13 Corporate Governance 3 Directors Duties Content 1

13 Corporate Governance (3): Directors’ Duties

Content 1. UK Law: Duty to Exercise Independent Judgment 2. UK Law: Duty to Exercise Reasonable Care, Skill and Diligence 3. UK Law: Duty to Avoid Conflict of Interest 4. UK Law: Duty Not to Accept Benefits from Third Parties 5. UK Law: Duty to Declare Interest in Proposed Transaction or Arrangement

1. UK Law: Duty to Exercise Independent Judgment 173 Duty to exercise independent judgment (1) A director of a company must exercise independent judgment. (2) This duty is not infringed by his acting— (a) in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or (b) in a way authorised by the company’s constitution.

- Equitable principle: - directors may bind themselves by an agreement that they will act as directors in a particular way if, at the time of making the agreement, they bona fide consider that it is in the interests of the company

2. UK Law: Duty to Exercise Reasonable Care, Skill and Diligence 174 Duty to exercise reasonable care, skill and diligence (1) A director of a company must exercise reasonable care, skill and diligence. (2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with— (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and (b) the general knowledge, skill and experience that the director has.

(1) Test MBCA 2011, § 8. 30(a): Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation. MBCA 2011, § 8. 30(b): The members of the board of directors or a committee of the board, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.

Twofold Objective/Subjective Test The degree of care is the care that would be taken by a reasonably diligent person having both: (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company (the objective test), and (b) the general knowledge, skill and experience that director has (the subjective test). * * Norman v Theodore Goddard (1991) BCLC 1028, per Hoffmann J.

(2) Where directors are liable (a) Directors knowingly participate in a wrongful act - improper of corporate funds, knowing that the use is wrongful - assent to the use of financial statement to obtain credit, knowing that it is false or fraudulent

(b) Figureheads or honorary directors - a spouse who agrees to be a director in order to meet the statutory requirement - failure to direct at all

Francis v. United Jersey Bank (N. J. 1981) Plaintiff (Trustees of a bankruptcy Co) Defendant (Representatives of directors)

Summary Defendants argued that the corporate directors whom defendants represented were not liable for fellow directors' conversion of trust funds because they were not aware of it. Plaintiffs argued that the directors were negligent in noticing or trying to prevent the misappropriation, and that their negligence proximately caused the resulting harm. The court held that the directors did have a duty to exercise ordinary care in managing the corporation. The court noted that ordinary care included becoming familiar with corporate business, staying informed about activities, becoming familiar with corporate financial status, and objecting to or taking means to prevent illegal activity when it was discovered. The court then found that the directors had breached their duty by failing to do those things, and that such negligence proximately caused plaintiffs harm. The court affirmed the judgment, holding that the directors whom defendants represented had a duty to prevent other directors from misappropriating trust funds, that they breached that duty by not taking an active role in the corporation, and as such, caused plaintiffs harm.

(c) Where the director is aged, ill, resident of a distant place, or merely lazy or unduly trusting - if the responsibilities and obligations are too burdensome, the proper course for the director is to resign

(3) Where directors are not liable - MBCA 2011, § 8. 30(d)-(f) - Directors, in the absence of other information, may assume that managers and officers are honest - Directors are not liable if they rely in good faith on information, opinions, reports or statements prepared by responsible corporate officials, counsel, or committees of the board

- Director is not considered to be acting in good faith if he has knowledge concerning the matter in question that would cause such reliance to be unwarranted - Standard of good faith reliance does not permit a knowledgeable director to bury his head in the sand rely on information or advice he or she should know is erroneous

* US Law: Business judgment rule - Decisions made by the board of directors upon reasonable information and with some rationality do not give rise to directoral liability even if they turn out badly or disastrously from the standpoint of the corporation - Business judgment doctrine: such decisions are valid and binding upon the corporation and cannot be enjoined, set aside, or attacked by shareholders

- court should not second-guess good-faith decisions made by independent and disinterested directors - court will not decide whether the decisions of board are either substantively reasonable by the reasonable prudent person test or sufficiently well informed by the same test.

- Corporate Governance Project of American Law Institute, section 4. 01(a): A director or officer who makes a business judgment in good faith fulfills his or her duty if — (i) he is not interested in subject of the business judgment (ii) he is informed with respect to the subject of the business judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances (iii) he rationally believes that the business judgment is in the best interests of the corporation

- The rule involves a decision or judgment - The rule does not primarily involve a court in the substantive evaluation of the business judgment - The rule protects many types of transactions if they turn out badly from the standpoint of the corporation

- Scope of business judgment rule Smith v. Van Gorkom (488 A. 2 d 858; 46 A. L. R. 4 th 821; 1985 Del. ) Plaintiff Stockholders Defendant’s decision: a cash-out merger Defendant Directors

Summary Plaintiffs argued that defendant directors' decision to approve a cashout merger of their corporation into another violated Del. Code Ann. tit. 8, § 251, and did not warrant business judgment rule protection. The court agreed, finding that defendant directors based their decision on one person's representations, which did not constitute a report on which they could reasonably rely under Del. Code Ann. tit. 8, § 141(e), and that they did not seek documentation of either the merger terms or the adequacy of the proposed price per share. The court also found defendant directors were grossly negligent in permitting the agreement to be amended in a way they had not authorized. Finally, the court found that the stockholders' vote did not ratify the action, because the stockholders weren't aware of the lack of valuation information, and because defendant directors' statements were misleading. The court reversed the judgment, holding that defendant directors' decision to approve the merger was not the product of an informed business judgment, that efforts to amend the merger agreement were ineffectual, and that defendant directors had not disclosed all material facts to the stockholders.

3. UK Law: Duty to Avoid Conflict of Interest (1) Equitable principles - no-conflict rule - no-profit rule

175 Duty to avoid conflicts of interest (1) A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. (2) This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity). (3) This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company. (4) This duty is not infringed— (a) if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or (b) if the matter has been authorised by the directors. (5) Authorisation may be given by the directors— (a) where the company is a private company and nothing in the company’s constitution invalidates such authorisation, by the matter being proposed to and authorised by the directors; or (b) where the company is a public company and its constitution includes provision enabling the directors to authorise the matter, by the matter being proposed to and authorised by them in accordance with the constitution. (6) The authorisation is effective only if— (a) any requirement as to the quorum at the meeting at which the matter is considered is met without counting the director in question or any other interested director, and (b) the matter was agreed to without their voting or would have been agreed to if their votes had not been counted. (7) Any reference in this section to a conflict of interest includes a conflict of interest and duty and a conflict of duties.

(2) Nominee directors - Nominee director: “impossible position” by a conflict of interest of the company and his nominator Scottish Cooperative Wholesale Society Ltd v Meyer (1959) AC 324 Kuwait Asia Bank EC v National Mutual Life Nominee Ltd (1991) 1 AC 187

(3) Corporate opportunity doctrine - Meaning - there is a breach of fiduciary duty if a director of a company pursues for his or her own benefit a business opportunity which would be regarded in equity as belonging to the company - The breach is not avoided by resigning the directorship

- A serious question is When is an opportunity a corporate opportunity?

* In the US: two tests - (a) Line of business test: for determining whether the corporation has a legitimate interest in the opportunity at all - (b) Fairness test: if it does, under what circumstances may the director nevertheless take advantage of it

- Other factors - Whethere were negotiations with corporation about the opportunity - Whether the opportunity was originally offered to the corporation or to the director as an agent of corporation - Whether the director learned of the opportunity by reason of his position with the opportunity - Whether the director used corporate facilities or property to take advantage of the opportunity - How substantial was the need of the corporation for the opportunity

* In the UK: tests - (a) whether the company has a “specific interest” in the opportunity - (b) whether it would have been “worthwhile” for the company to have acquired the property - Director’s duty to inform the company of the opportunity: duty arises when it is clearly within the company’s normal line of business

Bhullar v Bhullar (2003) EWCA Civ 424, (2003) 2 BCLC 241 Canadian Aero Service Ltd v O’Malley (1973) 40 DLR (3 d) 371: a general approach - “the general standards of … must be tested in each case by many factors which it would be reckless to attempt to enumerate exhaustively. ”

Klinicki v. Lundgren (298 Ore. 662; 695 P. 2 d 906; 1985 Ore. ) Respondent Director Petitioner Stockholder Respondent 1 st Co Respondent 2 nd Co

Summary Petitioner, a minority stockholder of respondent first corporation, complained that respondent director of respondent first corporation formed respondent second corporation, of which he was sole owner, for the purpose of diverting a contract. The trial court found for petitioner but granted respondent director judgment notwithstanding the verdict on petitioner's punitive damages claim. The court of appeals affirmed. The state supreme court also affirmed. Respondent director's actions constituted misappropriation of a corporate opportunity. Respondent director owed respondent first corporation a fiduciary duty. Since petitioner suffered no discernible harm, the trial court rightly struck the jury's punitive damages award. The court affirmed the lower court's decision, because respondent director misappropriated a corporate opportunity of respondent corporation, to which he owed a fiduciary duty, and because the trial court properly struck the punitive damages award where petitioner was awarded no actual damages.

4. UK Law: Duty Not to Accept Benefits from Third Parties 176 Duty not to accept benefits from third parties (1) A director of a company must not accept a benefit from a third party conferred by reason of— (a) his being a director, or (b) his doing (or not doing) anything as director. (2) A “third party” means a person other than the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate. (3) Benefits received by a director from a person by whom his services (as a director or otherwise) are provided to the company are not regarded as conferred by a third party. (4) This duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. (5) Any reference in this section to a conflict of interest includes a conflict of interest and duty and a conflict of duties.

5. UK Law: Duty to Declare Interest in Proposed Transaction or Arrangement - Equitable principle - when a company is entering into a transaction, a director of the company must disclose to it any interest which that director has in the transaction

177 Duty to declare interest in proposed transaction or arrangement (1) If a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors. (2) The declaration may (but need not) be made— (a) at a meeting of the directors, or (b) by notice to the directors in accordance with— (i) section 184 (notice in writing), or (ii) section 185 (general notice). (3) If a declaration of interest under this section proves to be, or becomes, inaccurate or incomplete, a further declaration must be made. (4) Any declaration required by this section must be made before the company enters into the transaction or arrangement. (5) This section does not require a declaration of an interest of which the director is not aware or where the director is not aware of the transaction or arrangement in question. For this purpose a director is treated as being aware of matters of which he ought reasonably to be aware. (6) A director need not declare an interest— (a) if it cannot reasonably be regarded as likely to give rise to a conflict of interest; (b) if, or to the extent that, the other directors are already aware of it (and for this purpose the other directors are treated as aware of anything of which they ought reasonably to be aware); or (c) if, or to the extent that, it concerns terms of his service contract that have been or are to be considered— (i) by a meeting of the directors, or (ii) by a committee of the directors appointed for the purpose under the company’s constitution.

Companies Act 2006 General duties of directors Introductory – 170. Scope and nature of general duties The general duties – 171. Duty to act within powers – 172. Duty to promote the success of the company – 173. Duty to exercise independent judgment – 174. Duty to exercise reasonable care, skill and diligence – 175. Duty to avoid conflicts of interest – 176. Duty not to accept benefits from third parties – 177. Duty to declare interest in proposed transaction or arrangement