Fiduciary Duties of New Zealand Company Director

The purpose of this essay is to analyse the fiduciary duties of a company director in New Zealand both at common law and the Companies Act 1993. The essay also critically evaluates the effectiveness of the existing statutory whether it meets the purpose of reaffirming the value of the company. Although the existing statutory aims to provide a balance between the legislation and corporate reality, there are a number of arguments on the base assumption of the duties of directors such as whom the duties should be owed to when there are more than one interests and concerns in difference circumstances, how the legislation should be interpreted, when there is a breach of duties, and what This seems to indicate that the statutory formulations of directors’ duties should be revisited and the technical improvement may be required to filling those gaps.

Directors are required in common law to exercise their powers to obtain what they believe to be the best interest of the company. The fiduciary nature of the director’s position is effectively emphasised on Re Smith & Fawcett Ltd. [1] Arguably the interest of the company in common law view may not be the same as the interest of its shareholders as a whole. [2] This means only the company could take action against directors for breach of their duties as directors owe fiduciary duties to the company, but do not necessary owe to the individual shareholders or the company creditors. [3] There are examples of cases that support where duties of directors might require the directors to consider the interest of shareholders and creditors such as the case of H Timber Protection Ltd v Hickson International plc [4] , Australian Metropolitan Life Assurance Co Ltd v Ure [5] , and Kinsela v Russell Kinsela Pty Ltd. [6] Since the interest of the major shareholders is generally also in the interest of the company, the Companies Act 1993 addresses this issue by providing a balance between the legislation and the business reality, as well as providing some duties of directors are owed directly to shareholders. [7]

Under Section 131, it states that directors of a company that is a wholly-owned subsidiary may act in a manner which they believe to be the best interest of the holding company, even if it may not be the best interest of the company, provided the directors is permitted by the constitution of the company. [8] The same rule applies for the company that is a subsidiary but not a wholly-owned subsidiary, except an additional requirement to obtain the prior written agreement of the shareholders other than its holding company. [9] Where the company is carrying out a joint venture between the shareholders, and expressly permitted by its constitution, the directors may act in a manner that they believe is in the best interest of shareholders, even though it may not be in the best interests of the company. [10] The duties to take into account from different interest group could put the directors to a difficult position to balance those interests, especially where the company is in a state of near insolvency. This could be found in Lion Nathan v Lee [11] and Peoples Department Stores Inc v Wise [12] , where directors were found not liable for their decision when the company got into financial difficulty. Although, the legislation merely allows the directors to take into account different interests other than those of the company itself, it is suggested that the legislation is need to be more specific in those circumstances.

The Companies Act 1993 requires that directors must exercise their powers for a proper purpose. [13] There are questions on what is regarded as a “proper purpose” as this duty has not yet been the reference to much case law and the common law development. [14] Because of this, the Court recognises that, even though directors may act bona fide in the best interest of the company, directors who use their power for something other than what the purpose was are subject to a breach of duty. This duty also reflects to some extent on the common law and one of the commonest examples is the issues of shares. In Hogg v Cramphorn Ltd [15] case, the directors used their power to issue shares to their employee trust to affect the voting position to defeat a takeover bid as they honestly believed, in good faith, that the takeover would not be in the best interest of the company. However, the purpose for issuing shares in generally is to raise the capital, therefore this has been regarded as a breach of duty. Furthermore, when there is more than one purpose for issuing shares other than the raising of capital, the Courts will ascertain the primary purpose whether it is a proper one, for instance the case of Howard Smith Ltd v Ampol Petroleum Ltd. [16] There is still room for an underlying duty in the legislation to clarify what are the proper purposes which would certainly make the law more accessible.

A director must not agree, cause or allow the business of the company to be carried on in a manner likely to create a substantial risk or serious loss to the company’s creditors [17] and must not agree to the company incurring an obligation unless, at the time, the director believes on reasonable grounds that the company will be able to perform the obligation when it is required to do so. [18] These duties are similar to the provision of the Companies Act 1955, but are not an exact counterpart in the common law. [19] There are some arguments in the use term of “substantial risk” and “serious loss” and because of this the Court seems continue to refer “recklessness” to the decision under s 320 in Thompson v Innes [20] and Lower v Traveller. [21] In addition, the “recklessness” can be taken not only when the company is in liquidation but also when the company survives their recklessness. The useful example can be seen in Re Wait Investment Ltd, [22] and Benchmark Building Supplies Ltd v Jackson, [23] where the duties imposed on directors’ conduct and decision making are not confined solely to the period in which the company is in liquidation. Since the interpretation of “substantial risk” and “serious loss” is still questionable, it appears that the legislation adds little or nothing to the previous provision and the creditors will have to rely on the Courts to justify if there is any breach of these duties.

The standard of care required of directors at the common law has been a low level in recognition of a person who occupying the position of director. Directors in common law were only liable for gross negligence based on the degree of skill of their knowledge and experience. [24] Extensively, the Courts said, according to Daniels v Anderson, [25] that the old cases referring to subjective tests and gross negligence are now outdated. The duty of care has been developed under the Companies Act 1993 that a director is required to exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances, taking into account, but without limitation, the nature of the company, the nature of the decision, and the position of the director and the nature of the responsibilities undertaken. [26] The Act 1993 appears to offset the objective in interpreting the standard requirement of skill and care of directors. The Act also recognises the standard of care required to an ordinary person or a person with an ordinary degree of prudence to be taken into account in assessing whether the duty of care has been breached. However, a prudent director may avoid potential liability under section 137 by relying on professional or expert advice [27] in certain circumstances. The reliance is only permitted when the director acts in a good faith, makes proper inquiry when appropriate, and does not know that the reliance is unwarranted. [28] Nevertheless, some matters will require the directors to exercise their own judgment and the reliance is permitted, Nippon Express (NZ) Ltd v Woodword [29] , otherwise the directors are still liable for that breach of duties, Dairy Containers Ltd v NZI Bank Ltd [30] .

At common law, directors cannot have a conflict of interest [31] , whereas in the legislation directors are required to disclose their personal interest in company transactions, and the conflict of interest is therefore permitted in those circumstances. [32] If directors are interested, defined under section 139, in the company transactions they must disclose those in the interests register [33] and disclose to the company’s board if the company has more than one director. [34] Where a director is a shareholder, director, officer, or trustee of another named company or other person, a general notice to that effect may be entered into the interest register, and will constitute a sufficient disclosure of interest in relation to that transaction. [35] The disclosure is one of the methods used to offer the protections for shareholders. In addition, a failure to comply with the disclosure requirement does not affect the validity of a transaction [36] although directors who fail to comply commit an offence. [37] The director is deemed not interested in a transaction to which a company is a party where the transaction only involves the giving of security in respect of the obligation by the company to the third party. [38]

The company has the right to avoid any transaction in which a director of the company is interested at any time before the expiry of three month after the transaction is disclosed to all shareholders [39] or when the company specifically provides the avoidance rights in its constitution. [40] A transaction cannot be avoided if the company has received fair value [41] and the fair value is assessed on the basis of the information know to the company and to the director concerned at the time the transaction is entered into. [42] The issue of whether a transaction can be set aside and how disclosure may take place were considered by the Court of Appeal in Rockyana Lodge Ltd v Stenberg [43] , when disclosure of interest had not been communicated to all shareholders, and therefore there was a technical breach of nondisclosure. Moreover, the company is presumed to receive fair value when the transaction is entered into in the ordinary course of business and on its usual terms. [44] Due to the presumption, this appears the onus always rests on the company to establish the lack of fair value. The proving of fair value under section 141 is still questionable whether it is viewed as an objective or whether it is viewed as a modified equitable rule applied from one to another. For instance, the case of Sojourner v Robb [45] , the test of fair value in s 141(5) did not more than to apply logical thinking of the common law or the usual equitable duties.

The fiduciary duties at common law prohibit directors from using any company confidential information obtained in the course of their position as directors for their own personal profit. [46] In some circumstances, directors could be held liable to account for any profits made out of business opportunities of the company for their own benefit even if directors cease to hold their position as directors. [47] The Companies Act 1993 under section 145 contains situations relating to the use of company information, thus the fiduciary duties are usually involved with the conflict of interest under section 139 to 144 and the breach of good faith under section 131. Under the Act 1993, directors may, unless prohibited by the board, disclose information to a person whose interests the director represents or to a person in accordance with whose directions or instructions the director may be required, or is accustomed to act, and the name of such persons must be entered in the interest register. [48] If particulars of the transaction are entered in the interest register of the company, the information may be disclosed where there is prior authorisation by the board and the disclosure is unlikely to prejudice the company. [49] The Act 1993 provides the power to the board to prohibit on using any company information when there is any doubt that the disclosure may prejudice the company.

Directors or employees must comply with the prohibitions against insider trading in the Securities Amendment Act 1988 as well as the duty under the Companies Act 1993 section where they are in possession of confidential information. Directors who have sensitive information in their capacity as directors or employee of the company or a related company may only acquire or dispose shares in the company or a related company for fair value. [50] Fair value will be determined on the basis of all information known to director and publicly available at the time. [51] The director must pay to the person for any amount in excess for a fair value for disposing of or acquiring the shares. [52] The issue of determining of “fair value” had been discussed in Thexton v Thexton [53] whether the fair value has been received when the confidential information is known to both parties to the transactions. Since the information is an objective to determine the fair value, it seems that the person taking proceeding against the director needs to establish that the fair value is not received. The Act 1993 also requires directors to disclose the information of share dealing and ensure that this is entered in the interest register [54] if there is a relevant interest. [55] This will help to provide the protection to shareholders as well as to capture share dealing by persons or companies on behalf of directors of the company.

According to Percival v Wright [56] , directors owe fiduciary duties to the company at common law, but do not necessary owe to the individual shareholders or the company creditors. Where there is a breach of duties by director, shareholders or creditors will have no direct right of action against the director of the company. [57] However, in certain circumstances, the common law recognises the right of shareholders to appoint a shareholder to bring a proceeding on behalf of the company [58] or to directly bring a proceeding against directors. [59] Within the Companies Act 1993, there are a number of duties that specifically owe to individual shareholders [60] such as the supervision of the share register [61] , the disclosure of interest [62] , and the disclosure of share earning. [63] While personal actions are not limited to only these three duties, the remaining duties in the Act are likely to be depended on a case by case basis through the common law.

The Act 1993 imposes no express duties of directors that are enforceable by the creditors directly where there is a breach of their duties. When a company is in financial difficulties, unlike common law only applies when the company is in liquidation, a creditor are entitled to bring an action that a director have breached duties under section 135 or section 136 to the company repay money directly to the creditor under section 301. These statutory duties of company directors provide some protection for the creditors by putting them in a stronger position, similar to the provision under the Companies Act 1955. The useful examples can be seen in Re Hilltop Group Ltd (in liq), [64] Benchmark Building Supplies Limited v Jackson, [65] and Fatupaito v Bates. [66] Although the Court can order the repayment of money to the creditors, because of the way in which section 301 is worded, the order requiring payment of any breach of duty could not be paid directly from director to creditor. [67] In Re Cellar House Ltd; Walker v Allen [68] and Re Gellert Development Ltd (in liq), Re; McCullagh v Gellert [69] , Peace and Glory Society Ltd (in liq) v Samsa, [70] directors are also liable when they have failed to keep proper accounting records under section 194 and that caused the company is in liquidation or unable to pay its debts to creditors. [71] Directors’ liabilities of this non-comply are described in section 374(2) of the Companies Act 1993.

In summary, the existing statutory is designed to restate aspects of the common law and to introduce some regulation rules imposed on directors. Although, the fiduciary duties of directors are owed to the company, directors are assumed to promote the interest of its shareholders or creditors when the company is insolvent. It is undeniable that the issues of fundamental interpretation of provision still remain and it is therefore needed to be reviewed by New Zealand Courts and a case law to ensure that the legislation does meet its objectives.

BIBLIOGRAPHY

Books

Beck, Andrew Morison’s Company Law (NZ) (online looseleaf ed, Lexisnexis, at 24)

The Laws of New Zealand (online looseleaf ed, Lexisnexis)

Watson, Susan The law of business organisations (4th ed, Palatine Press, Auckland, 2003, at 12).

Journal Articles

Matthew Berkahn “Directors’ Duties to “the Company” and to Creditors” Companies and Securities Law Bulletin (NZ) [2002] CSLB 31.

Peter Watts “Editorial: The attempt to nationalise the company – introducing “stakeholder” ideology into the foundations of company law” Companies and Securities Law Bulletin (NZ) [2005] CSLB 103.

Peter Watts “Editorial: Statutory Formulation of Directors’ Duties – Some Issues” Companies and Securities Law Bulletin (NZ) [2003] CSLB 95.