FIDUCIARY DUTIES OF DIRECTORS OF COMPANIES
By:
MUHAMMAD
AJMAL
Scholar
for PhD in
The fiduciary duties of directors were first particularized by
common law judges short of any guidance from the formal written law. The fiduciary
duties of directors are continuing to evolve without formal written law.[1]But, modern enactments have
changed the tradition and these duties are being codified. The fiduciary
relationship of the directors is highlighted by good faith, loyalty and trust. The
word “fiduciary” itself originally comes from the Latin fides, meaning
faith.[2] There are dissimilar
situations giving rise to fiduciary duties and the test to weigh them is
subjective. The directors hold a fiduciary relationship qua the company and are
required to exercise power vesting in them for the benefit of the company. When
the need of the company for increase of capital is established, the fact that
in promoting the interest of the company, the directors made use of this need
to promote their own interest as well, their action cannot be dubbed as breach
of trust.[3] Moreover, the directors
are in fiduciary relationship with the company and not with shareholders.[4] The directors of a company
stand in a fiduciary capacity to company concerned.[5] The fiduciary has a duty
not to be in a situation where personal interests and fiduciary duty conflict
e.g. a duty not to be in a situation where their fiduciary duty conflicts with
another fiduciary duty; and a duty not to profit from their fiduciary position
without express knowledge and consent. The fiduciaries must conduct themselves
at a level higher than that trodden by the crowd.[6] The directors owe
fiduciary duties to the company and its shareholders.[7] The fiduciary must treat
all the shareholders fairly whether they are sponsors or the general public.
Moreover, they must discharge their statutory obligations in good faith with
conscientious, fairness, morality and honesty in purpose. When a fiduciary duty
is imposed, equity requires a stricter standard of behavior than the comparable
tortuous duty of care at common law.[8] The corporate executives
are today possessed of immense power which must be regulated not only for the
public good but also for the protection of those whose investments are
involved. The directorships will always be susceptible to abuse. The some
directors will always be faithless to their trust. They can capitalize their
strategic position in the company to serve their own interest.[9]
The first most obvious obligation of persons in fiduciary position
is to act with honesty. The greatest good faith is expected in the discharge of
their duties.[10]
Good faith requires that all their endeavors must be directed to the benefit of
the company. Thus, where a director of a company being also the member of
another company, earned bonuses from the other company by providing some
business facility of his company, he was held liable to account for such
profits although the company had itself lost nothing and also could not have
earned the bonus.[11]
Traditionally, the duties
of directors were non statutory. They were fashioned out essentially from the
common law as developed through the cases. But, company legislations of some
countries including
Similarly, the Company Act
2013 of India has also introduced National Company Law Tribunal which is a
single window institution for corporate justice; National Financial Reporting
Authority (NFRA) with wide powers to recommend, enforce and monitor the
compliance of accounting and auditing standards and Serious Fraud Investigation
Office (SFIO) to investigate corporate frauds and detecting and prosecuting or
recommending for prosecution white-collar crimes/frauds.
Disclosure of Interest by
Director
The disclosure of the interest by
directors is compulsory to avoid any liability under the Companies Ordinance,
1984.[14] Where
a director was aware of the fact that the company’s property was being sold for
less than real value, this was a
breach of the fiduciary duty and since the recipient of the property was aware
of this fact, he became a constructive trustee towards the company for his
gain.[15] Where a director acquires
interest in a running transaction of the company, he should disclose this fact
at the next meeting of the board held after he becomes so interested.[16] The general disclosure of
interest is not enough to save director from vacating office in regard to
transactions mentioned in sections.[17] The company may adopt the
transaction where it is in the interest of the company and thereby waive its
right of rescission.[18] Moreover, there should be
clear and specific allegations of acts creating duty of disclosure, and
violation of that duty should be established. There should be the intention to
defraud the shareholders.[19] There is another codified fiduciary duty of the directors who are
interested in a contract or transaction with the company. They are prohibited
to participate or vote in proceedings in which the subject matter under
consideration is in their interest.[20] Interest means personal interest and not official or other
interest.[21]
When an interested director voted, the proceedings are not thereby invalidated
but only his vote will not be counted.[22] However, non-disclosure
will in all cases render the interested director liable to account for any
secret profit made by him.[23] Where all the directors
are interested, the board cannot pass a resolution at all.[24]
Elements of the Fiduciary
Duty:-
The fiduciary is the person
on whom the fiduciary duty is imposed. Therefore, a fiduciary has a duty not to
be in a situation where personal interests and fiduciary duty conflict; a duty
not to be in a situation where their fiduciary duty conflicts with another
fiduciary duty and not to profit from their fiduciary position without express
knowledge and consent. A fiduciary cannot have a conflict of interest.[25] A fiduciary will be
liable to account if it is proved that the profit, benefit, or gain was
acquired by him in any of these circumstances:-
“A fiduciary's duty must not conflict with another fiduciary duty.
The http://en.wikipedia.org/wiki/Fiduciary - endnote_stewart conflicts between one fiduciary duty
and another fiduciary duty arise most often when a lawyer or an agent such as a
real estate agent represents more than one client and the interests of those
clients conflict. This usually occurs when a lawyer attempts to represent both
the plaintiff and the defendant in the same matter. The rule comes from the
logical conclusion that a fiduciary cannot make the principal's interests at
top priority if he has two principals and their interests are diametrically
opposed and this situation is not acceptable to equity.[26]
A fiduciary must not profit
from the fiduciary position. This includes any benefits or profits which
although unrelated to the fiduciary position, accrued because of an opportunity
the fiduciary position afforded. However, if the principal consents, the
fiduciary may keep the benefit. If this requirement is not met then the
property is deemed by the Court to be held by the fiduciary on constructive
trust for the principal.[27] The directors being
trustees of money on behalf of company could not retain any profit which he had
made as director.[28]
Conflict of Interest and Duty
A fiduciary must not put themselves in a position where their
interest and duty conflict. He must always serve the principal's interests
subjugating his own interest and his state of mind is irrelevant.[29] When, the directors being also directors of its associated
companies did not make a conscious decision due to conflict of interest and
deprived the shareholders from benefits, was termed as breach of fiduciary duty.[30] The directors breached
their fiduciary duty by providing unnecessary benefits to its associated
undertakings where they are major shareholders and thereby acting against the
interest of its shareholders.[31]
Test for Performance of Duty
The test for fiduciary duty
is a subjective one. The directors must act bona
fide in what they consider and not what the Court may consider is
appropriate. D:\AJMAL\CORPORATE LAW\Directors\Board of directors -
Wikipedia, the free encyclopedia.htm - _note-13#_note-13[32] The
directors must act honestly and in good faith. The directors may be held to
have failed in this duty where they fail to direct their minds to the question-
whether in fact a transaction was in the best interests of the company.[33] The directors are not
required by the law to live in an unreal region and to act in the vague mood of
ideal abstraction from obvious facts which must be present to the mind of any
honest and intelligent man when he exercises his powers as a director.[34]
The overall conclusion drawn from the
preceding lines is that the fiduciary duties are natural in characters which
are based upon the equitable doctrine of equity and good conscience and
fairness. Mainly, these fiduciary duties are not codified but recognized by the
law. The directors of the companies are under legal obligation to honor and
fulfill fiduciary duties. The question of fiduciary duties surmounts when there
is conflict of duty and duty, position to extract personal advantages and
conflict of duty and interest. To ascertain the violation of the fiduciary
duties, the Courts normally apply the subjective test i.e. what the director
honestly and intelligently think advantageous and not what the Courts thinks
advantageous.
--------------------
[1] Professor
Bernard S. Black, Stanford Law School,
The Principal Fiduciary Duties of Boards of Directors, Presentation at
Third Asian Roundtable on Corporate Governance Singapore, 4 April 2001
[2] http://en.wikipedia.org/wiki/Fiduciary.
[3]. PLD 1992 SC 276.
[4] 1983 CLC 162.
[5] PLD 1975 Kar. 327.
[6] Mein hard v. Salmon (1928) 164 NE 545 at 546.
[7] In the matter of M/s Kohinoor Power Company
Ltd, Show Cause Notice No. and Date: EMD/233/404/2002-755-61, Dated
28.07.2006.
[8] In the matter of Searle Pakistan Limited, Number
and date of show cause notice EMD/233/596/2002/7456-7463 dated June 15, 2007.
[9] William C. Douglas, “Directors who do not Direct”, (1934) 47 Harv. LR 1305, 1307.
[10] Patel in Bank of Pona v Narayan as, AIR 1961 Bom 252-253.
[11] Boston Deep Sea Fishing and Ice Co v Ansell, (1888) 39 Ch D 339.
[12] Section 217 of the Companies Ordinance, 1984.
[13] PLD 1995 Lah. 264.
[14] Section 214 of the Companies Ordinance, 1984.
[15] AvilingBarford
Ltd v Perion Ltd, 1989 BCLC 626 Ch. D.
[16] (1970) 40 Com Cases 1131 (Ker.).
[17] PLD 1958 Lah. 721.
[18] AIR 1966 SC 170.
[19] (1999)
97 Com Cases 582 (Mad.)
[20] Section 216 of the Companies
Ordinance, 1984.
[21] AIR 1957 Mad. 4.
[22] AIR 1936 Bom.
62.
[23] AIR 1929 Mad. 353.
[24] (1973) 43 Com Cases 225 (Mad.).
[25] Keech v
Sanford [1558-1774] All ER Rep 230.
[26] [1991] 3 NZLR 535.
[27] [1988] 2 Qd R 1.
[28] 1986 MLD 1870.
[29] (1991) 22 NSWLR 189.
[30] Re. Searle Pakistan Limited, Number
and date of show cause EMD/233/596/2002/7456-7463 June 15, 2007.
[31] Ibid.
[32] Re Smith & Fawcett Ltd [1942] Ch 304.
[33] Re W & M Roith Ltd [1967] 1 WLR 432.
[34] Mills v Mills (1938) 60 CLR 150.