The Board of Directors

Published 29 Jul 2016

By way of summary, this case pertains to a managing director who is at the same time the Chairman of the Board of Directors of North Ltd. He was approached by South Ltd which expressed its interest to purchase property owned by North Ltd. He then persuaded the other directors of his own company, North Ltd. to enter into a contract of sale of a piece of land with the said company, South Ltd.

As a result of this transaction, Zac, the managing director of the said company received a commission. He later revealed that he received the commission from the transaction to the other directors. Eventually, the majority shareholder discovered that the land sold was developed by South and was later sold to another company for a higher price.

This essay aims to shed light on the duties which the Board of Director of a company owes to his company. Specifically, this essay will deal with the repercussions when a director becomes interested with a contract entered into by his own company with another company. A discussion will also be made on the right of action which the law grants a stockholder in case the directors violate their fiduciary duties to the corporation.

A company or a corporation is only an artificial being created by mere operation of law. It can only act through its representatives – the board of directors who are elected and chosen by the shareholders. As the representatives of the company, the Board of Directors of a corporation are vested with the authority to exercise corporate powers, conduct all business and control and hold all properties of the corporation. The supreme authority insofar as the management of the business regular and ordinary affairs of the corporation is vested with the Board of Directors. Thus, the board of directors of the corporation is responsible for the overall direction and management of the corporation. In this case, it is within the power of Zac, as the managing director of the company and the chairman of the board of directors, to enter into transaction with another company provided that the decision was made at a meeting duly called for that purpose and that the decision was with the consent of the stockholders.

Section 229 – of the Companies Act clearly states that “an officer of a corporation shall at all times act honestly in the exercise of his powers and the discharge of the duties of his office”.Directors act as fiduciaries to the corporation, and once elected they must serve the best interests of the corporation and the shareholders. A fiduciary is one who owes to another the duties of good faith, trust, confidence, and candor or one who must exercise a high standard of care in managing another’s money or property. This fiduciary duty arises out of the board’s fiduciary relationship with the corporation and shareholders.

The following are the three-fold duties of a director: the duty of obedience; duty of diligence and duty of loyalty.

Duty of Loyalty

The duty of loyalty is the consequence of the fiduciary relationship existing between the directors of the corporation and the corporation and the directors of the corporation and its stockholders. As fiduciaries, they are expected to act with utmost candor and fair dealing for the interest of the corporation and without the taint of selfish motives. The directors of the corporation are expected to first serve the interest of the corporation and their interest later. They are enjoined not to manipulate the affairs of the corporation to the detriment and disregard of the standards of morality and decency. As corporate insiders, the directors cannot utilize any inside information they have acquired for their own benefit. Further, as directors of the corporation, they are not allowed to obtain any personal profit, commissions, bonus or gain for their official actions. Lastly, a director is prohibited from seizing any business opportunity or developing it at the expense and with the facilities of the corporation. Thus, the duty of loyalty requires a fiduciary to act in the best interests of the corporation and in good faith.

The easiest way to comply with this duty is not to engage in any transactions that will involve the conflict of interest. The transaction is “self-dealing transactions.” The theory here is that when a board of director deals with his own corporation, the resulting agreement is always not favorable to the company. Two competing interests are at stake every time a board of director deals with his own company. On one hand, the board of director desires to profit from the transaction as an individual. On the other hand, the corporation desires likewise to profit from the transaction. In this case, Zac, knowing that he will be entitled to the commission for the transaction, successfully persuaded the members of the Board of Directors to sell the company property to South Ltd. Zac cannot be the slave of his two masters: the corporation and himself.

As a board of director, Zac violated the foremost duty of loyalty to his own company. As fiduciaries, Zac should not place himself in a situation where his own interest and duties conflict with the duties that he owes to the company. In the case of Aberdeen Ry v. Blaikie (1854), it was held that the board of director must give utmost priority to the interest of the company, to wit:

“A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting or which possibly may conflict, with the interests of those whom he is bound to protect… So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of the contract entered into…”

Duty of Obedience

The duty of obedience mandates that every director of the corporation must do and perform only those acts designed to achieve its mission. The director must constantly check whether his action is within the scope of his authority and in pursuance of the goals of the company as indicated in its articles of incorporation. Further, obedience does not only mean compliance with the rules of the corporation but it also means informing the corporation of any act done in violation of the rules of the corporation.

The duty of disclosure mandates that the board of director discloses the facts and circumstances surrounding a particular transaction.In this case, as a fiduciary, Zac should have disclosed to the members of the Board and to the shareholders the particulars surrounding the transaction, including his commission of 50,000. The purpose of the disclosure is clear and manifest. It seeks to ensure that the voting for a particular company decision is based on an informed decision. If despite the knowledge that one of the boards of directors will receive the commission for this particular transaction they still gave their acquiescence to the contract then the contract is valid and enforceable. In this case, Zac did not reveal before the members of the board and to Vince that he will receive the commission for the transaction. He only informed the other members of the board that he received the commission for the transaction after the contract of sale was completed. It is clear that Zac violated his duty of disclosure which renders the contract voidable. This duty requiring the directors to disclose in a meeting their interest in a particular transaction is affirmed by Section 228 of the Companies Act of 1985, to wit:

“An interest of a director in a transaction with his company can make the transaction voidable at the election of the company unless:the company in general meeting or all the members informally authorize or affirm the transaction after being fully informed, or the rights of innocent third parties have intervened.”

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