Reviewing the Companies Act in relation to Directors and Officers

Sections to be addressed: S131, S132, S132A, S132B, S132, S132C, S132E, S134

Section 131-Disclosure of interests in contracts, property, offices, etc

Section 131(1) provides that:

‘…every director of a company who is in any way, whether directly or indirectly, interested in a contract or proposed contract with the company, shall, as soon as practicable after the relevant facts have come to his knowledge, declare the nature of his interest at a meeting of the directors of the company’

S131(2) provides that a director does not have to declare his interest in a company contract if the interest is of him being a shareholder or creditor of a corporation, which is interested in a contract or proposed contract with the company and where such interest may be regarded as not material

Section 131 (7A) provides that:

‘For the purpose of this section, an interest of the spouse of a director of a company (not being herself or himself a director of the company) and an interest of a child, including adopted child or stepchild, of a director of the company (not being himself or herself a director of the company) in the shares or debenture of the company, shall be treated as an interest in the contract and proposed contract’

Illustration to Section 131 (7A):

Where interests in shares and debentures shall treated as interest in the contract and proposed contract:

According to Tan Bok Seong v Sin Be Seng & Co (Port Weld) Sdn Bhd [1995] 4 CLJ 795, if the director proves that the other directors are aware of his interest, then, that director need not formally declare his interest.

Lim Foo Yong v PP [1976] 2 MLJ 259

The Facts:

The Defendant was the managing director of United Malaysian Steel Mills Bhd (UMSM) and also an advisor to Ban Guan Ltd (BG).

The Facts (contd):

The Defendant was charged under S131(1) CA, 1965 for failing to declare the nature of his interest at the Directors Meeting of UMSM, that he is interested in a contract between UMSM and BG

Sessions Court:

Convicted the Defendant based on the following circumstantial evidence:

i) in the Companies concerned, the Defendant was shown to have direct or indirect influence through his family members;

Sessions Court:

Convicted the Defendant based on the following circumstantial evidence:

ii) at or about the time of execution of the contract, the defendant and his family agreed to sell their shares in UMSM and agreed to acquire shares in BG

Sessions Court:

Convicted the Defendant based on the following circumstantial evidence:

iii) the Defendant resigned from the Board of UMSM just before the demand for specific performance of the contract was received by BG

Sessions Court:

Convicted the Defendant based on the following circumstantial evidence:

iv) the ‘secret’ profits that would accrue to BG on the execution of the contract

High Court

Quashed the conviction as the circumstantial evidence did not point irresistibly to the guilt of the accused

i) The Sessions Court President failed to consider the personal guarantee given by the defendant to UMSM

High Court

Quashed the conviction as the circumstantial evidence did not point irresistibly to the guilt of the accused

ii) The Sessions Court President failed to consider that the sale price in the contract was fixed by the government

S131(7B) CA 1965 provides that:

‘Where a contract or proposed contract is entered into in contravention of this section, the contract or proposed contract shall be voidable at the instance of the company except if it is in favour of any person dealing with the company for any valuable consideration and without actual notice of the contravention.

The word ‘voidable’ suggests that the contract or proposed contract entered into in contravention of S131 can be ratified by the company

S131(8)

Penalty:

‘Imprisonment for seven years or one hundred and fifty thousand ringgit or both’

Section 131A-Interested director not to participate or vote

S131A(1) provides that:

‘Subject to Section 131, a director of a company who is in any way, whether directly or indirectly, interested in a contract entered into or proposed to be entered into by the company… shall be counted only to make a quorum at the board meeting but shall not participate in any discussion while the contract or proposed contract is being considered at the board meeting and shall not vote on the contract or proposed contract

the meaning of ‘shall not participate’

PP v Dato Haji Mohamed Muslim bin Haji Othman [1983] 1 MLJ 245

The facts:

The accused was a member of the State Executive Council and was present at the EXCO meeting which approved his application for State Land.

The facts (c0ntd):

The accused failed to declare his interest during the said EXCO meeting which approved his application for land.

Held:

Hashim Yeop A Sani J

The accused’s physical presence at the EXCO meeting was sufficient for him to be regarded to have used his public position for his advantage.

The accused was charged under Section 2 of the Emergency (Essential Powers) Ordinance, No 22 of 1070 for corrupt practice.

Punishment for ‘corrupt practice’

Section 2(1) of the Emergency (Essential Powers) Ordinance, 1970

‘..guilty of an offence and shall be liable to imprisonment for a term not exceeding fourteen years or to a fine not exceeding twenty thousand ringgit or to both.’

Definition of ‘corrupt practice’

Section 2(2) Emergency (Essential Powers) Ordinance, 1970

any act done by any Member or officer, whereby he has used his public position or office for his pecuniary or other advantage.

Now, Section 2(2) Emergency (Essential Powers) Ordinance, 1970 is superceded by the Anti-Corruption Act 1997

S58 Anti-Corruption Act 1997 (General Penalty):

‘ shall be liable to a fine not exceeding ten thousand ringgit or to imprisonment for a term not exceeding two years or to both’

the meaning of ‘shall not participate’

Sarawak Building Supplies Sdn Bhd v Director of Forest & Co [1991] 1 MLJ 211

The Facts:

The interested directors were absent from the meeting which passed the resolution on the subject matter.

Haidar J:

‘The absence of certain directors from the meeting did not mean that their absence gave the other directors the licence to proceed with the meeting and to pass the purported resolution..’

‘..their presence was necessary to constitute proper quorum… if they had interest in any contract or arrangement, they shall not vote. If they vote, their votes shall not be counted..’

Reconciling Dato Haji Mohamed Muslim bin Haji Othman (supra) and Sarawak Building Supplies Sdn Bhd (supra)

Interested directors merely sign their presence to make a quorum, and then excuse themselves from the meeting. They need not be physically present at the meeting

Section 131A does not apply to private companies. Therefore, the situation where all directors, due to their interest, are ‘conflicted out’ from voting does not arise

S131A(2) provides that:

‘Subsection (1) shall not apply to-

(a) a private company unless it is a subsidiary to a public company;

(b) a private company which is a wholly-owned subsidiary of a public company, in respect of any contract or proposed contract to be entered into by the private company with the holding company or with another wholly- owned subsidiary of that same holding company;

S131A(2)

(c) any contract or proposed contract of indemnity against any loss which any director may suffer by reason of becoming or being a surety for a company;

(d) any contract or proposed contract entered into or to be entered into by a public company or a private company which is subsidiary of a public company, with another company in which the interest of the director consists solely of-

S 131A(2)(d)

(i) in him being a director of the company and the holder of shares not more than the number or value as is required to qualify him for the appointment as a director; or

(ii) in him having an interest in not more than five per centum of its paid up capital.

S131A(3)

‘where a contract or proposed contract is entered into in contravention of subsection (1), … shall be voidable at the instance of the company except if it is in favour of any person dealing with the company for a valuable consideration and without actual notice of the contravention

Comments to S131A(3)

The word ‘shall be voidable’ seem to suggest that the contract entered into in contravention of subsection (1) can be ratified by the company.

S131A(4)

‘ A director who knowingly contravenes this section shall be guilty of an offence against this Act’

Penalty:

Imprisonment for five years or one hundred and fifty thousand ringgit or both.

Section 132(1)

Fiduciary Duty of Loyalty

The common law position

Re Smith & Fawcett Ltd [1942] Ch304

‘Directors must exercise their discretion bona fide in what they consider - not what a court may consider - is in the interest of the company..’

Directors must not exercise their powers for any ‘collateral purpose’

Mischief behind the old S132(1)

i) The word ‘honestly’ is not defined.

ii) Criminal liability only arises if it can be proven that the director is aware that the conduct is not in the company’s best interest.

iii) S132(1) is contrary to the common law position because:

(a) At common law, a director must comply with both the best interest of the company requirement and also with the proper purpose test.

(b) There is no requirement that the director had acted fraudulently or with deliberate intent to obtain personal advantage.

Kea Holdings Pte Ltd v Gan Boon Hock [2000] 3 SLR 129

The Facts:

A director suggested for orders to be cancelled even though he knew that there were buyers

Held:

The director had breached his duty to act honestly

In Multi-Pak Singapore Pte Ltd v Intraco Ltd [1994] 2 SLR 282

Held: -

The word 'honestly' does not mean that a director would only be in breach of duty if he had acted fraudulently. It means to act bona fide in the interests of the company. In exercising their discretion, the directors should only act to promote or advance the interest of the company.

The phrase ‘best interest of the company’ is not statutorily clarified in order to maintain flexibility

There is no need to prove dishonest intent because:

i) the word ‘honestly’ is replaced with the statement ‘exercise his powers for a proper purpose’ and in the ‘best interest of the company’

Examples where the Directors had acted in the best interest of the company BUT the transaction was motivated by some improper purpose:

Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821

The Facts: -

The Directors allotted shares to a company which had made a takeover bid. The Directors argued that the allotment was made to obtain capital for the company.

Held: -

The power to issue shares may be exercised for reasons other than raising capital provided those reasons relate to a purpose benefiting the company as a whole.

Held: -

However, on the facts, the Directors had improperly exercised their powers, as the effect of the share issue was to reduce the majority holding of two other shareholders who made a rival bid. The power to issue shares was used for a purpose of maintaining control of the company in the hands of the Directors themselves.

General Penalty Section

S132(3) provides that

‘an officer or agent or officer of the Stock Exchange who commits a breach of this section shall be-

liable to the company for any profit made by him or for any damage suffered by the company as a result of the breach; and

guilty of an offence against this Act

Penalty: Imprisonment for five years or thirty thousand ringgit’

Section 132(1A)

Duties of Care, Skill and Diligence

Position before Section 132(1A)

The duty to act with care and skill is derived from common law.

The old Section 132(1) is silent as to the standard of care, and skill required of a director. It merely prescribes that a director has a duty to act honestly and use reasonable diligence.

The Common Law Position

The leading decision is Re City Equitable Fire Insurance Co Ltd (1925) CH407 where it was held that ‘In discharging the duties of his position..a Director must..act honestly; but he must also exercise some degree of both skill and diligence.. so long as a Director acts honestly he cannot be made responsible in damages unless guilty of gross or inculpable negligence in a business sense."

Developments in the Commonwealth Jurisdiction

In New Zealand, Section 137 of the New Zealand Companies Act 1993 provides that a company director must carry out his directorial functions with such care, skill and diligence that would be exercised by a reasonable director in the circumstances of the former.

In the UK, the law has moved towards an objective assessment of the standard of care required of directors, as reflected in section 174 of the UK Companies Act 2006 which codifies Norman v Theodore Goddard (1991) BCLC 1028 and Re D’Jan of London Ltd (1993) BCC 646

Despite these developments, the position in Malaysia remained to be Re City Equitable Fire Insurance, as the court in Abdul Mohd Khalid v Datuk Haji Mustapha Kamal (2003) 5CLJ 85, had cited obiter Re City Equitable Fire Insurance as the applicable authority for directors’ duty of care and skill.

Problems with the subjective test:

There is no minimum objective standard required of a director. Since the subjective standard of care varies according to the skill a director has, a director with no specific skill or expertise need not be accountable.

The position today:

Section 132(1A) Companies Act 1965 provides that 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 in fact has.

where a director has additional knowledge, skill and experience, that director will be assessed against a reasonable person who has that additional knowledge, skill and experience.

The actual knowledge and experience of a director is to be considered in addition to the minimum standard.

Section 132(1B)

Business Judgment Rule in Malaysia

Mischief behind the Business Judgment Rule

i) Sections 131, 132C, 132D, 132E, 133, 133A, provide for sanctions that follow if a director breaches his duties.

As a result, an honest director is discouraged from engaging in vigorous business activities. This hampers maximum investment returns.

ii) Where a Director has made a genuine business judgment in good faith, he will be protected from liability for negligence even if these judgments turned out badly.

iii) Courts are badly equipped and should not substitute its judgment for that of the directors

The Malaysian model is taken from:

S180(2) Australian Corporations Act 2001

S132(1B) of the Malaysian Companies Act 1965 provides that:-

A director who makes a business judgment is deemed to meet the requirements of the duty under subsection (1A) and the equivalent duties under the common law and in equity if the director-

S132(1B) CA 1965

(a) makes the business judgment in good faith for proper purpose;

(b) does not have a material personal interest in the subject matter of the business judgment;

(c) Is informed about the subject matter of the business judgment to the extent the director reasonably believes to be appropriate under the circumstances; and

(d) Reasonably believes that the business judgment is in the best interest of the company

Comments on S132(1B) CA 1965:

The overriding requirement is that the Directors must make a conscious decision or exercise a conscious judgment

If the Directors failed to make a conscious decision or exercise a conscious judgment, the Business Judgment Rule will not extend its protection.

Section 132(6) defines business judgment to mean:

‘any decision on whether or not to take action in respect of a matter relevant to the business of the company’

S132(1C) permits the director to rely on expert advice but that reliance would only be considered reasonable if the director has made an independent assessment of the reports, advice, opinions and data received from the experts and consultants employed to provide them

Case Law Formulation

The Business Judgment Rule originated from Otis & Co. v Pennsylvania R.Co., 61 F. Supp. 905 (D.C Pa. 1945) and was affirmed in Aronson v Lewis (1984)

In Otis, a shareholder’s derivative action alleged that corporate directors failed to obtain the best price available in the sale of securities, resulting in the loss of nearly half a million dollars.

The federal district court ruled that:

the directors had acted in good faith and were not liable to the shareholders

“mistakes or errors in the exercise of honest business judgment do not subject the officers and directors to liability for negligence in the discharge of their appointed duties"

In Aronson v. Lewis, (1984) the Court affirmed that the Business Judgment Rule is:

"a presumption that in making a business decision.. Directors.. acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.."

re The Walt Disney Company Derivative Litigation, 2003 WL 21267266 (Del. Ch. May 28, 2003), concerned claims arising out of the hiring and termination of The Company’s former president, Michael Ovitz. The plaintiff shareholders alleged that the defendant directors knowingly or intentionally breached their fiduciary duty of care to the corporation in both approving Ovitz’s employment arrangement and failing to consider the terms of Ovitz’s termination that were negotiated exclusively by Disney’s Chief Executive Officer, and “close friend [of Ovitz] for over 25 years", Michael Eisner.

The Disney Litigation

The plaintiffs also alleged that Ovitz breached his duty as an officer and director to the corporation by maximizing his own interest in his employment and termination negotiations at the expense of the corporation. The defendant directors and Ovitz moved to dismiss these claims

The court concluded that the directors are liable as they failed to make any good faith attempt to fulfill their fiduciary obligations in the hiring and termination of Ovitz.

The Disney Litigation shows that American Courts have increasingly displayed an apparent willingness to review the substance of business decisions, contrary to the Business Judgment Rule

Section 132(2)-Duties to avoid Conflict of Interest

The Common Law Position

Situations of ‘conflict’

i) When a director makes a personal profit while acting in his position.

Regal (Hastings) Ltd v Gulliver [1942] 1 ALL ER 378

Held: -

Directors are fiduciary and is not allowed by equity to profit from his position.

ii)Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461

The Facts: -

The company entered into a contract to purchase goods from a business in which one of the Directors was a partner.

Held: -

The contract was void.

‘Conflict’ arose when the company enters into a contract, arrangement or transaction in which a director has interest in, and that director does not disclose his interest to the company.

iii) Avel Consultants Sdn Bhd v Mohd Zain Yusof [1995] 4 MLJ 146

Facts:-

The director had set up another firm to compete for contracts with the company.

Held:-

‘Conflict’ arose where a director uses or exploits an asset (including business opportunity and corporate information) treated as the company’s property, for his own purpose or the purpose of any one else (other than the company)

iv) Mahesan v Malaysian Government Officers’ Co-operative Housing Society [1978] 1 MLJ 149

Held: -

‘conflict’ arose where a director receives a benefit in some other way in connection with the exercise of his powers as a director (eg bribe)

v) Yukilon Manufacturing Sdn Bhd v Dato’ Wong Gek Meng & Ors [1998] 7 MLJ 551

Held: -

‘conflict’ arose where a director competes with the company.

The old S132(1) CA 1965 provides that:

‘A director shall at all times act honestly and use reasonable diligence in the discharge of his duties of his office’

The old S132(1) does not expressly refer to the common law situations of conflict.

The new S132(2) provides that:

‘A director or officer of a company shall not, without the consent or ratification of a general meeting-

use the property of the company;

(b)use any information acquired by virtue of his position as a director or officer of the company;

use his position as such director or officer;

use any opportunity of the company which he became aware of, in the performance of his functions as the director or officer of the company; or

(e) engage in business which is in competition with the company

to gain directly or indirectly, a benefit for himself or any other person, or cause detriment to the company’

This new provision amounts to a restatement of the common law conflict of interest situation.

It assists directors in appreciating situations of conflict which may cause them to act in breach of their duty to the company.

S132E-Substantial property transaction by director or substantial shareholder

S132E(1) provides that:

‘..a company shall not carry into effect any arrangement or transaction where a director or substantial shareholder of the company or of its holding company, or a person connected with such a director or substantial shareholder-

(a) acquires or is to acquire shares or non cash assets from the company; or

(b) disposes of or is to dispose of shares or non cash assets of the requisite value, to the company

Definition of “substantial shareholder"

According to Rule 1.01 of the Listing Requirements of Bursa Malaysia, it has the same meaning as S69D Companies Act 65

S69D(1) Companies Act 1965

‘…a person has substantial shareholding in the company if he has interest or interests in one or more voting shares in the company and the nominal amount  or aggregate of the nominal amounts of those shares is not less than 5% of the aggregate of the nominal amounts of all the voting shares in the company’

S69D(2)Companies Act 1965

‘…a person has substantial shareholding in company, being a company the share capital of which is divided into two (2) or more classes of the shares if he has interest or interests in one or more voting shares included in one of those classes and the nominal amount of that share, or aggregate of the nominal amounts of those shares is not less than 5% of the aggregate of the nominal amounts of all the voting shares included in that class.’

‘…a person who has substantial shareholding is a substantial shareholder in that company’

Definition of ‘persons connected with such a director or substantial shareholder’

S 132E(7) provides that:

‘for the purposes of subsection (1)-

(a) persons connected with a substantial shareholder" shall have the same meaning as that assigned to a “person connected with a director" in Section 122A save that all references therein to a director shall be read as a reference to a substantial shareholder

S122A CA 1965 provides that:

(1) For the purposes of this Division a person shall be deemed to be connected with a director if he is

(a) a member of that director’s family;

(b) a body corporate which is associated with that director

S122A CA 1965 provides that:

(c ) a trustee of a trust (other than a trustee for an employee share scheme or pension scheme) under which that director or member of his family is a beneficiary; or

(d) a partner or that director or a partner of a person connected with that director

‘In paragraph (1)(a) “a member of that director’s family" shall include his spouse, parent, child (including adopted child and stepchild), brother, sister and the spouse of his child, brother of sister.’

The Old S132E(2) provides that:

‘An agreement entered into in contravention of subsection (1) and any transaction entered into in pursuance of the arrangement (whether by the company or any other person) shall be voidable at the instance of the company unless the arrangement and transaction are, within reasonable period, ratified by the company in general meeting, and also, if the arrangement and transaction are for the transfer of an asset to or by a director of its holding company or a person who is connected with such director, by a resolution of the holding company in general meeting

The new S132E(2) provides that:

‘An arrangement or transaction which is carried into effect in contravention of subsection (1) shall be void, unless there is prior approval of the arrangement or transaction-

(a) by a resolution of the company at a general meeting; or

(b) by a resolution of the holding company at a general meeting, if the arrangement or transaction is in favour of a director or substantial shareholder of its holding company or a person connected with such director or substantial shareholder

S132E(3) provides that:

‘The resolution of the company or its holding company at the general meeting of the company or its holding company to consider the arrangement or transaction shall be subject to the director, substantial shareholder or person connected with such director or substantial shareholder, as the case may be, abstaining from voting on the resolution whether or not to approve the arrangement or transaction’

Previously, the transaction entered into in contravention of subsection(1) is voidable and can be ratified by the Company within a reasonable period.

Now, the transaction is entered into in contravention of subsection (1) is void and cannot be ratified by the company

S 132G(1) provides that:

‘Notwithstanding the provision of S132C and 132E, a company shall not enter into any arrangement or transaction to acquire the shares or assets of another company in which a shareholder or director of the acquiring company, or a person connected to such shareholder, or director, has a substantial shareholding.. unless the arrangement or transaction was entered into three years after such shareholder, director or connected person as the case may be, first held the shares in that other company or after the assets were first acquired by the said company, as the case may be’

S132G(2) provides that:

‘an arrangement or transaction entered into in contravention of subsection (1) shall be void and any consideration given for the shares or assets shall be recoverable accordingly’

Intention of Section 132G

to prohibit asset shuffling whereby shareholders could inject newly acquired assets into listed companies at excessively high value thereby adversely affecting the interests of minority shareholders.

Problems with Section 132G

Legitimate transactions are stifled since shareholder’s approval in general meeting could not save such transactions.

Companies can now under take mergers & acquisitions and restructure their business.

The safeguards to the abuse which S132G was aimed at can be found in the other provisions of Companies Act such as S131, S131A and S132C