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Breach of directors' duties: what you can do

Introduction

Much is written and said about the duties of company directors. However, there is much less information out there about the mechanisms for enforcement against directors who breach their duties. This article provides some practical steps which can be taken by a member of a company who believes that one or more of its directors are in breach of their duties.

Are the terms of Heads of Agreement or Term Sheet legally enforceable?

The terms of a heads of agreement or term sheet are capable of being legally enforceable if it can be shown that the parties intended them to be so. The document is interpreted in the same way as any other document alleged to be a contract. The issue normally arises where one of the parties acts in a manner inconsistent with the terms in the HOA and the other party issues legal proceedings for specific performance or damages based on breach of contract. The party issuing the proceedings will claim that the terms contained in the HOA represent legally binding and enforceable obligations.

Step 1: Establish the facts giving rise to the breach of duty

The first step is to establish the facts - mere suspicion is never going to be sufficient to build a case against delinquent directors. Gathering information can be tricky for minority shareholders who are not themselves directors and who are consequently not privy to directors' meetings or discussions about the company's day-to-day affairs. Nevertheless, shareholders are entitled to receive certain information and to attend the annual general meetings (AGM). The latter is an invaluable opportunity to ask questions. The directors are not necessarily obliged to answer every question so it is best to exercise some restraint in the manner and tone of the enquiry. Apart from attending the AGM, shareholders are also entitled to inspect the company's internal registers and contracts involving a potential conflict of interest of its directors. Here you will find more information about that. The information you gather need not demonstrate a definitive breach of duty by a director but it should be enough to raise the bar beyond a mere suspicion. More cogent evidence can be gathered at a later stage during litigation if the matter proceeds that far.

Step 2: Identify the director's duties being breached.

Company law expects a lot from company director - the list of duties is long and scattered. Section 228 of the Companies Act 2014 sets out the fiduciary duties of directors as distilled form hundreds of years of case law. The fiduciary duties of directors are that each director shall:

  1. Act in good faith in what the director considers to be the interests of the company.
  2. Act honestly and responsibly in relation to the conduct of the affairs of the company.
  3. Act in accordance with the company's constitution and exercise his or her powers only for the purposes allowed by law.
  4. Not use the company's property, information or opportunities for his or her own or anyone else's benefit unless (i) this is expressly permitted by the company's constitution or (ii) the use has been approved by a resolution of the company in general meeting.
  5. Not agree to restrict the director's power to exercise an independent judgment unless (i) this is expressly permitted by the company's constitution or (ii) he considers in good faith that it is in the interests of the company or (iii) it has been approved by a resolution of the company in general meeting.
  6. Avoid any conflict between the director's duties to the company and the director's other (including personal) interests unless he is released from his duty to the company by a provision in the company's constitution or in general meeting.
  7. Exercise the care, skill and diligence which would be exercised in the same circumstances by a reasonable person in his position;
  8. Have due regard to the interests of the company's members. This applies for as long as the company is solvent. Once the company becomes insolvent then the primary interest to which the directors must have regard is that of the creditors.

Step 3: Identify who the duty is owed to.

In the majority of cases where shareholders are in dispute with a director, it is because the former feels personally aggrieved by the actions of the latter. For example, in a small company with only three directors who are also shareholders, one of them may feel that he is being unfairly excluded from the business by the other directors. In that situation, the allegation is not so much that the two directors are in breach of their duty to the company but rather that they are being oppressive towards the complainant personally. The manner of dealing with each situation is quite different. The duties which are owed to the company may only be enforced by the company whereas relief for oppressive behaviour towards a shareholder can be sought by that shareholder personally. Thus, in her recent decision in Sutton v. Salumi Grazing Limited )ex tempore, High Court, Stack J, record number 2021/5206P), Stack J refused to grant an injunction to the applicant, a shareholder and director of a company, who claimed that the first respondent (the company's landlord) and second respondent (another director of the company) had wrongly terminated the company's lease and transferred it to another company of which the second respondent was also a director. The judge noted that the applicant had a strong case for the injunction, however, the duties alleged to have been breached by the respondents were owed to the company itself and not the applicant personally. Therefore, the applicant was wrong to have issued proceedings in his personal name and should have followed the procedure for bringing them in the name of the company.

Step 4: Raise the issue privately with the director(s).

This is probably easier to do in small companies where the shareholders know one another personally and often see each other on a daily basis. If that is not possible then the issue can be raised by email or formal letter to the Board of Directors. The correspondence should specify the concerns, identify the affected director/directors and state the remedy being sought. The remedy may be as simple as an explanation for a certain transaction or decision taken by the directors or it may be as drastic as the reversal of that decision or resignation of a director.

Step 5: Raise the issue at the AGM.

If no satisfactory resolution is forthcoming from the directors, it may be prudent to raise the concern formally at an AGM. In that way, the complaint can be formally recorded in the Minutes of the AGM and be made known to the other shareholders who attend the AGM. It is important however to avoid making any statement which may be defamatory to the director or directors concerned.

Step 6: Seek the director's removal.

A director may be removed from office by an ordinary resolution of the company at general meeting. Mustering sufficient support to remove a director may require co-ordinating with other members of the company. In some cases, for instance where the directors who are in breach of their duty are also majority shareholders (or who control 50% of its voting rights), it may not be possible. This article describes the steps for removing a director.

Step 7: Seek legal advice.

This can be done at any stage during the process and it is better to obtain advice at an early stage. In that way, you will know where you stand in terms of the law. A specialist lawyer should be able to tell you whether (a) there has been a breach of duty by one or more of the directors based on the evidence, (b) whether that duty is owed to the company or you personally or both, (c) the legal options available and (d) the likelihood of success in taking each option. Not only will a legal Opinion help you decide how to proceed but it also affords effective ammunition for confronting the directors about your concern.

Step 8: Request the Board of directors to issue proceedings.

Where one or more of the directors is in breach of their duty to the company and you have obtained legal Opinion to that effect, you can write to the Board of directors requesting that the company should issue legal proceedings against the director in question. The proceedings will need to be issued in the company's name, and only the Board of Directors has the power to make such a decision. Thus, the Board may decide to sue a director for profits made by him as a consequence of breaching his duties. Since the proceedings are issued by the company, they are paid for by the company.

Step 9: Litigation.

Because of the time and expense involved in litigation, we recommend avoiding it until other dispute resolution mechanisms such as mediation or arbitration have been attempted. However, where the case against the director is strong and the other directors refuse to seek redress on the company's behalf, litigation may be the only remaining option. This typically arises where the alleged wrongdoers (the company directors) are also the majority shareholders. Rather than ceasing or reversing their wrongful actions, they opt instead to use their voting powers to affirm those actions. Rather than causing the company to issue legal proceeding against themselves, they instead vote to ratify their wrongdoing. Since the company is thereby precluded from seeking redress, it is left to the complainant to compel the company to issue proceedings against them. This is done by way of a "derivative action", a complex procedure which is not set out in the Companies Act 2014 but rather contained in the Rules of the Superior Courts. The legal costs of a derivative action are paid by the company, and any damages awarded against the directors in the proceedings are paid to the company. This can be contrasted with proceedings under section 212 of the Companies Act 2014 where the applicant alleges oppression against him in his capacity as a member of the company. The remedy in those proceedings is normally awarded to the applicant personally.

Step 10: Consider other options.

There may be other options available aside from litigation. For example, the company or its shareholders may be willing to buy out your shareholding, resulting in an effective exit from the company. if you are a creditor of the company then, depending on the status and level of the debt, it may be possible to force the company into liquidation. If that happens, a liquidator will be appointed to scrutinise the directors' actions and, where appropriate, to issue legal proceedings against them on behalf of the company for breaches of duty.

Author: Mahmud Samad BL
Publication date: 10th June 2024