Introduction
I will give everyday or common type of issues which arise in companies and how directors deal with them.
When company issues arise, quite often the focus is on how to deal with it - and - forgetting the concept of fiduciary duties.
This is common because businessmen think commercially. There is a problem or issue, solve it and let's think on how to make money.
But the problem is, this concept of fiduciary duty which always existed will come to bite back later if the matter goes to Court.
What does fiduciary duty mean?
What does fiduciary duty mean?
Broadly it means as a Director you need to act for the best interest of the company, honestly and reasonably.
A. Getting Rid of a Business Partner
Let's take an example. Quite often a company is set up with a business idea amongst 2 or 3 friends.
They then start up a Sdn Bhd company with the same 3 friends becoming business partners as being the 3 shareholders having 33% each and 3 directors.
The 3 friends will say for major decisions we came as 3 persons then all 3 must decide unanimously OR whoever has 75% wins. They build the company and the company takes off. When all goes well, all making money, they will leave all the paper work to the Company Secretary.
Now along the way, there will be disagreements between the 3 persons.
2 gang up against the 1. But can't get rid of him because must decision of all 3 or 75%. Problem is even with 2 shareholders ganging up on the 1, it is only 66% against 33%.
So what normally happens, the 2 being the majority, gets the Company to issue new shares to increase their shareholding and thereby diluting the 1 person's shareholding. The 2 then get rid of the 1 partner. The 2 will say, yes it is provided by the Articles, M&A. So nothing wrong. We got the shares and we voted him out of his directorship. Courts said cannot do this and will declare the issuance of the shares as invalid and whatever decisions the 2 makes are invalid - Howard Smith [1974] AC 84. WHY?
Rationale is Directors must act honestly and reasonably and not act out of spite.
B. Minority Shareholders going after Directors even though the Directors Control The Board of Directors and are the majority shareholders
Next I highlight how a minority shareholder can sue the directors personally by using the company's own name to sue the directors even though the directors are in control of the company and the directors also happen to be the majority shareholders.
Quick recap - shareholders are the owners of the company whilst directors are the agents of the company. A shareholder can decide and vote whichever way he wants. BUT a director, who is actually a trustee for the company according to our Federal Court in PJTV Denson [1980] 2 MLJ must act honestly and reasonably.
Now a minority shareholder who owns 1 share only in the company and does not sit on the board OR where a former owner of the company who used to sit on the board but has now left the board and is only a minority shareholder, alleges that the directors who are also majority shareholders are committing fraud and made some undisclosed profit basically whacking the company's money. WHO is there to stop them?
After all, they are the majority shareholders and they sit on the Board of Directors. In such situations what happens? Most lawyers will tell you, go for Minority Oppression, wind the company up. They forget one thing, the minute the Winding Up Minority Oppression is filed, then a whole load of things can happen. Accounts get frozen, PL gets appointed. The investments get paralyzed. PL or Liquidators come in this country most times, there are of course exceptions, they will strip the company dry and at the end of day, the minority and majority will not get anything, probably very little.
All that happens, is the PL make money from the Company and quite a lot of money. It does NOT serve the bigger purpose or any purpose to anyone. WHY do you want to wind up a perfectly money making company.
You want to get a result i.e. a substantive result with money and not some paper judgment.
BUT you have an obstacle. You are alleging some funny business have taken place and that the majority have not disclosed the profit. The right person who should sue is the company against the company's agents i.e. because directors are only agents of the company.
The problem is, these fellows who have done all this problems also run the company. You can tell the company to sue. The company is run by the same people, will say no. They are not going to get the company to sue themselves.
SO WHAT you can do is file a Court Action called the Derivative Action. This concept was actually derived from America and has been applied in a lot of the Commonwealth countries including Malaysia whereby the minority shareholder can sue using the company's name to sue the directors personally - Abdul Rahim v. Krubong [1995] 3 MLJ.
Rationale: SO AS DIRECTORS EVEN THOUGH YOU ARE CONTROLLING THE COMPANY, YOU STILL HAVE THE FIDUCIARY OBLIGATION RATHER THAN RUNNING THE COMPANY LIKE A MILITARY JUNTA DICTATOR. In fact the shareholder can sue the directors personally as well in a Personal Action in Company Law - Prudential Assurance Case [1982] 2 ChD.
C. Directors' Way To Avoid Facing an Annoying Shareholder
There are times where an EGM or AGM is held, the directors will face the questions from the shareholder.
Then there is an annoying shareholder who year in year out asks all types of unreasonable questions.
So normally what happens, no notice is sent to the annoying shareholder on the date of the meeting so that he won't know the date of the meeting so that the meeting can proceed smoothly and the directors get their way. After all it makes no difference at the end result because he is only a minority shareholder and he is going to lose anyway. Whichever way he decides, the majority rules, whether he votes or not.
All the resolutions you passed on that day are fantastic resolutions. All benefits from the company i.e. employees, directors, shareholders, creditors and the company itself.
In such situations that particular shareholder can bring a Court Case against the Company to declare the resolutions invalid.
You know what is the Court will rule in his favour because the Courts have said that this is not an issue whether he votes one or not. It is his right to attend and his right to vote whether for or against. The right to vote is fundamental to his membership. The net result, regardless what the majority directors voted on that day and it may have been good resolutions, it turns out to be invalid.
So the rationale is as directors there is a fiduciary duty to act fairly regardless whether you like or dislike that particular shareholder. So do the right thing, send the notice to him and defeat him on majority ruling.
D. Duty To Creditors
Previously it is thought, that as long as the directors make disclosure to the Board and the Shareholders and the Board and Shareholders gives their approval, that's it. Their directors' fiduciaries duties are done. Nobody can question them.
That's what most people tell you. Don't worry Board approves. Shareholders - everything done deal. Not so. Company law has actually developed to include Directors' fiduciary duties include duties owed to creditors as well.
These happens usually involving companies within a group. Say 1 company is having problems, there are plenty of creditors and debts but the company has got very good assets sometimes includes licences as well. So before any winding up takes place or the company realizes it is heading to problems.
To save the company, what that company does is siphon-out the assets of that company to an associated company. All in the same group. Nothing to worry. Left pocket to the right pocket.
Problem is there is a breach of fiduciary duties to the creditors. Rationale is this.
The creditors - when they first time traded with you, it is because various reasons, the management, the people and the assets or licencing you have especially the assets. People tend to invest or trust companies who are strong asset based. They will feel safe. It is like a form of security.
BUT when that comfort zone is taken away, the creditors can file an action against the directors personally and also to declare the arrangements void - Multinational Gas Petrochemical Case [1988] 4 BCC 30.
HERE most times such arrangements takes place after winding up petition is filed or after the winding order takes place.
Whatever the arrangement that takes place, such arrangements are void because:
- if arrangements are made while the winding up petition is pending but before the winding order, then it is void under Section 223 Companies Act;
- if someone tells you, back date your arrangements before the winding up petition is filed so as to show genuine business transaction. That too won't work. The Courts have held in Sime Diamond Leasing [1997] 2 CLJ, any transaction or arrangements to dispose of the company's assets 6 months before the filing of the winding petition, then such arrangements are void. Have to go back to status quo;
- after this presentation, some were to say, alright, since 6 months is the cut-off point, then I will back date, 1 or 2 years back. You will still have problems. Because a smart lawyer will get the Court to ask for a Court Order call the Equitable Tracing Order. This Equitable Tracing Order is so powerful, if argued properly and if obtained, that person can go into company and search everything. It can easily trace when the person signed the agreement. Was the persons for both parties in the country when the so called agreement was signed. Then there is a stamp duty. The stamp duty franking will tell you when it was signed. If you say that it is only now it was stamped on grounds you forgot or your secretary left it in the drawer, then what about the late payment penalty for stamping. These are evidence or strong inferences to show that such arrangements are actually to defraud the creditors. In fact such arrangements ends up whether knowingly or unknowingly ends avoiding paying tax. Such arrangements according to the Thoong's Case [1995] CLJ will be declared void.
E. Incorporation Of Waiver Clauses
There has been a trend, where a company is doing well but wants to do better. Wants to diversify. The owners & directors of the company, their forte and skill is a particular area. So what they do, is look for directors to run the new diversified company.
The new directors whether they are salaried or not especially the foreigner will demand that the new diversified company has an additional clause in our normal M&A which exempts the director for negligence, breach of duties or breach of trust.
Do not worry about such clauses. Such clauses are void - Motivex Case [1986] BCC 99. Whether you put that clause or not, the law will impose on the director fiduciary duties and that directors are liable like the rest of the directors.
F. Shadow Directors / Nominees
A Case is brought against you. You say on record on ROC documents you are never a shareholder of the company and never a director of the company and therefore the claim against you should be struck off.
And it is not disputed that your name does not appear in the company statutory forms of the company as a director or shareholder.
If it can be shown that you represented to people and held out that you had control of the company's shares and can be shown you are actually running the show and that the rest of the directors act in accordance with your directions and instructions, then you are a Shadow Director. This particular individual is in actuality a puppeteer. He pulls the strings and his puppets on the board dance. In such situations the Court will investigate and this matter will go to full trial unless the case gets settled. This exactly what happened in Omega Holdings Bhd v. Dato' Tiah Tee Kian & Ors [2002] 7 CLJ 125.
In fact in such situations not only the Shadow Director be sued but also a Nominee director can be sued.
For a Nominee Director, it is NO answer or excuse to say that 'Hey I am just a nominee. I am only taking a nominal amount. The decisions are all taken by the rest of the directors.'
The law will respond by saying - TOO BAD. The full fiduciary duties will attach to the Nominee Directors as well as the Directors on records and as well as the Shadow Director.
G. TRUST
Shares can be held on Trust.
When Shares are put for registration, the Directors will have to decide whether to register or refuse the registration.
Disclosure should be made who is the beneficiary and who is the Trustee holding the Shares.
The question for the Directors is for what purpose is the Shares held on Trust?
If an arrangement is done to avoid paying tax, avoid approvals or avoid certain laws or avoid detection from authorities then such arrangements are void. Then in such situations then the Directors are in breach of their fiduciary duty because they are not acting honestly and reasonably. Courts will tear down such arrangements and declare it void as done in Aik Ming's Case. The loss falls where it lies meaning the person who is the Trustee, ends owning the Shares. Then the beneficiary will start suing the directors.
BUT if it is for a Genuine purpose say for example, the Shares are held on Trust because the beneficiary is only a small child. Then such arrangements are valid.
It is only if it is for a sinister purpose, then such arrangement will be declared void and the directors will be in trouble.
Conclusion
With that, I wish all of you the best in being Directors. Thank you
Advocate & Solicitor