The Duty of a Director in the Best Interest of the Company

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Introduction

The duties of a director can be defined as “a series of statutory, common law and equitable obligations owed primarily by members of the board of directors to the corporation that employs them” (Bostock & Jaques 2000, pp. 5). The law stipulates that the directors should carry out their duties in loyalty with the company and not shareholders, creditors or employees. They are required to carry out their functions in good faith in order to promote the endeavors of the corporation. Directors are also required to carry out additional duties in exceptional circumstances. For instance, the Australian law specifies additional fiduciary and statutory roles for directors. In the past, there have been several high profile cases regarding the duties of a director in exceptional situations (Bostock & Jaques 2000). These cases have been instrumental in the development and application of commercial legislative frameworks to redefine what the law requires of individual directors. This paper seeks to discuss the reasoning in the judgment for the difference between the decisions in Percival v Wright with the reasoning in Coleman v. Myers and Brunninghausen v. Glavanics. The paper will specifically address the issues with nominee director; the arguments for and against the proposal to change the corporations act to require (or allow) directors to take into account the interests of stakeholders and the broader community when making corporate decisions; and to identify whether the adjustments in James Hardie cases involving directors has made any changes to the law in this area.

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What are some of the issues with nominee director?

Under the Australian law, nominee directors are required to represent certain sectional interests on the board (Armsttrong & Francis 2008). Nominee directors are basically required to accomplish their duties in accordance with the interest of the whole company. They are thus required to strike a balance between opposing needs and desires of the faction they represent and the needs the company as a whole. If the law requirements regarding the duties of a director are strictly observed then it can be concluded that nominee directors should not consider any interests of a particular faction. The Australian company law (ACL) recognizes that directors may have their own interests as shareholders. This does not however imply that the directors can ignore the other interests they represent. Thus, nominee directors will be in consistent with their duty requirements if they act in the interest of a principal other than the company in mind, as so long as they have an honest and reasonable belief that they are doing so in the interest of the company as a whole (Armsttrong & Francis 2008). A breach of duty often arises when it can be inferred that the nominee director will still have acted the same way even after being aware that such an act is not in the interest of the company as a whole. In a scenario where company interests and sectional interests are not compatible, the director is required to discontinue the sectional interests in favor of the company interests. Many nominee director issues pertain to the inconsistency between sectional interests and the interests of the company as a whole. Issues often arise in companies where stakeholders rely on the nominee director to safeguard and cultivate their interests. The standard of a director’s conduct in a given firm varies depending on the role the director has assumed towards the shareholders. The role may be in the form of granting information and advice to the stakeholders; conducting self in a manner that instills trust and confidence in the stakeholders.

In the Coleman v. Myers case, the minority shareholders in a small private company hesitantly sold their shares to A.D. Myers who was the company’s managing director (Bostock & Jaques 2000). This was part of Myers plan to take over the entire equity capital of the company. Upon becoming the sole shareholder, Myers sold off some of the firm’s surplus assets, and announced a capital dividend which was much more than the expenses he had incurred in acquiring the shares. The plaintiffs in this case were satisfied that their shares and those of other shareholders had been bought by Myers following a gross undervaluation scheme that sought to conceal the true value of the firm’s assets. The judgment in this case held that the director owed a fiduciary duty to the shareholders.

In the Percival v. Wright case, “Mr. Wright was the chairman of a UK company, who in liaison with other two directors agreed to buy shares from Mr. Percival at 12.50 pounds” (Bostock & Jaques 2000, p. 3). Mr. Percival later learned that the directors of the same company had negotiated to sale the whole company at far higher price than 12.50 pounds per share. The directors had not informed Percival on the intention to sell the company. He thus claimed a contravention of the fiduciary duties by the directors (Cunliffe, 2007). In the judgment, Mr. Percival lost the case on the grounds that the directors work in the interest of the company and not the stakeholders. In this case the directors did not directly negotiate with the shareholders over the sale of his shares. The mere presence of negotiations with a third party did not merit a fiduciary duty to the shareholder (Bostock & Jaques 2000). The ruling in this case has attracted a considerable amount of criticism within the commonwealth. Mahon J criticized the ruling and said that it was contrary to the established commercial morality and concluded that the case was wrongly decided and should never be used as a basis to information decision in other rulings.

In the Brunninghausen v. Glavanics case, Brunninghausen and Glavanics were the only shareholders and directors of the company. Their relationship broke down and as a result Glavanics stopped receiving any information regarding the affairs of the company. Brunninghausen and Glavanics embarked on negotiations for Glavanics to sell his stake to Brunninghausen. In the course of the negotiations, a third party made conduct with Brunninghausen and made an offer to him to buy all the shares of the firm (Bostock & Jaques 2000). Brunnighausen did not however disclose this to Glavanics. Glavanics agreed to sell his shares at a considerably lower price than that paid by the third party. In the subsequent law suit, a fiduciary relationship was established on the account that the shareholder relied completely on the director for information regarding the company. And that one director (Brunninghausen) had acted in a manner that was considered oppressive to the other director/stakeholder (Glavanics). In this case the transaction did not concern the company but only concerned another shareholder (Armsttrong & Francis 2008). The presiding judge ruled that “fiduciary duty owed to by directors to shareholders where there are negotiations for the takeover of the company functions would require the directors to loyally promote the joint interests of all shareholders” (Bostock & Jaques, 2000, p. 6). Such issues arise when the nominee directors arises when the director decides to deal with the shareholder directly.

Historically, the law has always stated that the duties of a director are owed to the company, and not to the shareholders or the community (Armsttrong & Francis 2008). Recent developments have indeed clarified that the director’s duty can be owed to the shareholders in situations where certain dealings can result into a fiduciary duty. For instance, in regard to the Brunninghausen v. Glavanics case, the New South Wales court of appeal established a fiduciary duty owed by directors to stakeholders relating to dealings in their shares in situations where the director occupied a position of particular advantage over the shareholder (Cunliffe 2007). The fiduciary relationship was established on the account that the stakeholder was completely reliant on the director for information. It was also found that the proposal to transact the shares had arisen following direct liaison between the stakeholder and the director.

Under section 232 of the corporations Act, a member is allowed to pursue a remedy if a court establishes that a resolution passed by a section of the members was oppressive, unfairly prejudicial or unfairly discriminatory, or was contrary to the common interests of all members (Cunliffe 2007). This law may be revoked in instances where director utilizes his/her right as a stakeholder in a manner that can be considered to be oppressive to other shareholders.

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The Percival vs. Wright case played an important role in the enactment of the law against insider trading. The law against insider trading has existed in Australia since the 1970s. The law stipulates the penalty, term of imprisonment and the compensation to be made to the victims. The prohibition is captured in the securities commission Act 1989 and the corporations Act 1989 (Bostock & Jaques 2000).

What are the arguments for and against the proposal to change the corporations act to require (or allow) directors to take into account the interests of stakeholders and the broader community when making corporate decisions?

Those who propose that the duties of the director should also be owed to the shareholders and the community at large hold that, by limiting the duties of the directors to the company results into instances of unfair practice. Much criticism has been raised in regard to the 1902 ruling in Percival v. Wright case. It’s important to note that the criticism does not pertain to the establishment that fiduciary duties are owed to the company and not individual shareholders, but rather due to the fact that application of that doctrine in given circumstances might result into unfair practice (Armsttrong & Francis 2008). The ruling was never challenged anywhere, it however resulted in the enactment of a legislation against insider trading. There have been few cases dealing with incidences of insider trading in Australia. The most prominent feature of insider trading is that it is more easily recognized by the public and the media. Critics point out that the concept of insider trading that is formed by the public and the media is not necessarily what is being prohibited in the law. The prohibition of insider trading was first established through the securities and industry code of New South Wales (Cunliffe 2007). The few subsequent cases concerning the legislation have resulted in the failure to clarify and reform the law. Many analysts have regarded insider trading as a problem of non-disclosure whereby a person whose is in a position to access information on disparity between the value of a company’s securities and the price acts on the information before its made available to those with whom he is trading and therefore obtains a benefit due to his early knowledge (Bostock & Jaques 2000). The law has been reluctant I extending the fiduciary duties of the director to the shareholder because there would amount to legalizing insider trading. However, if information is made available to all the shareholders then cases of fraud might be reduced. Many family companies have been involved in cases where the minority shareholder suffers due to non-disclosure by the nominee director.

The issue of corporate social responsibility (CSR) has become very prominent in recent times (Cunliffe 2007). The boards of directors are increasingly getting involved in wide ranging social and environmental practices. However, the law still focuses the duties of the director to the “interests of the Company” (Bostock & Jaques 2000). There have been a lot of concerns regarding this law, with calls being made to amend it in order to clarify the extent to which directors can indulge into activities pertaining to corporate social responsibility, or consider the interests of the shareholders or other stakeholders. The need for directors to consider the interests of other stakeholders has been reinforced by the practice of making payments that can be regarded as unwarranted. Many cases involving such payments have held that it’s legal to make gratuitous payments provided they benefit the company in one way or another. This and other controversies have led to concerted efforts by certain groups to pressure the government to change the law. The extent to which the current Australian law allows directors to consider the interests of other stakeholders has been revisited by the Australian government on numerous occasions (Armsttrong & Francis 2008). To this point, no change has been recommended as it has been generally established that the current law is sufficient and elastic enough to allow directors to take into account all the appropriate interests.

The question as to whether directors can look beyond the interests of the company while discharging their duties does not arise, at least according to the senate standing committee on legal and constitutional affairs (SSCLCA) (Armsttrong & Francis 2008). The committee does not identify any interests that can be regarded as outside interests. The committee has established as when the law establishes the conditions corporations have to provide for their employees, how they should treat the environment, health measures, the directors should be able to fulfill all those requirements as part of the duty to act in the best interest of the company (Armsttrong & Francis 2008). Such interests are crucial in the continued wellbeing of the firm or company. Therefore gratuitous payments made to charities and other stakeholders do not constitute a breach of director’s duties. Opponents of bigger mandates for directors have often pointed out that such a move would put directors beyond the control of shareholders and may not result into better rights for other stakeholders. All in all, the pluralist objectives of maximizing the performance of the company to the benefit of all stakeholders can be best served by professional directors pursuing commercial opportunities within an established framework of standards and accountability (Armsttrong & Francis 2008). A pluralist overall objective should be pursued in the sense that directors should run companies in a sense that aims to achieve goodness for all stakeholders. The applicable laws must therefore take into account the different dynamics that play in the running of s commercial enterprise.

Have the adjustments in the James Hardie cases involving directors made any changes to the law in this area?

The James Hardie building and construction company moved its corporate headquarters from Australia to the Netherlands, and majority of its business activity to the United States (Armsttrong & Francis 2008). The company’s management thought that they had escaped the liability for its remaining subsidiaries to the asbestos victims that had now been left to depend on a critically underfunded medical scheme established by Hardie. A major public disapproval both in Australia and abroad forced James Hardie to go back and face the consequences of irresponsible action (Cunliffe 2007). The James Hardie Company has faced several law suits that generally pertain to governance.

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The adjustments in the James Hardie cases have not resulted in changes in the laws regarding the duties of a director. However, the cases have acted as a reminder of the law requirements. Under section 189 of the corporations act, directors are required not to rely on the advice of the management as a substitute of their own opinions of a matter that is within the board’s mandate (Armsttrong & Francis 2008). The findings of the case reminds non executive directors that, in spite of the fact that they are not actively involved in the daily affairs of the company, they remain responsible for the company and will be held responsible if it’s proven that they are not upholding the values expected of them while in that position. The James Hardie case also reminds the general counsels on their obligation to protect the company against legal upheavals. The general counsel is required to discharge its duties effectively in spite of the circumstances. This includes guarding against certainty wording when the counsel is aware that such wording creates a false impression. The general is also obliged to advise the board in regard to the limitation of external expert opinion. The case therefore reminds general counsels that if they have to participate in decisions of the company they are effectively acting as officers of the company and therefore they are required to uphold the set “standards of care and diligence stipulated in section 180(1) of the Corporations Act” (Bostock & Jaques 2000, pp. 7).

The cases concerning James Hardie played an important role in the extension of director’s duties to members who have appointed voluntarily. According to the corporations’ law, when an individual assumes the position of a director in a company, they are legally bound to the law requirements (Armsttrong & Francis 2008). The duty of care and diligence extends the directors’ duties beyond professional representation. Such duties demand that the director be knowledgeable on the operations of the company; be able to ascertain that the board is effective enough to check the company’s management; the director is also required to attend board meetings and to confirm that the company is working properly. A member of the board should not in any way, make use of inside information for a personal gain or cause harm to the organization or engage I activities that are outside their specified duties. The James Hardie case has provided a good example in regard to the behavioral expectations. The behavior of a company’s management, employees and associates can also affect the director’s duty of care (Bostock & Jaques 2000). Companies should not indulge in activities of taking and giving of bribes. Indeed it’s difficult to point out the illegality in the majority of such cases. However, they are considered unethical and have the potential to result into more fraud cases. The law requires company boards to be on the forefront in fostering a desirable corporate culture that is consistent with the values and strategies of the company. The general ethical values that form corporate governance standards include: Accountability; transparency; fairness and balance; honesty; dignity; legal compliance; and good will (Armsttrong & Francis 2008).

Ethical climates can be defines as “stable, psychologically meaningful, shared perceptions that employees hold concerning ethical procedures and policies existing in their company or organization” (Armsttrong & Francis 2008, pp. 15). Boards are required to be on the forefront in the development of a proper ethical culture that is consistent with the values of the company. Thus the first step is to ensure that the board itself recognizes ethical standards and goes ahead to approve written codes of conduct required. The written codes will benchmark what the board expects from employees and directors in terms of ethical behavior. The codes of conduct should include a detailed explanation of the repercussions of non-compliance. Ethical issues may involve decisions regarding employee issues such as “fair wages, safe working conditions, work morale and industrial relations” (Armsttrong & Francis 2008, pp. 17). The misconduct witnessed in the James Hardie case and a host of other companies has led to increased interest in ethics. Shareholders and other stakeholders are getting more concerned about the reputations of their companies especially due to increased media scrutiny and globalization. Ethics has received support by a principle 3 provision of the ASX that promotes good governance best practice in boards of directors (Bostock & Jaques 2000).

Conclusion

This paper sought to discuss the reasoning in the judgment for the difference between the decisions in Percival v Wright with the reasoning in Coleman v. Myers and Brunninghausen v. Glavanics. The paper has specifically addressed the issues with nominee director; the arguments for and against the proposal to change the corporations act to require (or allow) directors to take into account the interests of stakeholders and the broader community when making corporate decisions. The paper has also evaluated whether the adjustments in James Hardie cases involving directors has made any changes to the law in this area.

The paper has identified that the differences between the decisions in Percival v Wright, and Coleman v. Myers and Brunninghausen v. Glavanics were basically due to the ability to establish whether a fiduciary duty was owed to the shareholder or not. The decision in Percival v Wright has however attracted a considerable amount of criticism and is largely responsible for enactment of laws against insider trading.

The paper has also established that many issues concerning nominee directors are largely related to who the directors owes his/her duty. There has been a lot of pressure for the government to change the current law regarding director’s duties so as to reflect the current realities, but no change has been effected as the government states that the provisions are still effective. The James Hardie cases have not caused in changes in the Australian law regarding the conduct of directors but have nevertheless acted as a reminder of what is expected of them.

References

Armsttrong, A., & Francis, R 2008. ‘An Ethical Climate is Climate is a Duty of Care’, Journal of Business Systems, Governance and Ethics , vol. 3, no. 3, pp. 15-20.

Bostock, T., & Jaques, S 2000. Director’s duties: Recent developments and their implications for directors and advisers,Australian institute of company directorsMelbourne.

Cunliffe, S. A 2007. Materiality in insider Trading: An obstacle to enforcement and compliance, University of Otago, Dunedin.

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Premium Papers. (2022) 'The Duty of a Director in the Best Interest of the Company'. 17 May.

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Premium Papers. 2022. "The Duty of a Director in the Best Interest of the Company." May 17, 2022. https://premium-papers.com/the-duty-of-a-director-in-the-best-interest-of-the-company/.

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