Directors’ duty not to make secret profits and divert corporate opportunity

From Uni Study Guides
Jump to: navigation, search

This topic is within Business Associations.

Contents

Required Reading

Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC, pp. [7.455]-[7.495].

Introduction

As a part of their general equitable duties, directors have a duty not to make secret profits. This is an equitable duty that has its origins in the directors’ role as trustees of company funds – accordingly, if the directors misapply any funds they are liable to account for the profit made as if they were trustees: O’Brien v Walker.

  • The same principle applies to other property of the company: Re Land Allotments Co.
  • A more difficult situation arises where directors acquire property or derive profits not by direct appropriation of company funds or tangible property, but by use of their position in the company in other circumstances where personal interest is opposed to their duty. The duty applies to such situations as well.

The duty is now reenacted in the Corporations Act together with the duty to avoid conflicts of interests. Ss 182 and 183 (see duty to avoid conflicts) prohibit company officers, including directors, from both improperly using their positions in order to gain an advantage or cause the company detriment.

Origin of the duty

Before the legislation, equity dictated that the duty usually arose in two scenarios:

  1. Where the benefit is obtained in circumstances where there existed a conflict (or significant possibility of conflict) between directors duty to the company and personal or other interest which the director is bound to protect: Phipps v Boardman
  2. Where the benefit was obtained or received by use or reason of the office of the director of opportunity or knowledge resulting from it: Chan v Zacharia

In either case, the director or officer could only have retained the benefit if all material facts are disclosed to the appropriate organ of the company and approved by it.

  • The duty not to make secret profits is closely related to the duty to avoid conflicts on interests.
  • As noted in Chan v Zacharia, any such benefit is treated as being held by the fiduciary on a constructive trust merely because of the conflict - it is immaterial that there was no absence of good faith or damage to the person to whom fiduciary obligation was owed.
  • However, this rule is applied extremely strictly (Meinhard v Salmon) even producing results which do not always satisfy notions of fairness or not obviously consonant with fiduciary ideology.

Furs Ltd v Tomkies :[1]

  • Facts: The Defendant [Tomkies] was the managing director of the Plaintiff [Furs]. A part of the Plaintiff was being sold to a buyer. The Defendant was in charge of negotiating the deal. The Plaintiff informed the Defendant that he won’t be employed by them after the deal and told him ‘to make the best possible arrangement’.
    • The buyer offered the Defendant a job with them after the deal and a substantial cash payment if he would disclose some important information about the Plaintiff. The Defendant complied, which led a reduction in the purchase price. The Plaintiff discovered the substantial cash payment and claimed breach of fiduciary obligations.
  • Held (Rich, Dixon and Evatt JJ: “Except under the authority of a provision in the articles of association, no director shall obtain for himself a profit by means of a transaction in which he is concerned on behalf of the company unless all the material facts are disclosed to the shareholders and be resolution a general meeting approves of his doing so”
    • An undisclosed profit which a director gets as a result of his fiduciary duties belongs to the company in equity.
    • It doesn’t matter that the profit was of a kind which the company could not have ever itself have obtained, or that no loss is caused to the company by the gain of the director
    • Most important legal consideration was that the payment was obtained by the Defendant in the course of a transaction which he was carrying out on behalf of the company in execution of his officer of managing director.
    • The sale agreement is rescinded.

Cook v Deeks :[2]

  • Facts: TCC was formed to execute a tender for construction of railway line for CPR. When contract successfully completed CPR commenced negotiations with 2 directors of TCC, Deeks and H, for construction of another line. Deeks, his brother and H together held 3/4 of capital in TCC with remainder held by Cook. Those 4 people were the only directors of TCC.
    • Cook’s fellow directors decided to exclude him from any new contract, so they formed a new company, DCC, in which Cook had no interest. DCC then carried out the new contract. A general meeting of TCC was held at which Deeks, his brother and H used their voting power to approve sale of part of company’s plant to DCC and to declare that TCC had no interest in new contract.
    • Cook brought proceedings against other directors and DCC claiming they held contract for benefit of TCC.
  • Held (Lord Buckmaster LC): the directors obtained the new contract in the course of their role as directors of TCC, and therefore that contract rightfully belongs to TCC under the duty not to make secret profits. They cannot ignore their fiduciary duties and divert new business for their own purposes.
    • An attempt by the three directors (who constitute a majority of the TCC) to give up the new contract or ratify their own actions amounts to forfeiting the interests and property of the minority of shareholders in favour of the majority, which is not allowed – the general meeting cannot make resolutions to oppress the minority (see fraud on the minority).

Regal (Hastings) Ltd v Gulliver :[3]

  • Facts: the Plaintiff [Regal] was a company who owned a cinema and sought to acquire leases to two more cinemas through a subsidiary company which was basically operated and owned by the same people (same directors). The Defendants were the directors of Plaintiff and the chairmen (Gulliver, who was not a director).
    • The owner of the two cinemas wanted a personal guarantee which the directors refused to give. Instead, an arrangement was made where the subsidiary of the Plaintiff put in 40% and then each of the individual directors of the Plaintiff, the Plaintiff’s lawyer, and Gulliver, collectively made up the 60% personally. Gulliver did not put in the money personally – he raised the money through a few companies and effectively was the trustee of their fund.
    • The directors of the Plaintiff then sold the Plaintiff and made a big profit (personally, on the investments they made in the new cinemas). The new directors of the Plaintiff sued the old directors (including the Defendant) on the basis that this profit was obtained due to their position as directors and is thus held on trust for the Plaintiff.
  • Held (Lord Russell): the test is whether the directors obtained the benefit by reason (and only by reason) of the fact that they were directors of the company and in the course of the execution of their office. Liability arises from mere fact of profit having been made during course of acting in the position – fraud, presence or absence of bona fides/good intentions/dishonesty, and the fact that the company could not have gotten the benefit on its own anyway are all irrelevant.
    • The directors have a fiduciary relationship to the Plaintiff and they obtained the shares (and the profits) only because of their position. Accordingly, they are accountable for all profits.
      • They could have protected themselves through a resolution of the shareholders – whether before or after the profits were made.
    • However, the case of Gulliver was different – he was not a director, and the company (board of directors) asked him to raise the money. Furthermore, he didn’t actually make any profit – he was holding it on trust for the beneficiaries of his trust, who had nothing to do with the company and certainly didn’t owe it any fiduciary duties. Clearly, they do not have to account to the company.
    • Note: today, under s 182, both the chairman and solicitor would be liable, as they are deemed to hold a duty to the company. Also, if they had been dishonest (they weren’t in this case), they could not rely on a resolution of the general meeting to ratify their actions - ss 184, 182,
      • However, they could try rely on s 1317S to escape liability.

Peso Silver Mines Ltd (NPL) v Cropper :[4]

  • Facts: the Plaintiff was a mining company. A prospector offered them some ventures but the board rejected the offer. The Defendant [Cropper], who was the managing director of the Plaintiff, later formed another company, accepted the prospector’s offer and made a profit off it. Eventually, the Defendant disclosed his interest in his other company to the Plaintiff, and the fact he accepted and developed the prospector’s offer. He was asked to turn over that interest at cost price, to which he refused.
  • Held (Cartwright J): if a company rejects a proposal bona-fide, there is no reason why a director cannot later decide to accept that offer personally. In such a case, his profits are not treated as earned by the reason its position as a director.
    • In this case, it appears that the company made bona-fide resolution to reject the offer (ie, the Defendant did not turn it down just so he can accept it on his own - the board legitimately turned it down). The Defendant was then approached in his personal capacity, and accordingly, he is not treated as holding the interest by reason of the fact he was a director of the Plaintiff.

Phipps v Boardman :[5]

  • Facts: the Defendant [Boardmen] was the solicitor of the Plaintiff [trustees of the will of the late Mr Phipps]. The Plaintiff held shares in a company named L & H. The Defendant and Tom Phipps (son of late Phipps, one of the beneficiaries of the will) attended L & H’s meeting (in their capacity as acting for the Plaintiff) and gained insight into the financials of L & H.
    • They determined to purchase the rest of the shares (with approval of only some of the Plaintiff approval thus being ineffective). They couldn’t do so because the trust instrument didn’t allow it and because the trust didn’t have enough money. So they came up with an arrangement where they fund some of the purchase personally. They explained this to the Plaintiff and again obtained (partial) consent.
    • Eventually, the Defendant and Tom Phipps obtained virtually all shares in L & H, sold the company, and made a personal profit. The Plaintiff brought proceedings against the Defendant, claiming that the personal profit was earned by reason of their office as fiduciary for the Plaintiff and thus held on trust for them.
  • Held (Lord Hodson): the Defendant obtained knowledge by reason of their fiduciary position (being able to attend the GM of L&H) and they cannot escape liability by saying that they were acting for themselves and not as agents of the Plaintiff - whether or not Plaintiff could have taken advantage of the information is immaterial.
    • Even if the possibility of conflict is present between the personal interest and the fiduciary position, the rule of equity must apply. Appeal dismissed
  • Dissent (Lord Upjohn): the Defendant’s duties had come to an end, they owed no duty and there was no conflict of interest.

Industrial Development Consultant Ltd v Cooley :[6]

  • Facts: the Plaintiff [Industrial Development] had comprehensive construction service to large industrial enterprises. The Defendant [Cooley], who was an architect by trade, was its managing director. The Defendant, on behalf of the Plaintiff, offered a company called EGB services. This offer was rejected, but the Defendant was later approached by EGB in his personal capacity for the same purpose.
    • The Defendant made up a story that he was unwell and requested to resign from his employment at the Plaintiff. He then accepted EGB’s offer in his personal capacity to do the same work the Plaintiff offered to do. The Plaintiff claimed that profits made by the Defendant were obtained by reason of office as director and thus accountable to the Plaintiff.
  • Held (Roskill J): the Defendant argued that he had two capacities and that he made it clear that he was speaking in a private capacity with EGB and therefore he was not accountable.
    • This argument was rejected - at all times, the Defendant was acting as a managing director of the Plaintiff and the information only came to him because of that position. He had a fiduciary duty to pass that information (ie, personal offer) to the company.
    • As usual, the fact that the Plaintiff had no chance of obtaining the contract anyway is irrelevant – liability is established merely on the fact that there was a conflict of interests.
    • It is also relevant that the Plaintiff would not have let the Defendant resign if they knew he was resigning in order to receive this contract.

Canadian Aero Service Ltd v O’Malley :[7]

  • Facts: the Plaintiff [Canadian Aero] was a small Canadian company who dealt in topographic mapping. The Defendant [O’malley and others] were senior officers of the Plaintiff. The Defendants decided to resign because they were discontented. They formed a new business, Terra, which offered similar services.
    • Terra received a contract based on work which was done on some preparatory work that had been performed by the Defendants when they were still working for the Plaintiff. The Plaintiff claimed that profits out of this contract are obtained by reason of office as directors and thus accountable.
  • Held (Laskin J):
    • Question to be determined:
      • Were the parties directors?
      • Was there a duty?
      • Was it breached?
      • Is there liability for that breach?
    • Acted as directors, so it doesn’t matter that they weren’t validly appointed
    • Directors or senior officers are precluded from obtaining for himself, either secretly or with the approval of the company, any advantage either belonging to the company or for which it has been negotiating, especially if that director has been a participant in those negotiations
    • The duty applies where the director resigns where the resignation may fairly be said to have been prompted or influenced by a wish to acquire for himself the opportunity sought
    • Discussed Peso and stated that “it is a mistake to seek to encase the principle applied in Peso, adopted from Regal, in the straightjacket of special knowledge acquired while acting as directors”.
    • The general standards must be tested in each case by many factors which it would be reckless to attempt to enumerate exhaustively

Queensland Mines Ltd v Hudson :[8]

  • Facts: the Plaintiff [Qld Mines] was formed by AOE and Factors to acquire mining options held by AOE (joint venture). The Defendant [Hudson] was the managing director of the Plaintiff. After acquiring options and doing some drilling, the Defendant sought to (personally) obtain a mining exploration license and exploit the mines. This was disclosed to the Plaintiff and the board resolved that he’d be allowed to do it
    • The Defendant resigned as managing director, and acted on his own at own expense, earning significant profits. The Plaintiff claimed account of the Defendant’s profits.
  • Held (Lord Scarman): the board of the Plaintiff had reached a fully informed resolution to renounce all its interests in the exploitation of the license and has assented to the Defendant taking over the venture./
    • The Defendant’s venture was either “outside scope of trust and outside the scope of agency” created by fiduciary relationship or the Plaintiff gave fully informed consent to pursue matter no further, and leave the Defendant to do as he wished - it doesn’t matter which one.
    • Board approval was said to be tantamount to an approval by a majority of shareholders in general meeting - can take this case either as the rule or the exception, can argue it was confined to its facts.

Remedies

Civil Penalty Provision, injunction, constructive trust, account of profit

End

This is the end of this topic. Click here to go back to the main subject page for Business Associations.

References

Textbook refers to Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC.

  1. (1936) 54 CLR 583.
  2. [1916] 1 AC 554.
  3. [1967] 2 AC 134n.
  4. (1966) 58 DLR (2d).
  5. [1967] 2 AC 46.
  6. [1972] 1 WLR 443.
  7. (1973) 40 DLR (3d) 371.
  8. (1978) 52 ALJR 399.
Personal tools
Namespaces

Variants
Actions
Navigation
Toolbox