Directors duties and their corporate liabilities

Directors’ duties are now partially codified in terms of the Act. The old Companies Act of 1973 did not tabulate the directors’ duties and merely contained statutory duties which were largely regulated by the Common law and codes of best practice, like the King report on Corporate Governance.

The Common law position was mainly derived from case law which subjected the directors to certain fiduciary duties to act in good faith and in the best interest of the company and the duty to exercise their powers with care and skill.

The new Companies Act 71 of 2008 has partially codified the directors` duties which include similar duties to the Common law duties. The main advantage of codifying directors` duties is that it will enable directors to clearly identify the scope of their duties.

One of the main disadvantages of codification of directors’ duties is therefore the lack of flexibility. The role of the Common law has not been totally diminished by the new Companies legislation and will still be applicable. This will therefore ensure that directors’ duties are still flexible.

In the case of Ghersi v Tiber Developments (PTY) Ltd 2007 (4) SA 537 (SCA), the Court held that the ambit of the duty can change from time to time.

In Phillips v Fieldstone Africa (PTY) Ltd 2004(3) SA 465(SCA), the Court held that the existence of a fiduciary duty and its nature and extent are questions of fact to be adduced from a thorough consideration of the substance of the relationship and any relevant circumstances which affect the operation of that relationship.

Section 76 of the Companies Act 71 of 2008 addresses the standard of conduct expected from directors and extends it beyond the Common law duty of directors by compelling them to act honestly, in good faith and in a manner they reasonably believe to be in the best interest of, and for the benefit of their companies.

Section 76(3) of the Act states that a director of a company, when acting in that capacity, must exercise the powers and perform the functions of a director. In good faith and for a proper purpose, in the best interest of the company and with the degree of care; skill and diligence that may reasonably be expected of a person carrying out the same functions in relation to the company as carried out by that director and having the general knowledge; skill and experience of that director.

Section 76(4) of the Act states that in respect of any matter arising in the exercise of the powers or the performance of the functions of a director; a director will have satisfied the obligations in Section 76(3) of the Act; if the director has taken reasonably diligent steps to become informed about the matter; has made a decision or supported the decision of a committee or the board with regard to that matter and had a rational basis for believing and did believe that the decision was in the best interest of the company.

In further compliance with this Section, the director is required to communicate to the board, at the earliest practicable opportunity, any material information that comes to his or her attention, unless he or she reasonably believes that the information is publicly available or known to the other directors or is bound by a legal or ethical obligation of confidentiality.

Board Committees have the full authority of the board in respect of the matters referred to them and may consult with or receive advice from any person.

However, the creation of any committee and the delegation of any power do not by themselves satisfy or constitute compliance by a director with his or her duties as a director.

The personal liability of South African directors is an emotive and important issue. Directors need to be aware of the circumstances in which they can be held personally liable for the debts of a company should it be placed into liquidation.

Section 424(1) of the old Companies Act has been replaced by Section 77 of the Companies Act of 71 of 2008 which, while worded differently, retains the essence of the old Section 424.

Section 77 as read with Section 22 of the Act, penalises and holds directors personally liable for any loss incurred through knowingly carrying on the business of the company recklessly or with intent to defraud creditors and other stakeholders.

In terms of Section 77(2) (a), of the Companies Act of 2008, a director of a company may be held liable in accordance with the principles of the Common law relating to the breach of a fiduciary duty, for any loss, damages or costs sustained by the company as a consequence of any breach by the director of duties contemplated in Section 76.

Section 77(3) states that any director of a company is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director being party to an act or omission by the company despite knowing that the act or omission was calculated to defraud a company creditor, employee or shareholder, or had another fraudulent purpose.

Therefore liability in terms of Section77 is joint and several and includes also restoration of any amount improperly paid by the company and not recoverable in terms of the Act. However, the director can apply to Court for an order setting aside the transaction

In terms of Section 75 of the Act, a director is required to disclose any personal financial interest in any agreement or other matter of the company to the shareholders and must obtain their prior approval by an ordinary resolution before entering into an agreement.

At Common law the rule is that unless a director cannot have an interest in a contract with the company, whether direct or indirect, unless the company in general meeting approves the contract after disclosure to it of his interest.

The basis of the rule is the consequence of the fiduciary relationship between the director and the company, namely that any situation of a conflict between interest and duty is to be avoided.

The position under the Common law was changed, as in Section 75(7) (a); the section provides that the board has to approve the transaction or agreement, except where the director is the only director but not the only shareholder.

Section 75(7) (b) further provides that despite having been approved without disclosure of that interest, it
i. has subsequently been ratified by an ordinary resolution of the shareholders following disclosure of that interest or;
ii. has been declared to be valid by a Court in terms of subsection (8).

In coming to the present case Mashudu, as the only director who had personal interest in Vhathu CC and having failed to disclose same can also enjoin the provisions of Section 75(7) (b) of the Act.

In a situation where Mashudu has failed to comply with the disclosure requirements as stipulated in Section 75 of Companies Act 2008, the Act provides that any interested person has the right to make an application to Court for an order declaring the transaction or agreement valid.

Therefore Section 75 provides for two different situations with regard to the disclosure of personal financial interest. A prior approval will have to be obtained in a situation where Mashudu is the only director not the shareholder.

In some other cases the disclosure of personal financial interest must be made to the board of directors, the said disclosure must be made in a form of written notice to the board or the shareholders in advance. The aforesaid notice must explain the nature and extent of the interest.

There are defences that are also available to the directors, which Mashudu can also utilise to his benefit.

The Companies Act of 2008 makes a provision for the directors to raise “honest or reasonable” behaviour on their part.

Section 77(a) states that in any proceedings against a director, other than for a wilful misconduct or wilful breach of trust, the Court may relieve the director, either wholly or in part, from any liability set out in this section or on any other terms the Court considers just; if it appears to the Court that the director has acted honestly and reasonably; or having regard to all circumstances of the case;

including those connected with the appointment of the director, it would under circumstances be fair to excuse the director. This then is equivalent to the business Judgement rule.

The business is about taking risk for reward and in doing so, directors whether executive or non-executive are required to exercise their Judgement as to the best decisions or courses of action available to a company. However, sometimes even the best laid plans fail; and in such instances, the assessment of the appropriateness of the decisions taken by the directors is not based solely on the manner in which the decision turned out, but is also based on the process that the directors followed in arriving at their decision.

The business Judgement rule has been welcomed by many as the key form of protection for directors and allows them to make informed judgements without the threat of liability hanging over their heads and seeks to protect directors from liability to the company and shareholders as a result of poor decision making.

The rule contained within South African law is considered to be broader than the equivalent rule in other countries, as it is not limited to the judgements made by the directors but instead applies to all decisions that a director may take as it is related to the performance of his or her powers and functions

It is critical to note that the business Judgement rule can only be utilised if all of the requirements discussed above, as set out in the Act, have been complied with.

In addition, the director, prescribed officer or committee member must have been acting in furtherance of a lawful and legitimate corporate purpose.