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A director must act in good faith in the interests of the company

A director's duty to act in what he believes to be the best interests of the company

Nothing is more common than for shareholders to believe that the directors of their company are doing a poor job of managing the company's business.

What can shareholders do in such circumstances? Their primary remedy, of course, is to pass a resolution removing one or more directors from office and appointing others who are hopefully more competent - and the Companies Act enshrines the right of the shareholders' meeting to do exactly this by way of an ordinary resolution, that is to say, a resolution supported by a simple majority of shareholders' votes.

But if the discontented shareholders cannot, between them, muster sufficient votes to pass such a resolution, that course of action is not open to them. What can they then do?

The one thing they cannot do is to apply to court for an order that the directors must do x, y or z, for example, that they must close an unprofitable branch of the company's business.

The response of the court to such an application would be that the power to manage the company is vested in its board of directors and the court has no power to take on itself the task of making management decisions for the company. The courts have said on many occasions that, if the directors of a company are incompetent, then the fault lies with the shareholders for having elected them.

The court will of course be willing to listen to a complaint by shareholders, not that the directors are inept, but that they are breaching some aspect of their fiduciary duty or are exercising their powers in a manner that is unfair or oppressive to some of the shareholders.

The fundamental principle of company law is that the duty of a director is to act in what he or she honestly believes - not what a court may believe - to be the best interests of the company. In this regard, a director is required to bring an independent mind to bear on the question of what is the best interests of the company and to act accordingly.

This is not the only duty of directors, but it is the most fundamental of their fiduciary duties.

As the court held in In re Smith and Fawcett Ltd [1942] Ch 304 - which is the classic authority for this proposition ? the law requires that, when it comes to exercising the discretionary powers vested in them, for example, in relation to the management of the company, the directors -

"must exercise their discretion bona fide in what they consider - not what a court may consider - is in the interests of the company"

Thus, for example, in that case, where the articles of association give directors the power to refuse to register the transfer of shares to a person of whom they disapproved, all that the law required of the directors was to decide whether, in their honest opinion, a particular transferee was acceptable. If the directors, acting honestly, reach a decision in the negative, the court would not overrule their decision.


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