Thursday, September 11, 2008

The duties and liabilities of directors are governed by both common law and statute. Failure to properly perform the common law duties may render a director personally liable to pay monetary damages, whereas the inability to perform certain statutory duties may result in a director facing criminal liability. Currently, such statutory duties are regulated by the Companies Act, 1973 (“the Companies Act”) and the Corporate Laws Amendment Act, 2006 (“the Amendment Act”). A draft of the Companies Bill, 2008 (“the Bill”), which will replace the Companies Act and the Amendment Act in their entirety, is at present subject to public submissions and is envisaged to come into force in 2010.
The common law plays a significant role in the governance of directors and provides for certain fiduciary duties to be placed on directors. These duties are owed by the director to the company alone and include the obligations to act in the best interests of the company and to carry out their duties with good faith. Such duties, when interpreted closely, include the duty to exercise care, skill and diligence whilst acting within their powers so as to promote the success of the company through independent judgement.
In addition to these common law duties, directors have an obligation to comply with certain statutory duties imposed on them by the Companies Act and the Amendment Act. These duties are all related to the directors’ running of the company and include responsibilities such as ensuring the proper administration of the company’s affairs, the preparation of financial statements, the appointment of auditors and other such corporate activities. The Companies Act contains certain provisions which create offences based on non-compliance of such statutory duties. The result is that both the company and the director (whom had to have had some form of active participation in the commission of such offence) will be liable to prosecution.
The Bill has codified the common law duties and incorporated a simplified version of such obligations as stated in the Companies Act and Amendment Act. There are, however, certain notable additions in the Bill which extend directors’ duties and liabilities, therefore increasing the accountability of directors to the shareholders of a company.  These additions include those requirements which relate to directors’ use of information and conflicting interests (section 75), the standard of directors’ conduct (section 76) and certain liabilities which are placed on directors and officers (section 77). It is worth noting that these provisions are in addition to, not in substitution for, a director’s common law duties. Furthermore, the Bill refers to directors as including alternate directors and a prescribed officer or a person who is a member of a committee of a board of a company or of the audit committee of a company.
Section 75 of the Bill, which regulates a director’s use of information and conflicting interests, expressly states that a director must not, directly or indirectly, use his/her position to make a secret profit or “otherwise gain an advantage” for himself or someone else. Furthermore, a director is obliged to act in such a manner that will not cause detriment to the company, thus acting in the best interest of the company. A director must not improperly use his/her position to make, participate in the making of, influence or attempt to influence a decision on a matter in respect of which the director has a conflicting personal financial interest. A director with a personal interest in a matter may disclose such interest in advance to the company by delivering a notice in writing setting out the nature and extent of that interest. The director must declare the conflict and it’s general nature before the matter is considered at the meeting. The director is then obliged to immediately leave the meeting therefore prohibiting him/her from voting on the matter or trying to influence the discussion or vote at any time. A transaction between the company and a director in which the director has a personal financial interest is not void or voidable solely because of that interest if the transaction is approved by the board in the manner contemplated above, or is ratified by the passing of an ordinary resolution.
Section 75 does not apply to a director in respect of a decision that may generally affect all of the directors of a company in their capacity as directors or a class of persons unless the only member of the class is the director or person related to the director or if there is a proposal to remove that director from office. Furthermore, the section does not apply to a company or its director if there is only one director of the company or only one person holds all of the beneficial interests of the issued securities of the company. It must be noted that this section of the Bill must not be confused with section 234 of the Companies Act which compels a director to declare his/her interest in contracts to the board.
Section 76 of the Bill places a duty on directors to exercise a degree of care, skill and diligence that would be exercised by a reasonably diligent individual who had both the general knowledge, skill and experience that may reasonably be expected of an individual carrying out the same functions as are carried out by that director as well as the general knowledge, skill and experience of such director when gathering information or similarly preparing to act in a certain manner which may have an impact on the shareholders. The director is prohibited from using his/her position to gain an advantage or to knowingly cause harm to the company. These requirements place an additional onus on directors compelling them to act honestly, in good faith, and in a manner the director reasonably believes to be in the best interest of, and for the benefit of, the company and thus goes beyond the simple common law duty.
The Bill goes further to qualify a director’s judgement as being “reasonable” if the director has taken reasonably diligent steps to become informed about the subject matter at hand, does not have a material personal financial interest in such subject matter and furthermore indicates judgement that a reasonable individual in a similar position could hold in comparable circumstances. In complying with this section, the director is required to communicate to the board, at the earliest practicable opportunity, any material information that comes to the director’s attention, unless he/she reasonably believes that the information is publically available or known to the other directors or unless the director is bound by a legal or ethical obligation of confidentiality.
In terms of the manner in which the Bill has codified the liability of directors and officers, any provision of an agreement, the Memorandum of Incorporation (the company’s constitution) or a resolution is considered void to the extent that it directly or indirectly purports to relieve a director of liability in terms of “any law in respect of gross negligence, wilful misconduct or breach of trust”. The same principle applies to situations where a director acts in the name of the company, purports to bind the company or authorise the taking of any action by or on behalf of the company without the requisite authority or knowingly or recklessly signs or consents to the publication of a financial statement that contains false or misleading information or a prospectus that contains an untrue statement. In this instance, if the director knew or ought to have suspected that the statements were false, such director may be held equally responsible with the company for such contravention. In the same light, if a director is knowingly a party to the reckless carrying on of the business, or an act or omission by a company calculated to defraud a creditor, employee or security holder, such director will be held personally liable to the company and to any other affected person for any consequential loss suffered by the company or such person. The liability of a person is joint and several with any other person who is or may be held liable for the same act, unless otherwise determined by the court.
To assist companies in ensuring that directors do not contravene the provisions of the Bill, it has been proposed that “whistle-blowers” should be immune from civil or criminal liability for the disclosure made by them of a reasonable suspicion that a company or any of it’s directors or employees has, or may have, contravened the Bill or any other legislation, that could expose the company to an actual or contingent risk of liability, or is inherently prejudicial to the interests of the company. A new concept is incorporated into the Bill where a shareholder, director, employee, prescribed officer or company secretary may apply to the court to have a director declared delinquent or under probation under certain circumstances. In general terms, a declaration of delinquency subsists for the lifetime of the person declared delinquent. A person who has been declared delinquent or is subject to an order of probation may apply to court for relief and to have such order set aside.
On the flip side of the coin, the Bill protects the rights of directors to a certain degree by stating that a company may advance expenses to a director to defend litigation in any proceedings arising out of the director’s service to the company or may directly or indirectly indemnify a director for such expenses. However, the company may not indemnify a director, as contemplated above, in respect of any actions for liability for gross negligence, wilful misconduct or breach of trust. A company may purchase insurance to protect itself or a director against liability and expenses contemplated above.
Thus it is apparent that despite the introduction of a number of, what may seem as fairly onerous provisions on directors, which place liability on them for non-compliance, directors have been afforded a degree of protection, as described above. Through analysis, it appears that the Bill is not increasing the levels of responsibility and accountability of directors, but is in fact merely clearly codifying the common law duties, and setting out, in a comprehensive manner both the common law and statutory duties which are placed on directors, alternate directors and prescribed officers.
Lili Nupen is a senior associate at Bowman Gilfillan.