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9 June, 2018
Directors are conferred with wide powers of management. Although they are generally guided by the will of the majority shareholders, they are not necessarily shackled by the decisions of the shareholders since they may take actions deemed in the best interest of the company. However, these wide powers do not mean that directors are given free rein to steer the ship willy-nilly. The law places a safeguard to protect shareholders against negligent and errant directors.
Where is the line drawn? In what circumstances can a director be held responsible for their actions?
Section 213 of the Companies Act 2016 (“Companies Act”) (formally section 132 of the Companies Act 1965) provides that directors must:
- at all times exercise their powers for a proper purpose and in good faith in the best interest of the company; and
- exercise reasonable care, skill and diligence
Section 214 of the Companies Act also provides that a director who makes a business judgment is deemed to meet the requirements of his duty as a director if he:
- makes the business judgment for a proper purpose and in good faith;
- does not have a material personal interest in the subject matter of the business judgment;
- is informed about the subject matter of the business judgment to the extent that he reasonably believes to be appropriate under the circumstances;
- reasonably believes that the business judgment is in the best interest of the company
The next question would the be – what exactly is “the best interest of the company”?
In the recent case of Tengku Dato’ Ibrahim Petra Tengku Indra Petra v Petra Perdana Bhd & Another Appeal, the Federal Court held that the correct test to be applied in such cases is a combination of both a subjective and objective test:
- Subjective Test: The breach of director’s duty is determined on an assessment of the state of mind of the director; whether the director (not the majority of shareholders) considers that the exercise of discretion was in is the best interest of the company.
- Objective Test: The director’s assessment of the company’s best interest is subject to an objective review by the Courts. If the test was merely an assessment of what the director in question thinks was prudent, then any lunatic would be able to conduct the affairs of the company in a bona fide yet irrational manner.
In this case, the Defendant directors were sued for, among other things, causing the Plaintiff (the company) to undertake divestments which were allegedly against the best interests of the company. The Federal Court upheld the initial decision of the High Court in holding that the defendant directors’ actions were bona fide and just. The divestments were undertaken to address a genuine urgent cash flow problems caused by a downturn in the Plaintiff’s business. There was no conspiracy to injure the Plaintiff and based on contemporaneous documents, the Defendants had sought external advice as well from senior management of the company and professional advisers. As such, their actions were justified.
In summary, the Federal Court held:
- Powers of management conferred on directors cannot be overridden by an ordinary resolution passed by a simple majority of shareholders at a general meeting.
- Shareholders in general meetings may not control the powers of management conferred by the articles of associations on directors.
- The Board of Directors who have been duly authorised by a resolution passed in a general meeting that approved a transaction may thereafter act in its best judgment in the interests of the company, in the implementation of the resolution.
- The test to determine whether there is any breach of director duties combines both subjective and objective tests (above).
- Courts will not interfere with business decisions so long as the directors acted bona fide.
- Shareholders cannot determine or dictate what is in “the best interest of the company” by passing an ordinary resolution by a simple majority in general meeting in the context of determining the conduct of a director.
Commentary
Although directors are conferred with wide management powers, they are not unfettered as the law sets a limit to curb mismanagement of a company. That being said, courts have traditionally demonstrated a reluctance to substitute its own decisions with the business and management decisions of the directors.
As such, in the absence of fraud, breach of duty or conspiracy, the Courts will rarely assess the merits of a commercial decision made by directors, even if the commercial decision did not turn out favourably for the company. After all, risk-taking is part of every business and is an indisputable commercial reality.
For further information, please contact:
Donovan Cheah, Partner, Donovan & Ho
donovan@dnh.com.my
