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LW5962 LAW RELATING TO COMPANIES &

BUSINESS

SEMINAR 7 (A):
DIRECTOR AND DIRECTOR’S DUTIES II
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Directors’ duties
• The need: the (what economists call as) agency
problem
• How to regulate
• Quality control
• Duty of care (general law and CO s 465)
• Integrity control
• Duties super-imposed by Equity: fiduciary duties
• Statutory rules (e.g. CO Part 11)
• Non-statutory guidelines (e.g. Guide on Directors’
Duties)
Fiduciary Duties
• Fiduciary Duties
• Duty to act bona fide (in good faith) in the
interests of the company
• Duty to exercise powers for proper purposes
• Duty to avoid conflict of interests
Fiduciary Duties
• Fiduciary Duties
• Duty to act bona fide (in good faith) in the
interests of the company
• Duty to exercise powers for proper purposes
• Duty to avoid conflict of interests
Proper Use of Directors’ Powers
• The directors are not required to make the best
possible decisions, but the powers of directors
are limited insofar as
• 1) they are made in good faith for the benefit of
the company (subjective and a question of fact)
and;
• 2) they have been exercised for a proper
purpose (objective test determined by looking
at the primary purpose v. proper purpose of
power)
Duty to act bona fide in the interests of the company
In re Smith and Fawcett Ltd (1942)
J Fawcett N Smith
(d. 26/2/1940)
4001 shares
4001 shares
Art 10: The directors may at any
Co time in their absolute and
uncontrolled discretion refuse to
register any transfer of shares …

• Facts: The issued capital of the company consisted of

8002 ordinary shares, of which the two directors of the
company, J. F. and N. S., held 4001 each. J. F. died, and
his son as his executor applied to have the testator's
shares registered in his name. N. S. refused to consent to
the registration, but offered to register 2001 shares and to
buy 2000 at a fixed price.
Duty to act bona fide in the interests of the company
Re Smith & Fawcett Ltd [1942] Ch 304

• Held: N. Smith did not breach his fiduciary duty.

Lord Greene: “They [the directors] must exercise

their discretion bona fide in what they consider –
not what the court may consider – to be the
interests of the company, and not for any collateral
purposes.”
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Duty to act bona fide in the interests of the company

Re Smith & Fawcett Ltd [1942] Ch 304
• In the absence of prima facie evidence that the
defendant director has exercised his power in
bad faith, the presumption is that the power has
been exercised in good faith.
• The plaintiff bears the burden to prove otherwise.
• The defendant director is not required to provide
reasons for the impugned exercise of power.
• Note different regulation now: HK CO s 151 (3): Right to
request the company to give reasons for any refusal to
register the transfer.
Duty to act bona fide in the interests of the company
What is “the interests of the company”?
• In general, “the interests of the co” means the
interests of members as a general body.
• Does the law require directors to prioritise
shareholder’s short-term interests?
• Directors must take into account both the long- and the
short-term interests of shareholders and strike a
balance between them.
• Can directors considers the interests of the group
or other group companies?
• No. The directors must act bona fide in the interests of
the appointing co, not the group.
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What is “the interests of the company” in insolvency?

Kinsela v Russell Kinsela (1986) 4 NSWLR 722
Facts:
• The company had leased one of its properties to
two of its directors (a couple) with an option to
purchase when the company was insolvent. The
term of the lease was commercially questionable.
• The transaction was approved by all of the
shareholders with informed consent.
• Action taken by the liquidator.
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What is “the interests of the company” in insolvency?

Kinsela v Russell Kinsela (1986) 4 NSWLR 722
Held:
• Transaction voidable – it was entered into by
the directors in breach of their duty to act bona
fide in the interests of the company.
• The interests of the company when the
company is insolvent is the interests of the
creditors.
• The shareholders were not in the position to
approve the transaction – the risk now was to
be borne by the creditors.
Fiduciary Duties
• Fiduciary Duties
• Duty to act bona fide (in good faith) in the
interests of the company
• Duty to exercise powers for proper purposes
• Duty to avoid conflict of interests
Duty to exercise powers for proper purposes
• Identify the power used by directors
• Identify the proper purpose for which that
power was delegated to the board of directors
• Identify the substantial purpose for which the
power was in fact used
• Decide whether that purpose is proper
(Extrasure Travel Insurances Limited v.
Scattergood [2003] 1 BCLC 598.)
Duty to exercise powers for proper purposes
Howard Smith v Ampol Petroleum Ltd [1974] AC 821

A+B Bid for remaining

A
Shares $
55%

M LTD

Consequences of issuance H
of shares to H: $$$
1. M Ltd had capital
2. A+B 55%-> 36.6%
3. H positioned to takeover co
Duty to exercise powers for proper purposes
Howard Smith v Ampol Petroleum Ltd [1974] AC 821

Facts:
• A made an offer for all the issued shares of M, and
another company, H, announced an intention to make a
higher offer for those shares. M's directors considered
A's offer too low and decided to allot shares to H.
• The effect of that issue was that
• M had much needed capital;
• A and B's shareholding was reduced to 36.6 percent,
of the issued shares and
• H was in a position to make an effective takeover
offer.
• A challenged the validity of the issue of the shares to H.
Duty to exercise powers for proper purposes
Howard Smith v Ampol Petroleum Ltd [1974] AC 821

• Held: Although the directors had acted honestly and had

power to make the allotment, to alter a majority shareholding
was to interfere with that element of the company's
constitution which was separate from and set against the
directors' powers and, accordingly, it was unconstitutional for
the directors to use their fiduciary powers over the shares in
the company for the purpose of destroying an existing
majority or creating a new majority; and that, since the
directors' primary object for the allotment of shares was to
alter the majority shareholding, the directors had improperly
exercised their powers and the allotment was invalid.
Duty to exercise powers for proper purposes
Howard Smith v Ampol Petroleum Ltd [1974] AC 821

Application
• Identify the power used by directors
• Allotting shares
• Identify the proper purpose for which that power was
delegated to the board of directors
• Raising capital
• Identify the substantial purpose for which the power was
in fact used
• Destroying an existing majority or creating a new majority
• Decide whether that purpose is proper
• No.
Duty to exercise powers for proper purposes
Hogg v Cramphorn Ltd [1966] 3 All ER 420

• B offered to buy existing shares in C Ltd.

• Directors issued shares to trustees (to hold for
employees) so as to command a majority for
the directors and their supporters.
• Held: It is in breach of fiduciary duty if a board
issues or allots shares to enable one faction to
obtain or retain control of the company
management.
Duty to exercise powers for proper purposes
Hogg v Cramphorn Ltd [1966] 3 All ER 420
“It is not, in my judgment, open to the directors in such a
case to say, "We genuinely believe that what we seek to
prevent the majority from doing will harm the company and,
therefore our act in arming ourselves or our party with
sufficient shares to outvote the majority is a conscientious
exercise of our powers under the articles, which should not
be interfered with." Such a belief, even if well-founded,
would be irrelevant. A majority of shareholders in general
meeting is entitled to pursue what course it chooses within
the company's powers, however wrong-headed it may
appear to others, provided the majority do not unfairly
oppress other members of the company….The power to
issue the shares was a fiduciary power and if, as I think, it
was exercised for an improper motive, the issue of these
shares is liable to be set aside.”
Duty to exercise powers for proper purposes
Hogg v Cramphorn Ltd [1966] 3 All ER 420
Lessons:
• Proper purpose is an objective test. The mere fact that the
directors genuinely believed that they were acting for the
benefit of the company does not mean that the conduct
cannot be impugned.
• The duty to exercise powers for proper purposes is a duty
independent of the duty to act in good faith in the interests
of the company. The former can be breached even though
there is no breach of the latter.
Fiduciary Duties
• Fiduciary Duties
• Duty to act bona fide (in good faith) in the
interests of the company
• Duty to exercise powers for proper purposes
• Duty to avoid conflict of interests
Duty to Avoid Conflict of Interests

• Fiduciary duty requires fiduciaries to put their principals’

interests ahead of their own; it requires fiduciaries to act
altruistically.
• Unless a fiduciary has his principal’s prior informed
consent, he cannot enter into any transaction that
involves a conflict between his personal interests and his
management duties (conflict rule) and cannot profit in any
secret way from his position (profit rule).
• “informed” -> disclosure duty
• “consent” -> prior approval
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Duty to Avoid Conflict of Interests

Disclosure
Disclosure duty at general law
• Disclosure of conflict of interest must be made to general
meeting
• Furs Ltd v Tomkies (1936) 54 CLR 583.

• Effects of non-disclosure: transaction voidable at election

of company
• At the choice of the shareholders
• Return the shareholders to the position they were in before the
breach
• The general meeting or the articles can modify the duty by
requiring disclosure to be made to the board only.
Duty to Avoid Conflict of Interests
Disclosure
Disclosure duty under the CO:
• Disclosure of conflict of interests must be made to the
other directors
s536- “(1) If a director of a company is in any way, directly or
indirectly, interested in a transaction, arrangement or contract, or a
proposed transaction, arrangement or contract, with the company
that is significant in relation to the company’s business, and the
director’s interest is material, the director must declare the nature
and extent of the director’s interest to the other directors in
accordance with sections 537, 538 and 539.”
• Effects of non-disclosure: Commit an offence
s542- “(1) A director or shadow director who contravenes section
536(1), (2) or (3) commits an offence and is liable to a fine at level
6.”
The relationship between the director’s statutory and equitable duty to disclose
Man Luen Corp v Sun King Electonic Printed Circuit
Board Factory Ltd (1981)
• Statutory requirement is mandatory
• Compliance with statutory obligations does not
mean there is compliance with equitable
obligation.
• Directors need to disclose both to the general
meeting and the board.
“Section 162 [s536 of New CO] of Companies Ordinance
(Cap 32) merely supplemented the duties imposed by the
general law upon directors…. Strict compliance of the
general law on disclosure at shareholders’ meeting was
required.”
Conflict Rule
Transvaal Lands Co v New Belgium (Transvaal) Land
and Development Co [1914] 2 Ch 488

• H is a trustee shareholder in a co which sold

shares to the co of which he was a director, H
having taken part in the decision to make the
purchase.
• Held: The transaction was voidable. The sellers
were entitled to have the purchase money
repaid or their shares returned.
Conflict Rule
Transvaal Lands Co v New Belgium (Transvaal) Land
and Development Co [1914] 2 Ch 488
“[D]irectors of a company have duties to discharge of a
fiduciary nature towards their principal, and that 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; and
that so strictly is this principle adhered to that no
question is allowed to be raised as to the fairness or
unfairness of a contract so entered into.” Swinfen Eady,
LJ
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Profit Rule
Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134
£
4 Regal A 3rd
4 other Regal
directors party
persons (R Co)
& SH buyer
Shares in R & subsidiary

1000 shares 2000 shares 2000 shares

Leases over to cinemas

Amalga-
Mated
Landlord
(subsidiary)
£
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Regal (Hastings) Ltd v Gulliver

Facts:
• The subsidiary (Amalgamated) incorporated to hold two cinema
leases to be taken up and on sold to another person along with
a cinema owned by the holding co (Regal).
• Landlord was concerned that Amalgamated was under-
capitalized and required that either the directors of Regal
provide personal guarantees or the capital of Amalgamated
(£5000) be taken up and fully paid up.
• The Regal directors refused to provide guarantees and the 2nd
option was taken. As a result, the Regal directors, who were
also majority shareholders in Regal, acquired shares in
Amalgamated.
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Regal (Hastings) Ltd v Gulliver

Facts:
• The proposed sale of the cinema and leases fell through –
instead, what was sold was the shares in both the holding co
and the subsidiary owned by individual shareholders - they
were sold at a profit of £2.16 per share.
• Regal sued directors and alleged that they had obtained that
profit by using their offices as directors and were therefore
accountable for it to Regal, and also that in so acting they had
placed themselves in a position in which their private interests
were likely to be in conflict with their duty to Regal.
Held:
• Directors are in breach of their fiduciary duties and should
account profits to Regal.
Regal (Hastings) Ltd v Gulliver
Lord Russell (P. 149)
“The rule of equity which insists on those, who by use of
a fiduciary position make a profit, being liable to account
for that profit, in no way depends on fraud, or absence of
bona fides; or upon such questions or considerations as
whether the profit would or should otherwise have gone to
the plaintiff, or whether the profiteer was under a duty to
obtain the source of the profit for the plaintiff, or whether
he took a risk or acted as he did for the benefit of the
plaintiff, or whether the plaintiff has in fact been damaged
or benefited by his action. The liability arises from the
mere fact of a profit having, in the stated circumstances,
been made. The profiteer, however honest and well-
intentioned, cannot escape the risk of being called upon
to account.”
Profit Rule
• What if the directors acted honestly? See Regal
(Hastings)
• “Duty to act bona fide in the interests of the co” vs “duty to avoid
conflicts of interests”
• Does it matter if the company did not suffer any loss? See
Regal (Hastings)
• What if the company could not have exploited the
opportunity? See Regal (Hastings)
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Business Opportunity
• Duty to avoid conflict of interests prevents a
director pursuing opportunities for himself that he
has a duty to pursue for the company.
• What is the legitimate reach of corporate
opportunities?
• A director is barred from taking up opportunities he
comes by because of his director role. Ex. He learns of
a business opportunity in the capacity of a director. See
Industrial Development Consultants Ltd v Cooley [1972]
2 All ER 162.
Remedies for company
• Breach of equitable duties
• Account of profits (independent of whether company has
suffered any loss)
• Constructive trust (e.g appropriate for property, tracing)
• Rescission
• Injunction
• Equitable compensation
• Re third parties (transaction may be set aside if shown
that the third party was aware [not actual knowledge] a
directors breach of duty)- rescission; constructive trust.
• Breach of common law duties
• Damages
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Ratification of the breach

• Ratification by the company (s473)
(1) This section applies to the ratification by a company of conduct by
a director involving negligence, default, breach of duty or breach of
trust in relation to the company.
(2) A decision of the company to ratify the conduct may only be made
by resolution of the members of the company.
(3) If such a resolution is proposed at a meeting, every vote in favour
of the resolution by a member who—
(a) is a director in respect of whose conduct the ratification is
sought;
(b) is an entity connected with that director; or
(c) holds any shares in the company in trust for that director or
entity,
is to be disregarded.
• Cannot ratify the breach if the co is insolvent: Chingtung
Futures Ltd (in liq) v Lai Cheuk Kwan Arthur [1992] 2 HKC 637