The Development of Directors’ Duties of Skill,

Care & Diligence. UUUK 6265, Advance Company Law

Siti Fairuz Nor Azhar (P73969)

Contents

1.Introduction

2.Background

3.Directors : Development of its duties

4.Conclusion

Contents

1.Introduction

2.Background

3.Directors : Development of its duties

4.Conclusion

Introduction <Why choose this topic?>

Interesting because in my opinion, directors, especially the from the private sectors, specifically expatriates directors or directors from small company, tends to overlook the importance of recognizing the statutory requirements required of them.

<Objective>

To identify the standards and the degree of skill, care and diligence that is required of a director.

<Purpose>

1. The understand the linkage between the principles of corporate governance and the directors’ duties.

2. To see the development and changes that took place in section 132 of the Malaysian Companies Act 1965.

<Target>

To achieve the above objective and target, we need to see the historical developments of the concept of the duties of the directors.

Contents

1.Introduction

2.Background

3.Directors : Development of its duties

4.Conclusion

Background

1. The concept of Corporate Governance:- Dennis & McConnell, 2003 : “a set of mechanism to ensure that outside investors get a fair return of their investment.”

Carlson, 2001 : “Good corporate governance exists when they address two important integral aspects of corporate governance, i.e; accountability & business prosperity.

2. The elements in Corporate Governance:- Independence of the Directors and the Board of Directors as the caretaker of the interest of the shareholders and other stakeholders; Accountability:- those that hold the controlling power of the company should be made accountable towards protecting the shareholders and other stakeholders interest. Roles & responsibility:- the directors need to understand the roles and responsibility in order to make the right decisions in the best interest of the company. Integrity & ethical behavior:- the legal & ethical norms should act as a guide for establishing & maintaining stakeholders relationships between responsible and irresponsible notion of profit seeking. Transparency:- good corporate governance should ensure that timely & accurate disclosure is made so as to make relevant information easily accessible by the shareholders.

Sample of Corporate Governance Model

Corporate Governance

Accountability

Effectiveness

Shareholders

Board

Company

Stakeholders

Assurance

Assurance*source: Corporate Governance Insight, KPMG, 2001

Aspiration: that good corporate governance can be achieved via synergistic nexus between the board of directors, management, shareholders and other stakeholders such as employees, customers, creditors and the community.

Sample of CG structure in HMSB

CEO

HEAD OF DIVISION

HEAD OF DIVISION

HEAD OF DIVISION

HEAD OF DEPARTMENT

HEAD OF DEPARTMENT

HEAD OF DEPARTMENT

OPERATIONOPERATION OPERATION

ⓆDo you think this easy governance structure can lead the company’s operation to be efficient, fair and transparent?

Absolutely Not!!

Sample of CG structure in HMSB

CEO & MD

HEAD OF DIVISION

HEAD OF DIVISION

HEAD OF DIVISION

HEAD OF DEPARTMENT

HEAD OF DEPARTMENT

HEAD OF DEPARTMENT

OPERATIONOPERATION OPERATION

DIVISION REPORT

CHECKLIST

DIVISION REPORT

CHECKLIST CHECKLIST

DIVISION REPORT

CODE OF CONDUCT

HCG SECRETARIATCOMPANY REPORT

COMPLIANCE OFFICER

BUSINESS ETHICS COMMITTEE

ETHICS PROPOSAL LINE

REGIONAL AUDIT

Corporate Governance is about alignment of the shareholders’, the board of directors and the management interests, also taking into consideration of the stakeholders’ rights in the company. It is encourage that the shareholders and the board members engage in frequent dialogue about CG on frequent basis so that the interest of the company is well taken care of.

Contents

1.Introduction

2.Background

3.Directors : Development of its duties

4.Conclusion

Malaysian Code of Corporate Governance

1996:- The ROC (now

CCM) had introduced a

Code of Ethics for directors

1995:- Securities

Commission started disclosure requirement for primary & public listed companies

1993:- The Securities

Commission Act & Future Industry

Act was introduced

1989:- The Banking &

Financial Institution Act

was introduced

2000:- The Malaysian

Code of Corporate

Governance was first issued

1999:- The High Level

Finance Committee released 70

recommendations about CG

practices in M’sia

2012:- Malaysian Code

of Corporate Governance was

updated

2007:- The C/A 1965 was amended and the revised Malaysian

Code of Corporate

Governance was issued

1998:- The

establishment of National

Economic Action Council & the

High Level Finance

Committee

1997:- The Financial

Crisis & financial fraud activities

2003:- CCM announced

to amend the C/A 1965 & formed Corporate Law

Reform Committee

Malaysian Code of Corporate Governance

Malaysian Code of Corporate

Governance

Part IContains 13 principles

of good corporate governance

▪ Board of Directors ▪ Directors’ Remuneration ▪ Shareholders ▪ Accountability & Audit

Part II Contains 33 Best

Practices for Company

▪ Board of Directors ▪ Accountability & Audit▪ Relationship with shareholder

Part IIIExhortations to other

participants

Its addressed to investors, especially to

institutional shareholders and auditors

Part IVContains Explanatory

Notes & mere best practices

Provides explanatory notes to Part 1-3

2000:- the MCGG was first issued → 2007:- the MYCG was revised to strengthen the roles and responsibilities of the Board of directors, audit committee and internal audit function → 2012:- the MYCG focuses on strengthening board structure and composition recognizing the role of directors as active & responsible fiduciaries.

In A Nutshell: Directors’ Roles & Responsibilities

Before appointment After Appointment & During tenure After resignation or disqualification

1. Appointment committee

2. Remuneration Committee

3. Appointment as director

4. Induction or training for the new director

5. Director obligations:-

a) Understand;

b) Meet the expectations;

c) Review and strategic planning

6. Think critically

7. Ask questions:- a) To whom I owed my duties? b) What is the duty of skill and care? c) What is the duty of good faith; d) How much can I delegate and rely on others? e) What is the business judgment rule? f) What is position of conflict of interest and insider trading? g) What must I disclose? h) What must I do to make sure I comply with the statutory

requirements?

8. Understand the potential liability under other acts @ risk management and internal controls.

9. Special circumstances:- a) What is the position if the company is insolvent? b) What is the position that is designated with take overs? c) To whom should I notify first if company is near insolvent? d) What is my defense? e) In what situations will the corporate veil be lifted?

10. Is there insurance to cover me?

11. What situations justify disqualification?

12. How do I resign?

13. Will I still be liable after disqualified or after resigned?

Before appointment

After appointment On going duties

Self Defense for Directors

DIRECTORS’ DUTIES

Fiduciary duties of loyalty and good faith Care, skill and diligence

Duty to act bona

fide in interest of the

company

Duty to use

powers for proper purpose

Duty not to fetter

discretions

Duty to avoid

actual and potential conflict of

interest

Duty to ensure

integrity of financial

information

Directors’ Duties under the Common Law

DIRECTORS’ DUTIES

Fiduciary duties of loyalty and good faith Care, skill and diligence

Duty to act bona

fide in interest of

the company

Duty to use powers for

proper purpose

Duty not to fetter

discretions

Duty to avoid actual

and potential conflict of

interest

Duty to ensure integrity of

financial information

S.132(1):- Duty to act for proper purposes

and in good faith

S.132E:-Related

party transactions

S.132(2):-Duty not to misuse

property, information, opportunity or competing with

company

S.131(1), S.131A, S.134 & S.135 :-

Disclosure of interest in contracts, property,

offices

S.132(1A):-Duty to use care and reasonable diligence

subject to business rule (S.132(1B)) and reliance

on others (S.132(1C).

Directors’ Duties under the Companies Act 1965

Problem Analysis Situation Analysis:-

1.In Re Cardiff Savings Bank, Marquis of Bute’s Case (1892) 2 Ch 100:- The Marquis De Bute assumed office replacing his late father as President at the age of 6 months old. Under the Bank’s constitution, the bank is managed by the president and the managers. But in reality, the bank is managed by bank officials. One of the bank officials committed fraud which resulted in the bank failure. The Marquis was 39 years old at that time and he only attended one meeting once. The liquidators brought an action against the Marquis for neglect of his duties as president of the bank. Court held: The Marquis took no part in the conduct of the business by the bank & therefore, cannot be made responsible for the loss suffered by the bank.

2.In Re Brazilian Rubber Plantations and Estate Ltd. (1911) 1 Ch 425:- Neville Judge states that: “for a director, the degree of care that he has to have or the reasonable care that he is required to practice is to be “measured by the care of an ordinary man might be expected to take in the circumstances on his own behalf.”

Problem Analysis:- 1. A director that is not involved in the operation of the business can simply be excused from liable based on the

above principle, hence what about the rights of the shareholders or the creditors and what about their protection?

2. Basic rule is that directors are answerable to the shareholders and the company, can they simply deny liability for the negligence?

3. Is the above standard of care i.e.; “of an ordinary man” suitable to be applied in the developing company principles and law (which is becoming more and more complex and multi-disciplinary?)

In A Nutshell : The Development of the standards

The Subjectivity Test The Objectivity Test The objectivity and subjectivity test 1. In Re City Equitable Fire

Insurance Co. Ltd (1925):- a) A director need not exhibit ,

in the performance of his duties, a greater degree of skill than may be reasonable expected from a person of his knowledge and experience.

b) A director is not required to give continuous attention to the affairs of the company and his duty arise intermittently while performing his functions at board meeting.

c) A director is entitled to delegate his duties. In the absence of grounds of suspicion, the director is justified in trusting the official (to whom his duties were delegated) to perform such duties honestly.

2. In Dorchester Finance Co. Ltd v Stebbing (1989):- applied the subjectivity test and found the directors negligent.

1. In Re D’Jan (1994):- The duty of care owed at common law is accurately stated in s.214 (4) of the Insolvency Act A986. It is the conduct of a reasonable diligent person having both:- a) The general knowledge, skill and

experience that may be reasonable expected of a person carrying out the same functions as are carried by that director in relation to the company; and

b) The general knowledge, skill and experience that the director has.

2. In Daniels v Anderson (1995) @ AWA:- a) A director must acquire a basic

understanding of the business of the company and must be familiar with the fundamentals of the company’s business.

b) Directors are under continuing obligation to keep informed about the activities of the company.

c) Detailed inspection of day-to day activities is not required but what is required is general monitoring of the company’s business affairs.

d) While directors are not required to audit the company’s book, they should maintain familiarity with the financial status of the company by regular review of the financial statements.

Director Director

vs.

Director Director

vs.

Special skill etc: accountant

1. The United Kingdom Company Law Review proposed three options in relation to the standard of care required of a company directors:-

a) The first option specified a subjective standard of care where the director’s duty is measured against a reasonable person having the director’s skill and experience;

b) The second option specified a mixed test of an objective and subjective standard

c) The third option specified an objective standard where any of the director’s skill will be ignored.

2. Thereafter, the UK Companies Act 2006 at s.174:- the double threshold (item b) is adopted i.e; using both the objective and subjective test approach.

3. Australia :-S.180 of the Australian Corporations Act provides that in determining what standard of care will be exercised by a reasonable person, regards will be given to the nature of the company, nature of the decision and the position and responsibility undertaken by that director.

4. Singapore:- S.157 of the Singapore Companies Act specifically places an obligation on directors to use reasonable diligence when discharging their duties in the office. Breach of this section will expose the director to civil liability and penal sanctions.

The approach in Malaysia Companies Act 1965

Pre 2007:-

Section 132 of the C/A 1965:- “ A director shall at all times act honestly and use reasonable diligence in the discharge of the duties of his office.”

Note:- 1. the above section is

silent on the degree of skill & care that is required for directors to exhibit;

2. The High Level Finance Committee had recommended that section 132 (1) should not be amended as they do no want to codified the subjective standard of care that was introduced in Re Equitable Fire Insurance.

2003:-

1. The CLRC thinks otherwise, that the section 132 should be amended because:-

a) The subjectivity test is too flexible which its application will varies according to the skill that a director brings to the office; which can create some sort of an excuse for a director that has no skill or expertise to be made accountable merely because there is no minimum objective standard of care that is required of him.

b) By having & codifying the standards, this approach is targeted to encourage for the directors to be proactive and not passive and to at least have the relevant skills and know how of the industry in which his company is operating.

2007:-

Section 132 (1) was amended & section 132 (1A) was introduced.

S.132(1):- “A director of a company shall at all times exercise his powers for a proper purpose and in good faith in the best interest of the company.

S.132 (1A):- A director of a company shall exercise reasonable care, skill and diligence with:-a) The knowledge, skill and

experience which may be reasonable expected of a director having the same responsibilities;

b) Any additional knowledge, skill and experience which the director in fact has.

The new section follows s.174 of the UK Companies Act 2006. Para (a) sets out the objective standards and para (b) sets out subjective standards.

Contents

1.Introduction

2.Background

3.Directors : Development of its duties

4.Conclusion

Conclusion

PROPOSED BILL COMPANIES ACT 1965 Duties and responsibilities of directors211. (1) A director of a company shall at all times exercise his powers 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 reasonable be

expected of a director having the same responsibilities; 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, upon conviction, be liable to imprisonment for a term not exceeding ten years or a fine not exceeding three million ringgit or to both.

Section 132. As to the duty and liability of officers (1) A director of a company shall at all times exercise his powers for a proper purpose and in good faith in the best interest of the company. (1A) 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 has.

No provision in the existing Act.

With the implementation of new laws into the country such as the Competition Act 2010, the Whistleblower Act 2010 and the Personal Data Protection Act 2010, the directors need to be on alert as they are subjected to potential risks of being liable if their acts or company are found to be in contravention of these laws. The new laws such as mentioned above are very aggressive in the sense that they have statutory powers to make the directors personally liable and also maybe be subjected to imprisonment.

For example, under the Competition Act 2010, they have quasi-judicial power to impose penalty on a company that conducts anti-competitive activities or the Competition Commissioner can also made a direction and request the shareholders of a company to remove any director that is found guilty of approving anti-competitive acts.

In the meantime, the Companies Act 1965 is also going through another round of amendments and are in the finalization stage. One of the related sections that are proposed for amendment is Section 132 of the Companies Act 1965.

The comparison of the proposed amendment and the current section can be seen at below table:-

Conclusion

Disadvantages of not observing the statutory requirements when carrying out

duties as a director:-

1. Passive directors will not be able to rely on the defenses accorded in the Companies Act 1965.

2. If the proposed draft Companies Bill 2013 on breach of the directors’ duty and responsibilities is enforced, the director who contravene the section commits an offence and shall upon conviction, be liable for imprisonment for a term not exceeding 10 years or fine not exceeding RM3.0 million or both.

3. The company will lose its appeal to potential investors as the issue of transparency is being doubted.

Advantages of observing the statutory requirements when carrying out duties as a

director:-

1. Directors who observe the recommendations made by the corporate governance will observe the statutory requirements and will be able to use the BJR or Reasonable Reliance Defenses to protect them from being liable or disqualified.

2. Compliance will not be subjected to any civil suits or penal sanctions.

3. By implementing corporate governance, the company will be able to grow healthy and sustain longer as the investors are confident with the company.

4. Potential creditors will not turn away from agreeing to provide loans since they know that the financial status of the compliance company is strong and able to pay back the loans.

THANK YOU