Directors’ duty to avoid conflicts

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This topic is within Business Associations.

Contents

Required Reading

Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC, pp. [7.340]-[7.380].

Corporations Act, ss 182, 183.

See case list on the course outline.

Introduction

The second component of directors’ fiduciary duties (the first being the duty to act with good faith) is this duty to avoid situations where, without consent of the company, the director’s personal interests (or another interest which the director is bound to protect) conflicts or may possibly conflict with their duty to the company.

The tiers of rules affecting directors’ interests in transactions with their company

There are really three tiers of legal rules which apply in relation to transactions or other dealings with a company in which one of its directors has an interest:

  1. The equitable principle - this operates to make transactions made under a conflict of interest rescindable (provided it is possible to restore the parties to their original position - see bars to recission) by the company, irrespective of the fairness of the transaction from the comapny’s perspective.
    • Note: the replaceable rule in s 194 gives statutory force to this duty.
    • The transaction is recindable irrespective of the fairness of the transaction from the company's perspective. Liability is based on the conflict of interests alone.
    • In Furs Ltd v Tomkies it said that “it is neither wise nor practicable for the law to look for [another] criterion of liability. The consequences of such a conflict are not discoverable. Both justice and policy are against their investigation”
    • However, this absolute prohibition upon conflicts is contractible - ie, it can be released by consent of the beneficiary of the obligation (the company). Contracting-out provisions (in a company's constitution) are widely adopted so that companies may secure services of well networked directors and avoid the conflict of interests principle.
  2. Provisions in company constitutions modifying the equitable rule/its consequences, usually by relieving against its rigour; and
  3. The statutory duty of disclosure imposed by the Act.

Statutory duty

The Corporations Act stipulates a duty to disclose a conflict of interest. Some of the key provisions include:

  • s 182: Use of position – civil obligations – a director/officer must not improperly use position to gain advantage or cause detriment to the company (civil penalty).
  • s 183: Use of information – civil obligations – a director/officer must not improperly use information obtained under their role to gain advantage or cause detriment to the company (civil penalty).
  • s 191: Material personal interest – directors’ duty to disclose – directors who have a material personal interest in a relevant matter must disclose that to other directors.
    • Subsection 2 sets out exceptions
    • Subsection 3 stipulates that notice must give details of the nature and extent of the interest and the relation of the interest to the affairs of the company.
    • s 193: these rules do not displace operation of equitable rules about conflict of interest and constitutional provisions restricting directors from interests/officers which might involve a conflict.

The disclosure requirement usually refers to interests in contracts/proposed contracts, officers and property but may extend more widely.Interests that attract this statutory disclosure obligation must be both personal and material.

  • A personal interest includes pecuniary interests but is not limited to such interests.
  • May include interests arising from close personal relationships, especially family relationships: R v District Council of Victor Harbour; Ex parte Costain Australia Ltd (1983) (SA).

The standard of materiality looks to the showing of a substantial likelihood that, under all the circumstances, the interests would have assumed actual significance in the deliberations: Re Rossfield Group Operations Pty Ltd [1981]

  • Where director of public company is director of another company which is contracting with the public company, materiality standard would ordinarily be satisfied automatically so that disclosure is required: Transvaal Lands Co v New Belgium (Transvaal) Lands and Development Co [1914].

The Act provides an attenuating provision for proprietary companies through a replaceable rule - if a director of a proprietary company has a material personal interest in a matter regarding the affairs of the company and the director discloses interest under s 191 (or if he doesn’t need to because it falls under the exceptions) then:

  • The director may vote on matters that relate to interest.
  • Any transactions that relate to interest may proceed.
  • Director may retain benefits under transaction even though he/she has interest.
  • Company cannot avoid transaction merely because of existence of interest.

Restriction upon board participation by interested directors of public companies

A director of a public company who has a material personal interest in a matter that is being considered at a directors’ meeting must not be present while matter is being considered at meeting/vote on matter: s 195. Exclusion does not apply if:

  1. The interest is exempted from disclosure under s 191 (2);
  2. The directors who do not have material personal interest in matter pass a resolution that:
    1. Identifies the directors, the nature and extent of the directors’ interest in matter and its relation to affairs of company; and
    2. States that those directors are satisfied the interest should not disqualify the other directors from voting or being present: s 192 (2)
  3. With ASIC approval, where:
    1. A matter could not otherwise be dealt with for want of quorum and
    2. because of its urgency or another compelling reason, and
    3. Cannot be dealt with by the general meeting.
  4. The director with a material personal interest also possesses confidential info relevant to a matter before board disclosure, and non-participation may not be sufficient in circumstance to discharge duty: Wheeler.

This was discussed in Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461:

  • Facts:
    • Railway company contracted to purchase goods from a partnership and sought to avoid contract on ground one of its directors was member of partnership
    • Partnership was suing for performance of contract
  • Held (Cranworth):
    • “It is a rule of universal application, that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect”
    • So strict is the application of this rule that no question is allowed to be raised as to the fairness or unfairness of the contract entered into - it is so inflexible that no inquiry as to subject matter is permitted
    • Inability to contract depends not on the subject matter but on the fiduciary character of contracting party
    • Also notes that this rule is the same whether he was sole director or only one of many - no difference in principle
    • As partner of the partnership he would be trying to get the highest possible price, as member of co he would be trying to get lowest possible price - direct conflict of interest

Imperial Mercantile Credit Association v Coleman (1871) LR 6 Ch App 558

  • Facts:
    • Coleman (C) was a stockbroker in partnership with K, and was also a D of IMC
    • As broker, C contracted with P&C to procure subscriptions for debentures to be issued by a new company for a commission of 5% in cash and 5% in shares
    • At board meeting of IMC he proposed that they subscribe for these debentures
    • He offered IMC commission of 1.5% only and didn’t tell them of agreement with P&C though told them he was interested in transaction - board accepted his proposal
    • IMC later went into liquidation and C’s agreement with P&C came to light
    • Liquidator sued to compel C to account for commission he had received upon debentures placed with IMC
    • Article 83 of IMC’s constitution said “the office of D shall be vacated if he contracts with the company, or is concerned in/participates in profits of any contract with company… without declaring his interest at meeting of directors at which contract is determined on...and no director so interested shall vote at any meeting… on any question relating to such contracts”
  • Lord Hatherley:
    • Found C has made adequate disclosure of his interests for the purpose of art 83 which validated his agreement with the association:
    • Lord Cairns (on appeal):
    • The general equitable considerations of directors’ conflict of interest in transactions may be modified by provisions in company constitutions, or by circumstances of appointment, or by the informed and effective consent of the person to whom the duty is owed, allowing directors to have dealings which would otherwise be in breach of fiduciary duty
    • “A man declares his opinion or his intentions when he states what his opinion is, or what his intentions are, not that he has an opinion or has intentions”
    • He didn’t state his interest to the company or the general meeting, but to some other persons who were in just as much a fiduciary position as he was himself
    • Found C was liable for the whole of the profits which were obtained

Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co [1914] 2 Ch 488

  • Facts:
    • Company’s constitution provided that two directors should form a quorum and that “no contract or arrangement should be avoided, provided a director discloses the nature of his interest, but that no director could vote on the matter”
    • Y, S and H were directors - only Harvey and Young voted and S was a director of the defendant company and interested in the purchase
    • Harvey failed to declare he was a trustee shareholder (not beneficially interested in the shares), and that he had just been appointed but not yet accepted directorship in the defendant company
    • Had conflict in buying shares for the company at a cheap price, and making sure the shares he holds on trust retain high price
    • Company bought shares in the defendant company, which as tightly held would cause price to inflate
    • Question was whether the transactions effected by these resolutions can stand
  • Astbury J:
    • Makes no difference whether H was mere trustee of shares - his duty was to make best bargain for the company in relation to the shares and his duty as trustee was to make best bargain he could for the trust were obviously in conflict.
    • Rejected the argument that the constitution effectively contracted the company out of the traditional common law principles and that the directors were entitled to contract with company or partner firm and that such a contract wouldn’t be avoided by reason of fiduciary position as long as nature of interest was disclosed and they didn’t vote.
    • Rather, “There is no sufficient justification for saying that this is a company in which a director who is a shareholder in another contracting company may take part in passing a resolution in the way H has done”
  • Swinfen Eady LJ (Court of Appeal):
    • “Where a director of a company has an interest as shareholder in another company or is in a fiduciary position towards and owes a duty to another company which is proposing to enter into engagements with the company of which he is a director, he is within the rule”
    • Validity cannot depend upon extent of adverse interest of fiduciary agent - no enquiry permitted as to subject matter
    • The contract is voidable and the purchase is to be repaid

Gray v New Augarita Porcupine Mines Ltd [1952] 3 DLR (2d) 1

  • Facts:
    • During 5 year period G had exclusive management control of the company
    • Kept few records of transactions conducted for company and its property etc were intermingled with his own
    • Company’s affairs were conducted in Gs legal practise - Bourne, the only other D, was accountant employed by G
    • During period G used company’s funds for own purposes in constant breaches of his fiduciary obligations as director of the company
    • Made large profits to himself by issuing himself shares, taking them at discount and then trading them on stock exchange at much higher price
    • Pressure later lead to reconstitution of company’s board and one of the new directors, Bouck conducted own investigation
    • His report showed Gs indebtedness to company
    • Discussion ensued and agreement reached between company and G with outstanding claims settled on payment from G
    • Board minutes noted G declared interest ‘in all matters in which he was interested’ and refrained from voting
    • Company later sued G seeking recovery of profits derived in period prior to reorganisation or damage for loss it sustained
    • G pleaded that agreement was release of claims against him and it was accepted in the Court of Appeal and Privy Council that resititutio in integrum was impossible
  • Lord Radcliffe:
    • General principle is that such a contract is not binding on the company, as the director is not entitled to place himself in a position in which interest conflicts with duty - even if contract is not avoided, either as company elects to affirm it or because circumstances have rendered it incapable of recession, the director remains accountable to the company for any profit he may have realised by deal
    • Company can make provisions to alter this general principle - company’s laws make such a modification, with the result is G was not precluded from entering contract but not allowed to vote and could only retain such profits arising from contract/transaction if at meeting passing resolution he disclosed to his colleagues “the nature of his interest”
    • There is no precise formula which that will determine the extent of detail that is called for when a director declares his interest or the nature of his interest - must depend on each case including the nature of the contract or the arrangement proposed, and the context in which it arises
    • G’s actions fall short of what is required
    • If they cannot get rescission, may elect not to void the transaction and obtain an account of profit instead
    • Recession: Transactions are voidable at the suit of the company irrespective of the fairness of the transactions from the company’s perspective, provided it is possible to restore the parties to their original position

The fettering of board discretions

Directors must exercise independent judgment in the exercise of their powers

  • The rule prohibits directors from delegating discretionary powers to another group/individual (at least without sanction of constitution) or from binding themselves as to future exercise of those powers.
  • An agreement to do as such would be vitiated by assumption of obligations to “act in a specified manner to be decided by considerations other than [their] own conscientious judgement at the time as to what is best in the interests of [their company]”: Osborne v Amalgamated Society of Railway Servants
  • However, not every fetter upon future exercise of directors’ powers will offend the rule as Thorby v Goldberg demonstrates below

Thorby v Goldberg (1964) 112 CLR 597

  • Facts:
    • Company proposed to demolish building on land owned by it and erect multi-story and sell off suites
    • Defendants were the only shareholders in company and 7 of them were its only Directors
    • Defendants made agreement with plaintiffs with general purpose of bringing their capital into company upon mutually satisfying terms including terms as to right to occupancy of space in new building
    • Agreement contained covenant by defendants to cause a meeting of directors or company to allot specified shares to plaintiffs and a covenant for 3/5 directors to resign and 2 members of plaintiffs group to be appointed to board
    • Defendants challenged validity, inter alia, on basis that it purported to bind directors of the company in exercise of powers, that is fetter offended public policy and agreement accordingly void for illegality
  • Kitto J:
    • An agreement is void if the directors of a company purport to fetter their discretions in advance
    • There are many types of discretions at which time to exercise them are at earlier stage than time of performance - can’t bind yourself unless you exercise your discretion at earlier stage and circumstances are that it is tied to later time
    • As with this case, sale of land is perfect example - where all members of co desire to enter as group into transaction, transaction being one which requires action by board for its effectuation, seems proper time for directors to decide their proposed action will be in interests of company is the time when the transaction entered into and NOT time when their action under it is required

Competing directors

The obligation to avoid a conflict of interests sometimes precludes a director from becoming a director of a similar company.

  • Whilst partnership law prohibits such competition without consent of other partners, company law does not however impose such a blanket prohibition upon competitive activity by directors

Early case law posed few restraints on such a course of action:

London and Mashonal and Exploration Co Ltd v New Mashonaland Exploration Co Ltd [1891] WN 165

  • Facts: Company sought to restrain its chairman from acting as director of rival company. Chairman had attended no board meeting of applicant company and had made no undertaking not to become a director of similar company. Constitution of applicant company contained no such restraint
  • Chitty J: Looks at circumstances of the case and notes he has made no undertaking not to act as director in another company and constitution contained no such provisions, either express or implied
    • There was also no evidence to suggest he was going to/had disclosed any confidential info to rival
    • Not a breach of directors’ duties that he/she be director of company AND a rival company - not alone a breach of the duty

Chan v Zacharia (1984) 53 ALR 417

ASIC v Adler [2002] NSWSC 171

End

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References

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

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