstances, including the particular opportunity in question.
Of particular significance is the determination made by the court that a director could not escape liability by resigning before seeking to exploit an opportunity which the company was actively pursuing. Nor could the director escape from a situation whereby an opportunity within the scope of the company’s business activities, of which the director became aware in the performance of his or her duties as a director, was deliberately concealed from the company.
The court maintained that the opportunity remained that of the company and that director would remain accountable.
However, if the opportunity was not of such kind or if it was an opportunity which the director was obliged, in the absence of explicit contractual restraints, to exploit to the full – even though the scope of the company’s business activities arose after his resignation or was one which he was unaware prior to his resignation..
Duties and Liabilities of Directors in terms of the Companies Act 71, 2008
While the new Companies Act has been adopted by parliament and was assented to by the President on 9 April 2009. It is envisaged that it will enter into force by no earlier than 9 April 2010 and will, with effect from the commencement date, repeal the existing Companies Act in its entirety. Whilst the new Act has sought to strike a balance between adequate disclosure in the interests of transparency and over-regulation, it has sought to ensure the proper recognition of director accountability and a clarification of board structures and directors’ responsibilities, duties and liabilities.
Many of the common law duties and liabilities of directors have now been expanded in s76 of the Act entitled “Standards of Directors Conduct”, while retaining much of the common law intact.
These amendments should therefore promote higher thresholds of transparency, corporate governance and standards of accountability to directors in line with international best practice.
Section 76(3)(a): “Good faith and for a proper purpose”
The duties owed by a director dictate that in carrying out his duties, effectively acts as agent or fiduciary of the company, entrusted with the responsibility of promoting and protecting the company’s interests. These interests are owed by the director to his or her company alone and therefore seek to provide a number of protections to the company – to act pursuant to a proper purpose in the best interests of the company and carry out his duties with the utmost good faith.
Section 76(3)(b): “Duty to act in the best interests of the company”
As demonstrated in the Da Silva case by allegations levied against the appellant that he furthered his own interests and those of the distribution agency to the detriment of his previous company, a director owes his duties to the company to the exclusion of the company's shareholders and all third parties. If it is found that the conduct of the director was not to further the interests of the company, a director renders himself liable to being in breach of his duties.
Section 76(3)(c) “The Duty to Exercise care, skill and diligence”
The common law principle now codified in s76(3) that a director is obliged to exercise care, skill and diligence was highlighted in the case of Re City Equitable Fire Insurance Company Limited (1925), where the court found that a director was negligent, that director is entrusted with the responsibility of acting honestly. He must exercise such a degree of skill and diligence as would amount to reasonable care which an ordinary man, having that particular director’s knowledge and skills, may be expected to take in the same circumstances.
The consequence of this ‘subjective test’ is that a director will not be liable for mere errors of judgment. He is not required to demonstrate expertise in the type of business which the company conducts, and is akin to an ‘objective’ test, in that the Director is not expected to have any knowledge or to exercise skills which he does not possess.
In managing the company’s affairs diligently, the director is accordingly also entrusted with the responsibility of devoting a reasonable amount of attention to the company’s affairs. Failure to demonstrate proper diligence may be conclusive that a director has acted negligently and in some cases, even dishonestly.
Section 76(2)(a): “Duty to avoid conflicts of interest”
Although the SCA in Da Silva held that the alleged corporate opportunities which presented themselves to the appellant amounted to normal corporate competition and did not give rise to a conflict between the director’s personal interests and the interests of his formal company, as to the product claims, the director’s conduct amounted to a breach of a fiduciary duty and to unfair competition on the part of the second appellant, on whose behalf the transaction was concluded.
The ratio for submission was that this specific transaction was one which the appellant, while still the managing director of the respondent, was obliged to follow for the benefit of the previous company.
It may be seen therefore that s76(2)(a), read with s75(5), codifies the common law no-profit rule and provides that where a director competes with his company – or holds another office in a rival concern which places him in a position whereby his duties to the rival concern conflict (or possibly conflict) with his duties to his company – his company may claim all profits the director may have made or recover damages caused by the breach.
In terms of the Act therefore, where a director pursues his own interests as opposed to those of the company, he is liable to account to the company for any profit he makes or benefit he received regardless of whether or not he profits at the expense of the company.
Section 77(2) (a) and (b): “Liability of directors and prescribed officers”
Section 77, entitled “Liability of directors and prescribed officers”, provides for several circumstances in which directors may be held personally liable under common law.
Such liability relates to:
· Breach of a fiduciary duty for any loss, damages or costs sustained by the company as a consequence of any breach by the director or a duty contemplated in provisions of s75; or
· In accordance with the principles of the common law relating to delict (tort) for any loss damages or costs sustained by the company as a consequence of any breach by that director.
Draft Code of Governance: Principles of for South Africa 2009 published by the King Committee on Governance
King III became necessary as a result of amendments in terms of the new Companies Act and changes in international governance trends.
Although the governance of corporations can take place on a statutory basis as exemplified by the United States Sarbanes-Oxley Act which codifies a significant part of its governance, South African drafters of the Code have recognised that a “one size fits all” approach is unsuitable because the scales of businesses carried out by companies in South Africa vary to such a large degree.
It follows that in the case of Code, there is a level of flexibility in the Code’s application, as it merely constitutes a recommendation for a course of conduct. Yet simultaneously encourages the establishment of structures and processes alongside appropriate checks and balances to enable directors to discharge their legal responsibilities.
The Code asserts, therefore, that if a board believes the conduct to be in the best interests of the company, it can adopt a practice different from that recommended in the Code provided that the company is then in a position to explain it, thereby cultivating a culture of transparency, accountability and, thus, compliance.
Accordingly, although the Code does not have the force of legislation, it seeks to align itself with many of the precepts of the new Companies Act discussed above.
As a result, viewed cumulatively, governance codes and guidelines will, more than ever before, be relevant in the determination of what is regarded as an appropriate standard of conduct. Consequently, the more established certain governance practices become, the more likely a court, as in the case of Da Silva, would regard that conduct as conforming to practices expected by the Code and the Act’s required standard of care.
One of the sharper criticisms levelled against the Code is its burdensome compliance requirements in terms of implementation time and cost. The import of such a change in focus may have the resultant effect that the board and management become focused on compliance rather than the business of the enterprise.
And, whilst it is trite that the duty of the board of a trading enterprise is to undertake risk for reward and to try to improve the economic value of a company; it has been suggested that if a board elects to follow a narrow focus on compliance, rather than seeking to integrate governance into the company’s practice, the board’s initial responsibility towards its enterprise and its ultimate responsibility, namely performance, may potentially be diluted by a focus on administrative outcomes.It is therefore critical that South African companies recognise an inclusive approach to governance by taking into account the practical expectations of the company’s stakeholders in making decisions in the best interests of the company.
In addition, the Code, while adopting an international model of “apply of explain”, fails to appreciate the unique corporate context for which South African companies, in absence of a tradition of shareholder activism, are required to operate.
Minimal institutional shareholder involvement, exemplified by public voting policy documents and lower turnouts at annual general meetings, highlight the assertion that apathetic institutional shareholders do not often want an explanation. The implication of such passive shareholder involvement and optionality then justifies the immediate deviation from Code recommendations, circumventing the very purpose they have sought to achieve.
More contentiously, whilst the Code advocates the existence of an independent non-executive, it falls short in prescribing how many years a director can remain on a board before he is no longer classed as independent, as is the case internationally.
Notwithstanding such criticism, the Code, viewed cumulatively with new Companies Act, has the potential to redress many concerns emanating from the global recession by providing a forward-looking and sustainable framework for corporate governance and director accountability.