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The courts takes a strict view of directors' fiduciary duties to the company

A director's duty of loyalty to the company and to avoid conflicts of interes.

Consider the following scenario: a certain company was in the business of waste disposal and treatment. One of the company's customers - who was in the business of hiring equipment ? loaned an excavator and certain other plant and equipment (which was old, dilapidated and in poor condition) to one of the company's directors for the latter's personal use at no charge.

The director needed this equipment to renovate a dilapidated farmhouse belonging to him. He made no disclosure to the board of directors of this loan of equipment. The equipment remained with him for five years before the customer asked for it to be returned. The director would have had to pay about £5 000 if he had hired this equipment at commercial rates.

These, in essence, were the facts in the recent judgment of the United Kingdom Court of Appeal in Phillip Towers v Premier Waste Management Ltd [2011] EWCA Civ 923. In these proceedings, the company was suing the director for disgorgement of the allegedly improper and unauthorised profit he had made from this arrangement, namely, the value of the free use of the equipment.

What are the legal implications of such a scenario? In particular, how would it be regarded in terms of South Africa's new Companies Act of 2008?

The director in question regarded the matter as a storm in a tea-cup. The amount of money involved was trivial. He said that the loan of this equipment to him was a personal matter that had nothing to do with the company; the loan had been to him in his personal capacity, not as a director, and the customer in question had merely been doing him a favour. He said it was just a private arrangement between friends.

An issue of breach of fiduciary duty

The issue was whether the director had breached his fiduciary duty to the company by making a secret profit, in that he had been given the free use of the equipment in question.

The decision also turned on a director's duty of loyalty to the company and the "no profit" and "no conflict" aspect of a director's duties - that is to say, the duty not to make an unauthorised profit from his position, and not to put himself in a position of a conflict of interest.

The court did not accept that the loan of the equipment was a personal matter. In response to the director's argument that the amount of money involved was trivial, the court of first instance held (and no criticism was made by the appeal court) that -

'A secret profit may be large or small; it matters not which. The vice is the fact that it is secret, undisclosed. If it was so innocent or insignificant it ought to have been and could have been disclosed ...

None of the director's arguments in his defence found favour with the Court of Appeal. The court held that a director owes a duty of loyalty to the company, and must observe the "no conflict" principle (that is to say, the duty to avoid a conflict between his personal interests and his duty to the company) which includes a duty not to make a secret profit for himself.

The breach of that duty in this case had the effect of disloyally depriving the company of the ability to consider whether or not it objected to the diversion of an opportunity offered by one of its customers (namely, the right to the free use of equipment) away from the company and to the director personally.

The court held that it was irrelevant whether or not the company would have taken up the offer of a free loan of the equipment in question. Nor was it relevant that the company had not suffered any financial loss through the actions of the director. Nor was it relevant that the director had no corrupt motive, or that the value of the benefit was small.

None of these factors negated the cardinal fact that the director had used his position to make an unauthorised profit for himself. In the result, the Court of Appeal dismissed the director's appeal against the order made in the court below that he must repay to the company the amount of the secret profit he had made in the sum of £5 200 together with interest, making a total of £7 997.31.

A director's duty in regard to improper profits made by virtue of his position

The decision illustrates the cardinal principle that, when it comes to a director's duty in regard to secret profits (that is to say, profits not disclosed to and approved by the board), the breach of the legal duty is not based on causing financial loss to the company. Indeed, it is irrelevant whether or not the company suffered any loss. The duty is based on the principle that a director who has made an improper profit for himself, without proper disclosure and approval, must disgorge that profit to the company.

The Companies Act of 2008

What does South Africa's new Companies Act of 2008 say in regard to these principles?

The Act explicitly says in section 76(2) that -

'A director of a company must not use the position of director, or any information obtained while acting in the capacity of a director to gain an advantage for the director or for another person other than the company or a wholly-owned subsidiary of the company …'

It may be noted that there is nothing novel about this statutory declaration of directors' duties. It is merely a statement of one well-established aspect of a director's common law fiduciary duties to the company.

It is also significant that the Act necessarily tries to state a director's fiduciary duties simply and concisely. More expansive statements of the legal principles and of the underlying philosophy are to be found in judicial decisions.

One such decision, quoted many times over the years is that of Regal (Hastings) Ltd v Gulliver [1967] AC 134 at 144 where Lord Russell of Killowen said that the liability of a person in a fiduciary position, such as a director, to account for the profit made by use of his position -

" …in no way depends on fraud, or absence of bona fides; or upon such questions or considerations as whether the profit would or should otherwise have gone to the [party to whom the duty was owed] or whether the profiteer was under a duty to obtain the source of the profit for the plaintiff, or whether he took a risk or acted as he did for the benefit of the plaintiff, or whether the plaintiff has in fact been damaged or benefited by his action. The liability arises from the mere fact of a profit having, in the stated circumstances, been made. The profiteer, however honest and well intentioned, cannot escape the risk of being called upon to account." (Emphasis added.)

In short, a South African court, applying the provisions of the new Companies Act of 2008, would have come to the same conclusion and made the same order as was made by the UK Court of Appeal in the Phillip Towers case, discussed above.


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