Tuesday, June 24, 2008

Every director of every company must ensure that he/she is acutely aware of his/her common law duties. The consequences of not doing so may be serious.
Those duties may be conveniently divided into the following "categories", which tend to overlap in certain instances:

·         Duty to exercise care, skill and diligence;
·         Duty to act within their powers;
·         Duty to exercise independent judgement;
·         Duty to act in the best interests of the company;
·         Duty to avoid conflicts of interest;
·         Duty not to accept benefits from third parties – the no profit rule 
Duty to exercise care, skill and diligence
The degree of care which a director must exercise is measured by the care a reasonable man having that particular director's knowledge and skills may be expected to take in the same circumstances – a subjective test.
A director is not required to be an expert in the type of business which the company conducts unless he is appointed for his specialist knowledge and skills.  Directors are not expected have any knowledge or to exercise skills they do not possess.
In coming to a decision, directors are entitled to rely on the opinion of an outside expert.  The expert must, however, be qualified to give such advice and, upon receipt of the advice, a director must still exercise his own independent judgment and not blindly follow the advice of the expert.
A director is also entitled to rely on his co‑directors and employees, but such reliance should not be unquestioning.  Liability of a director for wrongs committed by the company’s employees will only arise where the director has failed to take reasonable care in the selection and supervision of the employees.  A director cannot be expected to attend to every minute business detail and is justified in accepting the reports of his subordinates on routine matters.
A director must also act diligently.  Diligence carries with it the necessity to devote a reasonable amount of attention to the company’s affairs. This will depend largely upon the number of directors and the nature of their respective duties.  Failure to exercise proper diligence may indicate that a director has acted negligently and may, in some cases, even indicate that a director has not acted honestly. 
Duty to act within their powers 
The powers granted to directors can only be used for the purposes for which they were granted. 
Duty to exercise independent judgement 
Each director must exercise independent, unbiased judgment in reaching the decisions he makes for the company. 
Duty to act in the best interests of the company 
Directors owe their duties only to the company they serve, to the exclusion of the company's individual shareholders and all third parties, including creditors. 
Directors act in breach of their duties to the company if their primary purpose is not to further the interests of the company.  Whether the company actually suffers or benefits as a result is irrelevant.
Duty to avoid conflicts of interest 
A director must not place himself in a position in which he has, or may have, a personal interest or a duty to another which conflicts, or may conflict, with the interests of the company or with his duties to the company.  A director cannot prefer his own interests to those of the company. 
A director cannot use – for his own purposes, or disclose – confidential information entrusted to him by virtue of his position. 
Duty not to accept benefits from third parties – the no profit rule 
If a director concludes a transaction or acquires an opportunity for himself which was, in fact, a transaction or an opportunity that was available to the company, then the law will treat it as having been made for the company.  If it is no longer possible for the company to enter into that transaction or acquire that opportunity, the company may claim any profits that the director may have made and/or any damages it may have suffered. 
A director is required to make full disclosure to his board of any interest he may have under a contractual arrangement in which both he and the company are involved.  Except with full disclosure to, and the consent of, the remaining directors, a director may not make a profit by using his position as a director to do so. 
General "rule" 
The above rules are somewhat esoteric.  There is, however, a general "rule" which, if observed, should ensure that a director will never have to face a charge of breach of his common law duties. 
This general "rule" is based on the fact that, in carrying out his duties, a director effectively acts as an agent of his company.  He is, however, more than just an agent – he is also a fiduciary vis-à-vis his company, which essentially means that he also has a duty to promote and protect his company's interests.  In his capacity as a director, the common law demands (and this is the general "rule") that a director must at all times: 
·         Act in the best interests of the company; and
·         Carry out his duties with the utmost good faith.
A company has three primary remedies for a breach by a director of his duties: 
·         A right to claim any profit or business opportunity acquired by the director in breach of that duty; 
·         A right, in certain circumstances only, to set aside transactions entered into in breach of that duty; and 
·         A right to claim monetary compensation for any loss or damage suffered by it as a result of the breach. 
Generally, the only remedy a shareholder has against a director is the common law "derivative action" – the right to require the company to institute proceedings against its director/s for its own benefit if the board refuses to do so.  A shareholder does not have the right to claim compensation from the director directly. 
Our next in this series will deal with the more important provisions of the existing Companies Act 1973, which impose personal financial liability on a director for breach thereof.
Carl Stein is a director at Bowman Gilfillan.