14 January, 2017
The High Court of Hong Kong has in a recent case held that a director (“Director”) who resigned from his directorship in order to take up a full-time paid position as financial advisor in the same organisation was in breach of his fiduciary duties, despite disclosure of interest and approval of such engagement (“Engagement”) by the board of directors. Consequently, the Director was liable to account for all remunerations made to him during the Engagement as financial advisor on challenge by the members.
Brief Background
The Director was a long-serving president of the board of directors (“Board”) of the subject organisation (“Organisation”).
Discussions were held within the Board about the recruitment of a full-time financial advisor to make investments for the Organisation.
The Director intended to take up the post.
The Engagement of the Director as financial advisor to the Organisation was unanimously approved by the Board. The Director subsequently resigned from directorship to take up the new post.
The remuneration to the Director under the Engagement was exceptionally high. There were subsequently disputes regarding payment of remuneration and the Director sued for such payment under the Engagement.
The Organisation is a body corporate established pursuant to an ordinance. However, rules of directors’ duties in companies and corporate governance were applied in the case.
Issue
The issues the High Court had to consider were, among other things:
- whether the Director was in breach of fiduciary duties despite disclosure of personal interest in the Engagement;
- whether the Engagement is liable to be set aside by the Organisation.
Decision
After thorough consideration it was held that:
The Director had not acted in the Organisation’s best interest and was in breach of his fiduciary duties, having engineered and practically secured the Engagement during his term while he was an influential member of the board. The Director had a personal interest in making the terms of remuneration favourable for the position of financial advisor while the Organisation’s interest was the exact opposite. The Director cannot escape liability simply by resigning even if it could be argued that the Engagement only became binding after his resignation.
The Director also failed to make adequate disclosure or secure the necessary informed consent to absolve him from liability.
The fact that the Director disclosed his personal interest according to the Bylaws does not displace the Organisation’s right to set aside the transaction or seek an account of profits. The Bylawsmerely regulate the procedure by which business of the Board should be carried out. It does not effectively “contract out” the director’s obligation to obtain the informed consent or ratification of the members under the general law, except such act is authorised under the provisions of the Bylaws.
The Engagement should be set aside and the Director is liable to account to the Organisation all remunerations made under the Engagement.
Comment
The case confirms the liability to account for profits can arise from a fiduciary taking advantage of the opportunity of his office. It also highlights the point that a director cannot avoid liability by subsequently resigning in order to take a personal gain.
The rules governing fiduciary duties are so strict and inflexible that a mere disclosure of interest according to the articles of association would not be sufficient to prevent avoidance of a contract by the company or liability to account for profits. This case can be contrasted with Article 86 of Table A of the previous Companies Ordinance (Cap.32) as well as Article 17 of the Model Articles of the current Companies Ordinance (Cap.622H) where both provisions expressly specify that the contract will not be avoided and the director will not be liable to account for profits realised in a transaction with the company in which he has a personal interest. Care should therefore be taken when drafting articles of a company to address a conflict of interest situation and to spell out the intended consequences flowing from it, according to the intention of the shareholders.
The fact that the articles merely allow a Director to vote on conflicted matters after disclosure of interest cannot be taken as conferring the necessary approval for the Director to keep his profits earned out of the conflicted matter.
For further information, please contact:
Machiuanna Chu, Partner, Deacons
machiuanna.chu@deacons.com.hk
