A director who fails to disclose his personal interest in company contracts risks imprisonment
Failure by a director to disclose a personal interest in company contracts is a criminal offence
It is widely accepted in the business sector and the community at large that company directors have legal duties of various kinds. It is also accepted that, where directors fail in their duties, they may be faced with claims for damages from the company, or from its shareholders.
However, the prospect of being criminally prosecuted probably does not feature prominently in a director's concern about the hazards of his profession.
It therefore came as a considerable shock to the commercial community when, earlier this year, the Supreme Court of Appeal handed down its judgment in S v Gardener 2011 (4) SA 79 (SCA), in which it dismissed an appeal from the High Court and imposed a sentence of seven years imprisonment on two directors of a listed company for criminal contraventions of the Companies Act.
The companies in question were LeisureNet Ltd and its offshore subsidiary, and the offence committed by the two directors in question was a failure to disclose their personal financial interest in transactions in which the company was involved and from which they made a substantial personal profit.
The court held that the directors had acted with a fraudulent intent
The court found that the directors in question had deliberately withheld material information from the company in regard to their personal interests in company contracts.
The court held that such non-disclosure had been fraudulent - that is to say, it had been done with conscious dishonesty and with intent to deceive the company, and had not occurred through negligence or inadvertence. The directors were held to have been aware of the damage that could be caused to the company through their actions.
The statutory provision in question, which imposed the duty and created the criminal offence, was section 234 of the Companies Act of 1973 which provided that a director of a company who has a direct or indirect interest in a contract entered into by the company or a contract proposed to be entered into "which is of significance in relation to a company's business" must declare the full particulars of his interest to a meeting of the board of directors.
The rationale for the duty of disclosure of personal interests
The reason why the law takes this duty so seriously, and provides for such a harsh punishment, is that a director's fiduciary duty obliges him to act in the best interests of the company. Where the company is entering into a contract in which the director has a personal financial interest, he is caught in a conflict of interest. It may not be in the interests of the company to enter into that contract, but the prospect of making a personal financial gain may sway him to vote in favour of the contract. The judgment in this case makes the point that the directors in this particular matter -
feared or mistrusted the steps which the board, properly informed [that is to say, if informed of their personal financial interest in the transactions under discussion] might take and intended to preclude such action.
It must be said that the circumstances of this particular case were exceptionally serious. The members of the board of this company had been repeatedly called on to disclose their personal interests, and this went unheeded by the directors in question. The company's contracts in question, in which the directors had a personal interest, brought about what the judgment called 'a vast enhancement' of their personal wealth.
The heavy custodial sentence imposed on the directors in this matter should therefore not be seen as typical of the penalty that a court will impose for non-disclosure of personal interests.
But the judgment stands as a warning of the seriousness with which the courts view a director's failure to disclose a personal interest in the company's contracts, particularly where that non-disclosure is deliberate and where the contract will result in substantial financial gain for the director in question.