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Personal gain
28/06/2005 The Star Articles of Law with Bhag Singh
Directors of companies have to be very careful when they carry out duties on
behalf of the company – especially when they are likely to obtain a benefit
for themselves in the process.
The line between incidental enrichment and a breach of fiduciary duty can
sometimes be a very fine one. The duty of a director as set out in the
Companies Act 1965 is “at all times to act honestly and use reasonable
diligence in the discharge of the duties of his office.”
Yet in reality, it may be difficult to make out that there has been a breach
of duty or a failure to act honestly. In almost all situations one person’s
gain is another person’s loss and a director may find that his personal
interest may be involved when acting on behalf of the company.
When this happens it may appear unfair that the director should sacrifice
his own interests to benefit the company. A better option would be for the
director to withdraw altogether. But on occasion such withdrawal may not be
in the best interests of the company either. If he continues there is
undoubted conflict. How can these interests be reconciled?
The Australian case of Furs Limited v Tomkies illustrates the difficulties
likely to be faced and how the matter may best be resolved.
G.V. Tomkies, managing director of Furs Limited, was authorised by the
directors to negotiate the sale of the tanning, dressing and dyeing branch
of its business which was coming to be seen as unsuccessful. Tomkies was
also the manager of that branch of the business.
In the course of negotiations, the prospective buyer wanted to be assured
that the services of Tomkies would be available to the company which was
proposed to be established in connection with the purchase of the business.
Tomkies had special knowledge of the tanning, dyeing and dressing branch of
the business, which had been developed under his management. He had been
sent abroad at the company’s expense and had knowledge of the process of
manufacture regarded to be of considerable value.
Tomkies repeated this to the chairman of the company who said that if the
company sold the branch of its business, which was under discussion, it
could not afford to keep Tomkies on its staff anyway. He advised Tomkies to
make the best deal possible in the new company.
Before the sale was concluded, Tomkies arrived at an arrangement with the
purchaser under which he would become an employee of the purchaser (or of a
company to be formed for the purpose) for three years for which he would be
paid a fixed salary as well as a lump sum (to be satisfied partly by shares
in the new company and partly by a guaranteed promissory note).
After the agreement had been made, Tomkies reported to the Board the price
the purchaser was offering for the business and the offer was accepted.
However, neither the directors nor the shareholders were told about the lump
sum Tomkies was receiving.
When the payment of a lump sum came to the knowledge of the company, after
the transaction had been completed, it claimed that Tomkies, being in a
fiduciary position, was guilty of a breach of duty and was liable to pay the
company the amount of the profit he made by way of the lump sum payment.
It was held that Tomkies was bound to account for the paid-up shares and the
promissory note, or the proceeds thereof, because they were undisclosed
profits received by him in the course of a transaction in which he occupied
a position which created a fiduciary relationship with the company.
This decision highlights the position of a director who finds himself in
such a situation. It establishes that an undisclosed profit which a director
derives from the execution of his fiduciary duties belongs in equity to the
company.
A number of aspects can be examined which show why the director’s action was
considered wrong and what he could have done to redeem the situation.
For one, the lump sum payment was not clearly identified in terms of what
the payment was for. No distinction was made between information that
belonged to the company and the knowledge and expertise which Tomkies had
acquired (which had become an inalienable part of him).
It would have been advisable to apportion the value of these two assets,
interdependent as they were, in favour of the company, an amount that would
be payable to it in respect of the know-how that could have been transferred
by it independently in any event.
The other aspect was the failure to make a full disclosure to the
shareholders and directors. The High Court of Australia rejected Tomkies’s
contention, “that his principal had placed him in a position in which his
duty and interest conflicted and thus waived the right to the performance of
an undivided duty.”
Tomkies argued that the company had lost nothing by his accepting the lump
sum because the purchaser was not prepared to pay anything beyond what had
been offered.
However, the court decided that: “It is no answer to the application of the
rule that the profit is of a kind which the company could not itself have
obtained or that no loss is caused to the company by the gain of the
director.” |
