5/13/2011
Company Law I
Lecture 9:
Directors (Part 2)
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Duty to act bona fide
in the best interests of the company
• Re Smith & Fawcett Ltd [1942] Ch 304 (Court of
Appeal)
company
Fawcett
Smith
son
 Held: no evidence to show that director did not act bona fide.
 Lord Greene MR:“the language of the article … does not point
out any particular matter as being the only matter to which the
directors are to pay attention in deciding whether or not they
will allow the transfer to be registered.”
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Duty to act bona fide
in the best interests of the company
• Re Smith & Fawcett Ltd [1942] Ch 304 (Court of
Appeal)
 “there is nothing in principle or in authority to make it
impossible to draft such a wide and comprehensive
power to directors …”
 Lord Greene MR: “The principles to be applied in
cases where the articles of a company confer a
discretion on directors … are, for the present
purposes, free from doubt. They must exercise their
discretion bona fide in what they consider – not what
a court may consider – is in the interest of the co, and
not for any collateral purpose.”
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Duty to act bona fide
in the best interests of the company
• Dorchester Finance v Stebbing [1898] BCLC
498
 Foster J: “a director must exercise any power
vested in him as such, honestly, in good faith and
in the interests of the co.”
• What does the term “good faith” refer to
here?
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Duty to act bona fide
in the best interests of the company
• Another example: Bishopsgate Investment
Management Ltd (in Iiq) v Maxwell (No 2) [1994] 1
All ER 261
 Acting contrary to the corporate constitution could also be
regarded as being in breach of the duty to act in the
interests of the co as the constitution can define and set
limits to the co’s interest.
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Duty to act bona fide
in the best interests of the company
• Business judgment rule
 Delaware courts will apply rationality review to
business judgments provided that the directors
have complied with their duty of care and their
duty of loyalty.
 English courts do not review business judgments.
Howard Smith v Ampol Petroleum Ltd.
But in Re Walt Disney Derivative Litigation 907 A 2d 693
(Del Ch 2005)
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Duty to act bona fide
in the best interests of the company
•
•
•
•
•
•
Who is the company?
Existing shareholders?
Individual shareholders?
Future shareholders?
Related companies?
Creditors?
 Nicholson v Permakraft (NZ) [1985] 1 NZLR 242
 Kinsela v Russell Kinsela Ply Ltd (in Iiq) (1986) 4 NSWLR 722
 Chingtung Futures Ltd (in Iiq) v Lai Cheuk Kwan Arthur
[1992] 2 HKC 637
• Employees?
• Others?
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Cases
• Chingtung Futures Ltd (in Iiq) v Lai Cheuk Kwan
Arthur et al [1992] 2 HKC 637
 Bokhary J: … I do not consider Lai’s conduct as being capable of
ratification. … such conduct jeopardized the very existence of the co.
 Cited Re Horsley & Weight Ltd [1982] Ch 442 at 454-456: … the
unanimous assent of the s/ers is not enough to justify the breach of
duty to creditors
 “Whether negligent conduct is capable of ratification does not turn on
whether the negligence was gross. … What matters is the nature of
the exposure brought about by the negligence.”
 “if any creditor of the co suffers loss and is driven to proving in the
liquidation for redress, the co’s claim against the negligent director or
directors cannot be defeated, to the ultimate detriment of any
creditor, by any ratification which such director or directors may be
able to procure of their own negligent acts or omission …”
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Duty to act bona fide
in the best interests of the company
• At common law, the interests of a co is the
interests of its members. But the authority in
relation to a company limited by shares is sparse.
 Gaiman v National Association for Mental Health
[1970] 2 All ER 362
Megarry J: “the co is an artificial legal entity, and it is not
very easy to determine what is in the best interest of the co
without paying due regard to the members of the co. The
interests of some particular section or sections of the co
cannot be equated with those of the co, … the interests of
both present and future members of the co, as a whole, as
being a helpful expression of a human equivalent.”
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Duty to act bona fide
in the best interests of the company
• In reaching his ruling, Megarry cited Greenhalgh v
Arderne Cinemas Ltd [1950] Ch 286, 291
 Lord Evershed J: “the phrase ‘the company as a whole’ does not
(at any rate in such a case as the present) mean the company as
a commercial entity as distinct from the corporators. It means
the corporators as a general body. That is to say, you may take
the case of an individual hypothetical member and ask whether
what is proposed is, in the honest opinion of those who voted in
its favor, for that person’s benefit.”
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Duty to act bona fide
in the best interests of the company
• For most companies, acting in the “company’s
interest” means acting to promote shareholder
value.
 Brady v Brady [1988] BCLC 20
 Nourse LJ: “the interests of a company, an artificial person,
cannot be distinguished from the interests of the persons
who are interested in. Who are those persons? Where a
company is both going and solvent, first and foremost
come the s/ers, present and o doubt future as well.”
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Duty to act bona fide
in the best interests of the company
• The interests of other constituencies could be taken
into account provided that so doing furthered the
interests of shareholders.
 Hutton v West Cork Rly Co (1883) 23 Ch D 654
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Duty to act bona fide
in the best interests of the company
• In the interests of members - default rule only
 In the absence of contrary intention set out in the co’s
articles, the co’s interests = the interests of present and
future members as a whole
 Co could elect to define its interests differently in articles:
to be run in the interests of other constituencies or a
combination of constituencies
Re Horsely & Weight Ltd [1982] Ch 442
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Duty to act bona fide
in the best interests of the company
• What is intended by the reference to future
members?
 Megarry J in Gaiman refers to both existing and future
members
 What’s intended to by the reference to future members?
 Sensible understanding?
• What if an individual shareholder’s interest diverge?
 Megarry J in Gaiman refers to the members’ interests “as a
whole”
 If the interests conflict, the board is entrusted with
maximizing overall s/er interests, which may involve
balancing and choosing between the different s/er
interests
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Duty to act bona fide
in the best interests of the company
• The interests of other constituencies?
 Subject to one exception, common law has not equated
the company’s interests with the interests of non-s/er
constituencies
 Bowen LJ in Hutton v West Cork Railway Co. (1883) LR 23
Ch D 654, 673: “the law does not say that there are to be
no cakes and ale, but there are to be no cakes and ale
except such as are required for the benefit of the co.”
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Duty to act bona fide
in the best interests of the company
• The interests of other constituencies?
 S 309(1) of CA 1980: “the matters to which the directors of
a co are to have regard in the performance of their
functions include the interests of the co’s employees, in
general, as well as the interests of its members”
 It was later restated in s 309(1) of the CA 1985.
 How to read this?
 Does this clause say anything about in whose interests
decisions should be made?
 Case law on directors’ duties and creditors
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Duty to exercise powers
for proper purposes
• Hogg v Cramphorn Ltd [1966] 3 All ER 420
 Baxter offered to buy existing shares in Cramphorn Ltd.
 Directors issued shares to trustees (to hold for
employees) so as to command a majority for the directors
and their supporters.
 Issue: if the allotment of shares is an improper use by the
directors of their discretionary and fiduciary power … to
decide to whom these unissued shares should be allotted.
 Pl’s argument: the issue is made with the primary object
of preventing Baxter from obtaining control and ousting
the then existing board → so it is a breach of duty
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Duty to exercise powers
for proper purposes
• Hogg v Cramphorn Ltd [1966] 3 All ER 420
 Df counsel argued that the establishment of an
employees’ trust was within the powers of the co; Pl’s
counsel did not dispute this
 The court accepted that the board complied with the duty
of good faith but the question is whether that’s sufficient
to halt any further inquiry into the use by the board of the
corporate power?
 Buckley J: “… the board acted in good faith and that they
believed that the establishment of a trust would benefit
the co, and that avoidance of the acquisition of control by
Baxter would also benefit the co.”
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Duty to exercise powers
for proper purposes
• Hogg v Cramphorn Ltd [1966] 3 All ER 420
 Buckley J, following Piercy & Mills, focused on the fact
that powers were being used to usurp the constitutional
settlement of powers in the co between board and s/ers
body
 The directors could not use their powers for the primary
purpose of interfering with ‘the exercise by the majority
of constitutional rights.’
 2 constitutional rights
 How do we articulate the holding of this case?
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Duty to avoid conflict of interests
• Four regulatory strategies:
• Three strands:
 (No-)conflict rule
 (No-)profit rule
 Misappropriation rule
• What if the transaction is fair to the company?
 Aberdeen Railway Co v Blaikie (1854) Macq HL 461 at 471
 Man Luen Corp v Sun King Electronic Printed Circuit Board
Factory Ltd [1981] 1 HKC 407
 Regal (Hastings) Ltd v Gullivers [1942] 1 All ER 378
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Cases
• Aberdeen Railway Co v Blaikie (1854) Macq HL 461
 Lord Cranworth: “the directors are a body to whom is delegated the
duty of managing the general affairs of the co. A corporate body can
only act by agents, and it is the duty of those agents so to act as best
to promote the interests of the corporation whose affairs they are
conducting.”
 “it is a rule of universal application that no one having such duties to
discharge shall be allowed to enter into engagements in which he has
or can have a personal interest conflicting or which possibly may
conflict with the interests of those whom he is bound to protect.”
 “no question is allowed to be raised as to the fairness or unfairness of
the contract”
 “it is impossible to demonstrate how far in any particular case the
terms of such a contract have been the best for the cestui qua trust
which it was possible to obtain.”
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Cases
• Aberdeen Railway Co v Blaikie (1854) Macq HL 461
 Lord Cranworth’s approach reflects the oft-cited views of Lord Eldon
when considering the no-conflicts principle in the trusts context in Ex
parte James [1803-13+ All ER Rep 78, at 82, … holding that ‘the
purchase is not permitted in any case, however, honest the
circumstances, the general interests of justice requiring it to be
destroyed in every instance as no court is equal to the examination
and ascertainment of the truth in much the greater number of cases’.
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(No-)conflict rule - equity
• Case law rule: disclosure of conflict of interest must be made
to general meeting and approval by it
 Imperial Mercantile Credit Association v Coleman (1871) LR 6 Ch App 558 at
567-8
 Man Luen Corp v Sun King Electronic Printed Circuit Board Factory Ltd [1981] 1
HKC 407
 Woolworths Ltd v Kelly (1991) 22 NSWLR 189
• Effects of non-disclosure: transaction voidable at election of
company
 Hely-Hutchinson v Brayhead [1968] 1 QB 549 (per Lord Denning)
 Man Luen Corp v Sun King Electronic Printed Circuit Board Factory Ltd [1981] 1
HKC 407)
• Modification of duty by articles is possible
 Liquidators of Imperial Mercantile Credit Association v Coleman (1873) LR 6 HL
189 at 205
 Woolworths Ltd v Kelly (1991) 22 NSWLR 189
 Table A reg 86(2)
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Disclosure of interests - CO s 162
• Companies Ordinance s 162
• Table A reg 86(1)
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Loans to directors, etc.
•
•
•
•
•
Prohibition: s 157H
Exceptions: s 157HA
Civil consequences of contravention: s 157I
Criminal liability: s 157J
Connected transactions: see Listing Rules Ch
14A
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(No-)profits rule
• Eg diverting business opportunity away from
company
• Regal (Hastings) Ltd v Gulliver [1942] 1 All ER
378
 Lord Greene MR in Court of Appeal held that the question of
whether the director could keep the profits was to be
determined by asking whether they acted in bad or good faith.
→ good faith requires subjective loyalty
 Viscount Sankey: “at all material times they were directors and
in a fiduciary position, and they used and acted upon their
exclusive knowledge acquired as such directors. They framed
resolutions by which they made a profit for themselves. They
sought no authority from the company to do so, and, by reason
of their position and actions, they made large profits for which,
in my view, they are liable to account to the company …”
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(No-)profits rule
• Regal (Hastings) Ltd v Gulliver [1942] 1 All ER
378
 Lord Russell of Killowen (the remaining 3 Law Lords concurred):
“they acted with bona fide, intending to act in the interest of
Regal” … “the liability arises from the mere fact of a profit
having been made. The profiteer, however honest and wellintended, cannot escape the risk of being called upon to
account.”
 Lord Wright: “*in+ both in law and equity, it has been held that, if
a person in a fiduciary relationship makes a secret profit out of
the relationship, the court will not inquire whether the other
person is demnified or has lost a profit which otherwise he
would have got. The fact is in itself a fundamental breach of the
fiduciary relationship. Nor can the court adequately investigate
the matter in most cases.”
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(No-)profits rule
• What if the directors acted honestly? See Regal
(Hastings)
• What if the company could not have exploited the
opportunity? See Regal (Hastings)
• House of Lords reasserted the strict common law
position same as the self-dealing articulated in
Aberdeen Railway v Blaikie Brothers
• What is the relationship between no profits rule and
no-conflicts rule? [Is no-profits rule a stand-alone
rule? Is no-profits rule a sub-rule of the no-conflicts
rule?]
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(No-)profits rule
• What if the board has first considered the
opportunity and rejected it?
 Queensland Mines Ltd v Hudson [1978] 18 ALR 1
 Peso Silver Mines v Cropper (1966) 58 DLR (2d) 1
 but cf Furs Ltd v Tomkies (1936) 54 CLR 583
• What if the director came across the business
opportunity in his private capacity?
 Industrial Development Consultants Ltd v Cooley
[1972] 2 All ER 162
• What if the director takes up the opportunity after
he resigns?
 Island Finance Ltd. V Umunna [1986] BCLC 460
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(No-)profits rule
• Where the business opportunity is only speculative:
 Kishimoto Sangyo Co Ltd et al v Akihiro Oba et al (HKCA)
[1996] 2 HKC 260
 Oba was MD of Kishimoto
 Oba was negotiating contracts on behalf of Kishimoto to supply
equipment to Prime View for Prime View’s “pilot” plant
 Oba then resigned and acquired another company and negotiated
with Prime View, eventually obtaining the contracts for the
“production project”
 Held: no breach of duty
 Litton V-P: followed Regal’s no-profit rule
 Remedies: breach of the duty of fidelity results in the common law
remedy of damages; breach of fiduciary duties calls for remedies
in equity
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Misappropriation rule
• Not permissible for directors to divert
company assets to themselves:
 Re George Newman and Co (1895) 1 Ch 674 at
686
Co made Newman (director) a gift of £3,500 to spend
on his house
The shareholders’ assent to the irregular transactions
was not given at any actual meeting
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Remedies for company
• Breach of equitable duties:







Account of profits *‘disgorgement’ of profits+
Constructive trust
Rescission
Injunction
Equitable compensation
Equitable allowance
Re third parties (knowing assistance I knowing receipt)
- rescission; constructive trust
• Breach of common law duties:
 Damages
• Criminal liability:
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Ratification I authorisation
• By members
 Bamford v Bamford
 but cf Chingtung Futures v Lai Cheuk Kwan
• By board?
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Directors’ duties - summary
• Some special transactions




Substantial property transactions
Loans, quasi-loans and credit transactions
Connected persons and associated companies
Payment for loss of office
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Directors’ duties - summary
•
•
•
•
•
•
•
Duty to act within powers
Duty to promote the success of the co
Duty to exercise independent judgment
Duty to exercise reasonable care, skill and diligence
Duty to avoid conflicts of interest
Duty not to accept benefits from third parties
Duty to declare interest in proposed transaction or
arrangement
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Directors’ duties - summary
• Relief from liability






Ways in which liability may be relieved
Ratification
Fully informed consent
Detriment of creditors
Indemnification and exclusion liability
Relief by courts
• Secondary liability
 Constructive trust of wrongfully disposed property
 Knowing receipt or dealing
 Dishonest assistance
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