Fiduciary Duties

1.0 Introduction

Fiduciary duty refers to a legal duty for an individual to act on behalf of another particular in order to make a relationship of confidence and trust (Davies, 2007). It consists of the set of moral value such as trust, honesty and confidence; fiduciary duty can be obviously seen in the relationship between the shareholders and the board of directors as the BOD are managing the company’s affairs on behalf of the shareholders. However, there is no legal duty between the relationship of individual shareholders and board of directors. Individual shareholders are unable to against the board of directors if the BOD causes any damage unless the company give permission to sue them on behalf of shareholders as BOD and shareholders are separate legal entity. Fiduciary duty is a common law however due to some unethically act of directors, government codified the directors’ duties under section 171 to 177 of Companies Act 2006 so that directors will act in good faith and best interest of the company. As these duties had been legalized under Companies Act 2006, the board of directors of every company are binding to these duties as the role of directors. Example of the role of directors are acting within the powers, promoting the success of the company, exercising independent judgement, exercising reasonable care, skill and diligence, avoiding conflict and declaring interest in proposed transactions or arrangement (Davies, 2007). It is very crucial for the BOD to abide the duties as they are managing the company’s affairs.

2.0 Duty to act within powers (Section 171 of Companies Act 2006)

In this section directors are required to exercise their power in the company’s constitution. Besides, they are not allows to use their power for any improper purposes such as issue shares for purpose of creating new majority within the company to gain control even though directors honestly believe their act is in the best interest of company; directors can only use their power for purposes which they were conferred or given. It is stated clearly in Section 171 of Companies Act 2006:

“(a) directors are required to act in accordance with the company’s constitution

(b) exercise power for purposes for which they are conferred”.

This principle implemented in Hogg v Cramphorn in UK. In this case, Colonel Cramphorn has abused his powers by issuing shares to stop Baxter from taking over the company. He also convinced other directors to vote against the takeover by issuing share capital. Although he believes that this action was the bona fide for the company’s interest, this case was held as breach of directors’ duties due to exercise power for an improper motive and it is considered as ultra vires (Mantysaari, 2005).

However, this principle does not consider as a breach of duty in Teck Corporation Ltd v Millar in Canada. This is because directors have to consider the reputation, experience and policies of people who are willing to take over the company before the new shares issued. Besides, they are also allowed to use their powers to protect the company if the takeover may cause significant damage to the interest of company (Kershaw, 2012).

2.1Duty to Promote the Success of the Company (Section 172 of Companies Act 2006)

Under this statutory, directors are obligated to this duty to act in good faith and act in the way that they consider to enhance the development of the company and get benefits for all members in the company. Moreover, in this section government also requires directors to take account of six factors in the decision making process. Consequently, Section 172 of CA 2006 provides that:

“(1)A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—

(a)the likely consequences of any decision in the long term,

(b)the interests of the company’s employees,

(c)the need to foster the company’s business relationships with suppliers, customers and others,

(d)the impact of the company’s operations on the community and the environment,

(e)the desirability of the company maintaining a reputation for high standards of business conduct, and

(f)the need to act fairly as between members of the company.”

The term “have regard” in section 172(1) indicates that government leave the decisions of how they implement the individual factors to directors. Furthermore, it is also no requirement for directors to give precedence of any factors; as directors take account of any listed factors or any relevant factors in the decision making process they are considered already fulfilled their duties in this section. The case law in this statutory concerned about the directors should exercise in best interest of the company rather than the principle of promoting the success of the company directly. For example the case of Hogg v Cramphorn, in order to take over the company, directors abused their power by issuing shares to create new majority within the company (Mantysaari, 2005). Under this section, directors must use their powers for intended purposes not collateral purposes and always act in the best interest of company.

2.2 Duty Not to Accept Benefits from Third Parties (Section 176 of Companies Act 2006)

The principle of this duty is stated clearly in the statutory. The benefits that accepted from third parties[1] by the directors are considered as breach of directors reason being provided in s.176(1) is because of theirs’ position or directors may do or not do as a director. This statutory also states that directors can only accept the benefits that paid by someone’s services as a director or otherwise to the company and benefits that will not affect the conflict of interest. Section 176 of the Companies Act 2006 provides that:

“(1)A director of a company must not accept a benefit from a third party conferred by reason of—

(a)his being a director, or

(b)his doing (or not doing) anything as director.

(2)A “third party” means a person other than the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate.

(3)Benefits received by a director from a person by whom his services (as a director or otherwise) are provided to the company are not regarded as conferred by a third party.

(4)This duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.

(5)Any reference in this section to a conflict of interest includes a conflict of interest and duty and a conflict of duties.”

One of the examples that breach the duty not to accept benefits from third parties is Tesco Stores v Pook. In this case, Mr Pook, the senior employee, fabricated false invoices about £500,000 and accepted a bribe of total £323,749 from third parties. He also denied that the payment is not a bribe but it is a start up loan for his business. However, Judge Peter Smith held that the money is a bribe as the means of false invoices and fraudulent value added tax had documented by the payers. Judge Peter Smith held that the bribe will be accounted on constructive trust based on the case of Attorney-General for Hong Kong v Reid[2] (Fisher, 2003).

2.3 Duty to Exercise Reasonable Care, Skill and Diligence (Section 174 of Companies Act 2006)

Generally, this duty was a common law duty which required directors to act with reasonable care, and skill; yet, government codified it under section 174 of Companies Act 2006 by imposing the objective and subjective of standards of care to directors. Directors are obligated to act reasonable care, skill and diligence which indicated by the term of “must” under s.174(1).

“(1)A director of a company must exercise reasonable care, skill and diligence.”

Also, directors are required to follow the subjective and objective standards of care that states in section 174(2) in order to fulfil the standard of competence given. Section 174(2) of Companies Act 2006 provides that:

(2)This means the care, skill and diligence that would be exercised by a reasonably diligent person with—

(a)the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and

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

Under this section, directors are not liable if the negligence found to be honest ought to be excused. It can be seen in the case of Re City Equitable Insurance Co Ltd that held by Romer J where the chairman of the company, Mr Bevan had committed fraud which caused the company loss of £1,200,000 in the investments. Romer J held that even other directors and auditors involved in this case due to negligence as overlooked the fraud and signed a blank cheque for Bevan, they were honest and still acting in the degree of both still and diligence. Therefore, they’re not suspicious and not liable (Chan, 2009).

3.0 Conclusion

In conclusion, there is no effective control on the board of directors even there is statutes as the relationship between board of directors and shareholders are based on fiduciary duty (trust) not legal duty. Therefore, there is no direct remedy for shareholders to against the board of directors as the board of directors only represented shareholders fiduciary. If board of directors had breached their duties, individual shareholders are not allowed to sue the board of directors because shareholders and the board of directors are two separate entities. Besides, when the board of directors breach their duties, the “victim” is the company not the shareholders. Hence, only the company can sue the board of directors only if the board of directors agrees to sue. Individual shareholders can only against the board of directors if the company accept or individual shareholders are able to raise the issue of minority protection. However, there are remedies to against the board of directors due to breach of director duties. The company allows to against the directors who make a mistake at their duties that causes loss in the company. Additionally, directors who make a mistake at their duties can be asked for compensation by the company due to their negligence. Moreover, company can also void the contract that director has an undisclosed interest (Davies, 2007).

Parmalat Scandal (2003)

Parmalat is an international corporate that produces dairy products which based in Italy. As this company is owned by family members, it causes the lack of transparency of the company which may not only harm the company but also the shareholders. This had led to the scandal of breach of director duties on financial fraud and money laundering in year 2003 by the senior executives of the company and causes 15,000 employees loss their jobs. In December 2003, Parmalat declared bankrupt as the company has a huge debt about €14 billion excluding the €4 billion hole in the company’s accounts due to financial fraud and money laundering (Chalkidou, 2011). This scandal also known as “brazen fraud”; it was started in mid-November where auditors and banks look into Parmalat’s accounts when the company defaulted on a bond payment which cost €185 million. They realized that one of bank accounts in Cayman Island which holding €4 billion did not exist (Chalkidou, 2011). The company also fake the statement of financial position by overstated the assets in order to hide the liabilities of €16.2 billion over a fifteen-year period. Moreover, Parmalat’s CEO also embezzled about €620 million to cover losses of other family-owned corporate (Chalkidou, 2011). There are about 20 individuals that involved in this scandal were sentence in jail included Calisto Tanzi, the founder and Chief Executive Officer of Parmalat and Fausto Tonna, the Chief Financial Officer of company (Tanner, 2010). Both of them where sentence in jail for 18 years and 14 years respectively; whereas, Giovanni Tanzi, Calisto’s brother where sentence 10 years in jail. Other former directors were also sentence in jail for less than 10 years.

[1] Third parties refer to company or individual who acting on behalf of an associated body corporation.

[2] In the case of Attorney-General for Hong Kong v Reid, it is held that the bribes should consider as constructive trust so that fiduciaries will not have gain any benefits from their illegal behaviour.