Company directors play a crucial role in the effective management and operation of a company. Directors are responsible for making important decisions that affect the company and its shareholders, and they must ensure that their actions are legal, ethical, and in the best interest of the company. Understanding the scope of their duties and responsibilities helps directors to fulfil their obligations and avoid any potential civil or criminal liabilities. It also helps shareholders to hold directors accountable and ensure that the company is operating responsibly and sustainably.
A company has a separate legal personality from its directors because it is considered a separate legal entity under the law. This means that the company can enter into contracts, sue and be sued, and own assets and liabilities in its name, independent of its directors. The directors are responsible for managing the company’s affairs, but they are not personally liable for the company’s debts and obligations unless they have acted in breach of their duties and responsibilities.
A director has both fiduciary duties and statutory duties to act in the company’s best interests. A director’s fiduciary duties are based on common law. Statutory duties are specific legal obligations imposed by legislation. The common law and statutory duties of directors exist simultaneously to complement the director’s role in the daily operation of a company. The duties and responsibilities that will be addressed in this article are non-exhaustive.
Common Law Duties
At common law, the fiduciary duties of a director include:
- To act in good faith and in the best interests of the company
- To exercise reasonable care, skill, and diligence
- To exercise powers for the purpose for which they were conferred
- To avoid conflicts of interest between personal and company matters
- To maintain the confidentiality of the company’s information
- To act with impartiality towards shareholders
- To declare any interest in a proposed transaction or arrangement with the company
- Not to make secret profits or take advantage of their position for personal gain
- Not to compete with the company
Statutory Duties
The common law fiduciary duties were previously codified in the Companies Act 1965. Since the Companies Act 1965 was repealed, the statutory position on director duties is now set out in the Companies Act 2016. Some of the important director’s duties and responsibilities are as follows:
The statutory duties of a company director are set out in Part III of the Companies Act 2016 and include the duty:
- To exercise powers for a proper purpose (Section 213(1))
- To act in good faith in the best interests of the company (Section 213(1))
- To exercise reasonable care, skill, and diligence (Section 213(2))
- To make business judgments for a proper purpose and in good faith (Section 214(1)(a)); and
- To avoid conflicts of personal interest in making business judgments (Section 214(1)(b)).
- To disclose any conflict of interest (Section 221).
- To abstain from voting on any matter with a conflict of interest (Section 222)
- To ensure that the company maintains proper accounting records (Section 245)
- To prepare and submit the company’s financial statements and reports (Section 258)
Reasonable Care, Skill and Diligence
Section 213 of the Companies Act 2016 codifies the common law duties of a company director to act in good faith and in the company’s best interests when performing their duties. Whilst doing so, a director should also perform their duties with a standard of knowledge, skill and experience that may reasonably be expected from other directors. This section is one of the most relevant to directors. Section 213 reads as follows:
213. (1) A director of a company shall at all times exercise his powers in accordance with this Act, for a proper purpose and in good faith in the best interest of the company.
(2) A director of a company shall exercise reasonable care, skill and diligence with—
(a) the knowledge, skill and experience which may reasonably be expected of a director having the same responsibilities; and
(b) any additional knowledge, skill and experience which the director in fact has.
(3) A director who contravenes this section commits an offence and shall, on conviction, be liable to imprisonment for a term not exceeding five years or to a fine not exceeding three million ringgit or to both.
Business Judgment Rule
The business judgment rule is a common law legal principle that protects directors from personal liability for decisions made in good faith and with reasonable care, skill, and diligence. Under the business judgment rule, courts will generally not second-guess a decision made by a director, even if the decision turns out to be wrong or causes loss to the company. However, the rule does not provide blanket immunity, and directors may still be held liable if they have breached their duties to the company.
The business judgment rule is intended to encourage directors and officers to take risks and make decisions in the best interests of the company without the fear of personal liability, while also holding them accountable for their actions.
In Malaysia, the business judgment rule has been codified in Section 214 of the Companies Act 2016, which reads:
214. (1) A director who makes a business judgment is deemed to meet the requirements of the duty under subsection 213(2) and the equivalent duties under the common law and in equity if the director—
(a) makes the business judgment for a proper purpose and in good faith;
(b) does not have a material personal interest in the subject matter of the business judgment;
(c) is informed about the subject matter of the business judgment to the extent the director reasonably believes to be appropriate under the circumstances; and
(d) reasonably believes that the business judgment is in the best interest of the company.
(2) For the purposes of this section, “business judgment” means any decision on whether or not to take action in respect of a matter relevant to the company’s business.
Federal Court Decisions
Board of Trustees of the Sabah Foundation & 2 Ors v Datuk Syed Kechik bin Syed Mohamed & Anor [2008] 5 MLJ 469
The requirement of a director to act in good faith and in the best interests of the company can also be found in common law as part of a director’s fiduciary obligations to the company. The Federal Court case of the Board of Trustees of the Sabah Foundation & 2 Ors v Datuk Syed Kechik bin Syed Mohamed & Anor [2008] 5 MLJ 469 explained that a director’s fiduciary duty at common law is aligned with the duties provided in Section 214 of the Companies Act 2016. Essentially, a director’s fiduciary duty provides that the director has to act in good faith and must not act for his own benefit.
There were two appeals before the court in the Board of Trustees of the Sabah Foundation case – the Zara Appeal and the Banita Appeal. In the Zara Appeal, the Sabah Foundation (SF) and its subsidiaries sued Datuk Syed Kechik bin Syed Mohamed (DSK) and his company, Zara Sdn Bhd (Zara), alleging that DSK committed a breach of fiduciary duty by failing to fully disclose information about the tower and coastal highway projects. The main issue in the Zara Appeal was whether DSK breached his fiduciary duty to SF.
The High Court found that DSK had breached his fiduciary duties by making decisions regarding the construction of the tower and coastal highway without declaring his interests in his company, Zara. The High Court ordered the disgorgement of profits made from the enhancement of the value of the Zara land due to the construction, which was assessed to be RM10 million. However, the Court of Appeal reversed this decision and found that the decisions regarding the construction were made by the state government, not DSK, and therefore he did not breach his fiduciary duties or act dishonestly. The Court of Appeal also dismissed a cross-appeal by SF and its subsidiaries. The Court of Appeal considered factors such as the Chief Minister’s dominant personality and control over important matters in the state and the government department status of SF and its subsidiaries.
The Federal Court dismissed the Zara Appeal, and found that DSK did not commit any breach of fiduciary duty, as he did not use or misuse trust information belonging to the appellants and did not place himself in a position of conflict of interest. He acted in good faith towards the appellants. The court also noted that even the trial judge did not find that DSK had been dishonest or committed the appellants to projects with the primary purpose of enhancing the value of the Zara land.
In the Banita Appeal, Banita Sdn Bhd sued DSK, alleging that he fraudulently concealed his control and beneficial interest in Banita. The main issue in the Banita Appeal was whether a director of a corporation could be held liable for breach of fiduciary duty when the corporation was a contractor to the state government and the state government granted a benefit to a company controlled by the director. The appellants in the Zara Appeal also challenged the validity of the decision of the Court of Appeal dated 6 June 2003 on various grounds.
The High Court found that DSK was liable for breach of fiduciary duty and awarded the respondents a combined sum of approximately RM29 million (including compound interest). The Court of Appeal dismissed the appellants’ appeal on liability but reduced the trial judge’s award to RM6.4 million and substituted the award of compound interest with simple interest. The Court of Appeal upheld the High Court’s finding on liability on the basis that DSK had made use of trust information belonging to SF.
The Federal Court found that DSK was in breach of his fiduciary duty to his principal, SF, and that a conflict of interest had arisen when he applied for the special timber licence of the Wallace Bay area without informed consent from SF. The court confirmed that a trustee must disgorge the entirety of any profit made in breach of fiduciary duty.
Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd and Another Appeal [2018] 2 MLJ 177
Decided cases also provide guidance on what it means to act in good faith and in the best interest of the company. The Federal Court in the recent case of Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd and Another Appeal [2018] 2 MLJ 177 applied both subjective and objective tests simultaneously to assess the director’s duties and responsibilities depending on the different company cultures and company policies. The Federal Court emphasised that the subjective test depends on what a director considers to be an act done in good faith and in the interest of the company, and not what a court may consider as being in the best interest of a company. The court’s assessment would come in the form of an objective test whereby the court would examine the director’s subjective assessment of what the director considers as being an act done in the best interest of the company.
The case of the Tengku Dato’ Ibrahim Petra involved two appeals against the respondent company, Petra Perdana Berhad. The dispute was based on whether the appellants, former directors of the company, had acted in the best interest of the company when divesting shares in Petra Energy Bhd (PEB). The company had sued the appellants and four others, alleging that they had acted in breach of their statutory duties and conspired to injure the company, causing loss and damage. The appellants argued that they had acted according to the mandates of the board of directors in the best interests of the company, which included meeting its urgent liquidity needs and alleviating its dire cash flow position. The High Court dismissed the company’s claim, but the Court of Appeal allowed the appeal against the appellants. The Court of Appeal held that the second and third divestments were not bona fide in the best interests of the company. The Federal Court allowed the appeal by three former directors and set aside the findings of the Court of Appeal.
The Federal Court found that the former directors had acted in good faith and in the best interests of the company when they sold PEB shares to address liquidity problems. The reasons for the sale were genuine, and there was no evidence of personal gain or ulterior motives. The board of directors considered all options and concluded that the sale of the PEB shares was the only way to resolve the cash flow problem. The disposal price of the shares under the third divestment was higher than the mandated price and the market price, and fell within the valuation range of the fairness consideration report procured by DSK before affecting the sale.
The Federal Court’s comments in the Engku Petra case highlight that a director’s actions should be reasonable and compared to those of other directors. The Court will objectively assess if the directors are acting reasonably and in good faith. A director must act in the best interests of the company and ensure their decisions are reasonable. Good faith alone is not enough; the court must assess reasonableness. If a director acts in good faith and makes reasonable decisions in the best interests of the company, they will likely not breach their fiduciary duties.
Other Statutory Duties
Reliance on information provided by others
Section 215 of the Companies Act 2016 allows directors to rely on information provided by others when making decisions, including advice, opinions, reports or statements. Directors may rely on information provided by company officers, professionals or experts, other directors or committees. This reliance is considered reasonable if it is made in good faith and after the director has made an independent assessment of the information, taking into account the complexity of the company’s structure and operations. This provision protects directors who make decisions based on information provided by others, as long as they act in good faith and exercise their own judgement.
Prohibition against improper use of property and position
Section 218 of the Companies Act 2016 prohibits a director or officer of a company from using the property of the company, information acquired by virtue of their position, their position as a director or officer, any opportunity of the company, or engaging in business in competition with the company, to benefit themselves or harm the company, without the consent or ratification of a general meeting. This provision aims to prevent directors and officers from using their positions for personal gain at the expense of the company.
General duty to make disclosure
Section 219 of the Malaysian Companies Act 2016 requires directors to give written notice to their company when they acquire or dispose of shares, debentures, or contracts in the company, or if there is any change in the information previously provided. The purpose of this requirement is to ensure transparency and accountability in the management of the company and to protect the interests of shareholders
Duty to avoid a conflict of interest
Section 221 of the Companies Act 2016 requires directors to disclose any interest they have in a contract or proposed contract with the company, either directly or indirectly. They must declare the nature of their interest at a board meeting as soon as possible after becoming aware of the facts.
Section 222 of the Companies Act 2016 sets out the rules regarding a director’s participation in contracts where they have an interest, whether directly or indirectly. If a director is interested in a contract, they must disclose their interest and cannot participate in any discussion or vote on the contract. However, there are exceptions for private companies and contracts involving indemnity or a director’s interest in another company.
Duty for accounts to be kept
Section 245 of the Companies Act 2016 requires companies and their directors and managers to maintain proper accounting and other records that explain the financial position and transactions of the company. The records must be kept in a way that allows for easy auditing and must be retained for at least seven years after the transactions or operations have been completed. These records must be kept at the company’s registered office or a place chosen by the directors but must be available for inspection by the directors.
Breach of director’s duties and penalties
A director who breaches his or her duties to the company can be held liable for damages. The company or its shareholders may bring a civil lawsuit against the director seeking monetary compensation for any losses suffered as a result of the director’s breach. In addition, the director may also be required to compensate any third parties who have suffered loss as a result of the breach. The sum of damages awarded will depend on the nature and extent of the breach and the losses suffered.
Section 347 of the Companies Act 2016 provides an avenue for shareholders to initiate a derivative action against a director who has breached his or her duties. This action is brought on behalf of the company rather than the shareholders themselves, as the company is the entity that has been harmed by the director’s breach. The purpose of Section 347 is to provide a means for shareholders to hold directors accountable for breaches of their duties, even if the company’s management is unwilling or unable to do so.
A director can also be arrested, charged and convicted for breaching his or her duties as set out in the Companies Act 2016. For example, a director who contravenes Sections 213, 219(1), 221 or 222 commits an offence and upon conviction may be liable to a fine of RM3 million or 5 years imprisonment.
Conclusion
Directors need to know what their duties are because they play a critical role in the effective management and operation of a company. They are responsible for making important decisions that affect the company and its shareholders, and they must ensure that their actions are legal, ethical, and in the best interest of the company. Understanding their duties and responsibilities helps directors to fulfil their obligations and avoid any potential civil or criminal liabilities. It also helps shareholders to hold directors accountable and ensure that the company is operating responsibly and sustainably.
By Raymond Mah, Aaron Liew and Jazlynn Wong
Note: This article does not constitute legal advice to any specific case. The facts and circumstances of each and every case will differ and therefore will require specific legal advice. Feel free to contact us for complimentary legal consultation.
