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Honesty in relation to a director’s conduct is a difficult concept

A director's duty to exercise his powers honestly

The most fundamental duty of a director is to exercise his powers honestly. South Africa’s Companies Act of 2008 does not express it in quite this way, but says in section 76 that a director must act "in good faith and for a proper purpose" and that he must act "in the best interests of the company".

If a director were, for example, to use his powers as a director to improperly divert the company's money into his own pocket, this would be a breach of those duties.

But what exactly does acting "honestly" mean in the context of a director’s role in the company’s affairs? And –of critical importance – under what circumstances does a director make himself culpably complicit in the dishonest actions of another person?

The difficulty of determining criteria for honesty

The Companies Act of 2008 states in section 5 that "a court interpreting or applying this Act may consider foreign company law". So our courts could, for example, take account of what the Court of Appeal of the Isle of Man had to say on this issue in Barlow Clowes International Ltd v Eurotrust International Ltd (Isle of Man) [2006] 1 All ER 333.

The background to this case was that, in the mid-1980s, a certain Peter Clowes, acting through a Gibraltar company called Barlow Clowes International Ltd, ("Barlow Clowes”), had operated a fraudulent off-shore investment scheme that purported to offer high returns from the investment of funds in UK gilt-edged securities. UK investors contributed some £140 million to the scheme and most of this money was dissipated in the personal business ventures and extravagant living of Clowes. The scheme collapsed in 1988 and Clowes was convicted and sent to prison.

Some of the investors' funds were paid away during 1987 through bank accounts maintained by companies which were administered from the Isle of Man by a company called International Trust Corporation (Isle of Man ) Ltd ("ITC”) whose principal directors were a certain Peter Henwood and Andrew Sebastian.

The liquidators of Barlow Clowes instituted legal proceedings against Henwood and Sebastian, claiming that, through them, ITC had dishonestly assisted Clowes to misappropriate the investors' funds.

In the High Court of the Isle of Man, Henwood was found liable for dishonestly assisting in the misappropriation of a large amount of these funds.

The judge said that liability for dishonest assistance requires a dishonest state of mind on the part of the person who assists in a breach of trust and that such a state of mind may consist in knowledge that the transaction is one in which he cannot honestly participate (for example, a misappropriation of other people's money), or it may consist in suspicion combined with a conscious decision not to make inquiries which might result in knowledge.

The judge went on to say that, although a dishonest state of mind is a subjective mental state, the standard by which the law determines whether it is dishonest is objective. Thus, if by ordinary standards, a person's mental state would be characterised as dishonest, it is irrelevant that that person adheres to a different standard.

The judge said further that, in the present matter, Henwood had strongly suspected that the funds passing through his hands were monies which Barlow Clowes had received from members of the public who had been misled into thinking that they were subscribing to a scheme of investment in gilt-edged securities. If those suspicions had been correct, said the judge, no honest person would have assisted Clowes to dispose of the funds for his personal use.

But, said the judge, Henwood consciously decided not to make inquiries because he preferred in his own interests not to run the risk of discovering the truth. The fact that Henwood lived by different standards, which produced a warped moral approach in which he believed that it was not improper to carry out his clients' instructions, meant that he may well have thought such conduct to be "honest", but (said the judge) he was wrong.

The Privy Council approved these statements of the law

The Privy Council held that these were correct statements of the law and went on to quote with approval from what Lord Hutton had said in Twinsectra Ltd v Yardley [2002] 2 AC 164 that, for a person to be liable as an accessory to another person's wrongdoing, the first-mentioned person "must himself appreciate that what he was doing was dishonest by the standards of honest and reasonable men."

How would such issues be dealt with under South Africa’s Companies Act 2008?

If similar issues were to present themselves for consideration in a South African court, in the context of the new Companies Act of 2008, the enquiry would not begin and end with the question of whether the director in question had acted “honestly”.

The Act does, indeed, provide in section 77(3)(c) that a director is liable for any loss or damage sustained by the company in consequence of the director’s having been a party to an act or omission by the company despite knowing that it was calculated to defraud a creditor, employee or shareholder of the company or had another fraudulent purpose.

However, the Companies Act of 2008 also requires that the director act with care, skill and diligence.

In short, the Companies Act recognises that directors’ legal duties should oblige them to act, not merely honestly, but that their conduct should also live up to various objective standards that are quite independent of the director’s own ideas of what is right or wrong.

Nonetheless, it is significant that section 77(9) of the Act states that, in any proceedings against a director other than for wilful misconduct – the court may relieve a director from liability if it appears to the court that the director acted honestly and reasonably and that, in the given circumstances, it would be fair to excuse the director.

The last-mentioned provision thus gives the court a wide discretion to relieve a director from legal liability for conduct that was both honest and reasonable – even where, according to the letter of the law, the director is indeed legally liable.

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