Directors’ Duty Not To Make Secret Profits Notes

Class 14 Directors’ duty not to make secret profits

Corporations Act ss 182, 183.

CORPORATIONS ACT 2001 - SECT 182

Use of position--civil obligations

Use of position--directors, other officers and employees

(1) A director, secretary, other officer or employee of a corporation must not improperly use their position to:

(a) gain an advantage for themselves or someone else; or

(b) cause detriment to the corporation.

Note: This subsection is a civil penalty provision (see section1317E).

(2) A person who is involved in a contravention of subsection(1) contravenes this subsection.

Note 1: Section79 defines involved .

Note 2: This subsection is a civil penalty provision (see section1317E).

CORPORATIONS ACT 2001 - SECT 183

Use of information--civil obligations

Use of information--directors, other officers and employees

(1) A person who obtains information because they are, or have been, a director or other officer or employee of a corporation must not improperly use the information to:

(a) gain an advantage for themselves or someone else; or

(b) cause detriment to the corporation.

Note 1: This duty continues after the person stops being an officer or employee of the corporation.

Note 2: This subsection is a civil penalty provision (see section1317E).

(2) A person who is involved in a contravention of subsection(1) contravenes this subsection.

Note 1: Section79 defines involved .

Note 2: This subsection is a civil penalty provision (see section1317E).

Redmond [7.455]-[7.495].

• The duty to avoid conflicts:

  • Duty and interest.

  • Profits and misappropriations.

  • When is there a conflict?

    • Strict formulation- no fiduciary enter ‘engagements which possibly may conflict with the interests of those he is bound to protect’- Aberdeen v Blaikie Bros.

    • Lenient formulation- ‘the reasonable man…would think there was a real sensible possibility of conflict- Phipps v Boardman

    • In Australia ‘a significant possibility’ of conflict- Chan v Zacharia, ‘a real or substantial possibility of conflict’- Hospital products.

    • Multiple conflicts within companies- shareholder/director; multiple or even competing directorships; nominee directorships.

• Fairness is irrelevant?

  • Implementation and evidential costs.

  • Occassional relaxation? Community values; in remedial orders, where breach is honest but mistaken.

• To whom is the duty owed?

  • To the company

  • Exceptionally- to the shareholders individually

  • Coleman v Myers

    • The idea that there may be exceptionally a director duty to the shareholders rather than to the company in deviation from an old rule from Persival v Right which in UK they said they owe their duties to the company. In this case there was a family company where there were family shareholdings over a number of different Myer generations.

  • Galavanics v Brunninghausen

Secret Profits: The Appropriation of Corporate Property, Information and Opportunity

Consider:

1. Is the director personally liable?

2. Is the transaction enforceable/reversible?

3. 3^rd parties?

The Distinct bases of Equitable Obligation

• Content of duty:

  • Use of position to obtain a benefit for self.

  • Use of information obtained from position to secure benefit for self.

  • Prophylactic and constraining control.

  • S182- note differences from general law.

  • S183- note differences from general law.

  • Reckless or dishonest- criminal- s184

  • Ratification

    • Sometimes confusion about how it should be carried out. Common law requires the informed consent and approval of shareholders.

• Secret profits: Furs v Tomkies.

• Diversion of opportunity: cook v deeks, regal Hastings v Gulliver, Peso v Cropper, Phipps v Boardman, IDC v Cooley, Canaero v O’Malley, Qld Mines v Hudson. What is the significance of dishonesty? Rurs, Cook, IDC, Canaero.

• While directors are not generally trustees of company property, they are treated as trustees of company funds in their hands or under their control. If directors misapply company funds, they are liable to make good the moneys upon the same footing as if they were trustees. Similarly, a director who misappropriates other property of the company will also be liable as constructive trustee of the property.

• A company director is under a fiduciary obligation to account to the company for benefits derived in 2 general situations:

  1. The first arises where the benefit was obtained in circumstances where there existed a conflict, or significant possibility of conflict, between the director’s duty to the company and personal interest or another interest which the director is bound to protect

  2. The second arises where the benefit was obtained or received by use or by reason of the office of director or of opportunity or knowledge resulting from it.

• A person who is under a fiduciary obligation must account to the person to whom the obligation is owed for any benefit or gain:

  • which has been obtained or received in circumstances where a conflict or significant possibility of conflict existed between his fiduciary duty and his personal interest in the pursuit or possible receipt of such a benefit or gain OR

  • which was obtained or received by use or by reason of his fiduciary position or of opportunity or knowledge resulting from it.

• Furs Ltd v Tomkies sets out the equitable principles, their rationale and remedies and canvasses release through informed shareholder consent.

7.460 Furs Ltd v Tomkies (1936) 54 CLR 583

High Court of Australia

Facts

• Tomkies was MD of Furs and manager of a certain section of the business. Another company wanted to buy that section but only if Tomkies would work for them. T told the chairman who said that T could no longer be retained by Furs if the sale went ahead but instructed him to make the best deal he could. After T agreed to the service contract with the purchaser, the purchase price dropped significantly. Nevertheless Furs accepted the offer without being aware of the payment to T. When the payment became known, Furs claimed it as an undisclosed profit received while acting in a fiduciary capacity.

Rich, Dixon and Evatt JJ:

• Unless the articles state otherwise, no director shall obtain for himself a profit by means of a transaction in which he is concerned on behalf of the company unless all material facts are disclosed to the shareholders and by resolution a general meeting approves of his doing so, or all the shareholders agree.

• An undisclosed profit which a director derives from the execution of his fiduciary duties belongs in equity to the company – he holds it on constructive trust for the company

• The fact that the company may not itself have obtained the same kind of profits, or that no loss is caused to the company is not an excuse to avoid this rule.

Present case

• The payment was obtained by Tomkies in the course of a transaction which he was carrying out on behalf of the company.

• By accepting the service contract, Tomkies greatly diminished the price obtainable by the company

• If he wanted to legitimately take such action, he could have made complete disclosure to the shareholders and sought confirmation from them.

Diversion of Corporate Opportunities

• Cook v Deeks: Directors will be accountable for profits to the company if they divert business opportunities away from the company and into their own business. Directors cannot sacrifice the interests of the company which they are bound to protect.

7.465 Cook v Deeks [1916] 1 AC 554

Privy Council

Facts

• Toronto Construction Co was formed to construct a railway line for the Canadian Pacific Railway. Upon completion, 3 of the 4 directors formed a new company in order to obtain a new building contract with CPR. A general meeting of Toronto was held at which the 3 directors used their voting power, holding a majority with 75%, to approve the sale of part of the company’s plant to the new company and to declare that Toronto had no interest in the new contract.

• The excluded director, Cooks, brought proceedings against the other directors and their company claiming that they held the contract for the benefit of Toronto.

• Deeks incorporated another corporate vehicle. They diverted the corporate opportunity of the second railway concession contract to the second corporate vehicle so Cook would get no benefit. To what degree can Cooks pass a ratification resolution (60% of company shares) that is self aggrandising and what effect should it have on Cooks rights? Normal resolution requires 50% vote so Cooks could do nothing.

• The directors cannot take the benefit of the opportunity themselves but must hold it on trust for the company they were directors and shareholders of in common with Mr Cook. The court held it was a fraud on the minority (aka Cook) to pass a ratification resolution which forgave Deeks brothers such an outrageous breach of duty which amounted to the brothers taking the company’s property. The complicating factor was that the contract rights were still in the process of being sorted out. If the concession was complete there would have been contract rights that came into play in the case.

• It is a good case for thinking about shareholder remedies and director fiduciary duties. Clear example of the limits of the ratification principle. Cannot take the company’s profits and oppress the minority shareholder through ratification even if you go through meeting formalities and have the majority. Majority has limitations for fraud against minority.

• All in same line of business. Cooks and Deeks wanted opportunity. Deceipt and fraud by Deeks. There was an attempt at ratification but held ineffective and oppressive to minority.

Lord Buckmaster LC:

• Held: the 3 directors were guilty of a breach of duty in the course they took to secure the contract.

Can Toronto Co claim from the defendant’s the benefit of the contract?

• They intentionally concealed all circumstances relating to their negotiations until a point had been reached when the whole arrangement had been concluded in their own favour and there was no longer any real chance that there could be any interference with their plans.

• This means they deliberately used their influence and position to exclude the company from gaining a benefit when it was their duty to ensure that the company received it.

• Thus the defendant directors were guilty of a distinct breach of duty and they could not retain the benefit of such a contract for themselves but must be regarded as holding it on behalf of the company.

Can this be made regular by resolutions of the company controlled by the defendants?

• The contract in question was entered into such circumstances that the directors could not retain the benefit of it for themselves, then it belonged in equity to the company and ought to have been dealt with as an asset of the company.

• Disclosure to the Board (the remaining 1 director) does not allow the directors to retain the benefit because it would be at a cost to the minority.

• Disclosure to the SHs also didn’t allow them to retain the benefit because the GM cannot authorise a theft from the company – which is what the resolution ultimately proposed. The directors wanted to take from the company the opportunity of contracting again with the CPR.

• Therefore the defendants must account to the Toronto Co for the profits which they have made out of the transaction.

Consider the following steps:

• How and why did the breach occur?

• Consequences?

• Can the General Meeting resolve?

There are two ways for a company to have knowledge:

1. Organic theory – if a person is the directing mind of the company (Leendard v Carrion Co) - we attribute the mental processes of that human being so that it becomes the company’s mental processes. By virtue of the fact that this person is the controlling mind then they are considered the mind of the company.

2. Agency – if the agent is conducting actions on behalf of the company then the agent’s mental processes are the mental processes of the company. In Cook v Deeks all the directors and shareholders knew what had happened with the company. If there be a breach, the reason why company no.2 as a result of the contravention.

Profits from Office

• Regal (Hastings) Ltd. v Gulliver: When profits are acquired by reason and in course of a fiduciary obligation, they must be accounted for.

• The liability arises from the mere fact of a profit being made.

• It is irrelevant if directors acted bona fide in the interests of the company as the breach will not depend on fraud or the absence of bona fide intentions.

• It is irrelevant that the directors acted in their capacity as directors, and had they acted as normal members of the public, the company would not have been to exploit the opportunity anyway.

7.470 Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n

House of Lords

Facts:

• Regal owned a cinema in Hastings. They took out leases on two more, through a new subsidiary, Amalgamated, to make the whole lot an attractive sale package. However, the landlord first wanted them to give personal guarantees. They did not want to do that. Instead the landlord said they could up share capital to 5,000. Regal itself put in 2,000, but could not afford more (though it could have got a loan).

• Four directors each put in 500, the Chairman, Mr Gulliver, got outside subscribers to put in 500 and the board asked the company solicitor, Mr Garten, to put in the last 500.

• They sold the business and made a cool 2.80 per share. But then the buyers brought an action against the directors, saying that this profit was in breach of their fiduciary duty to the company. They had not gained fully informed consent from the shareholders.

• Regal had Gulliver as chairman. 4 directors. Garten was a shareholder. Amalgamated was a subsidiary. They took advantage of an almost riskless turnaround. Regal did very well out of it and got the return on capital of $2000 pounds worth of investment. The directors made a decision of the board of regal. There were other avenues and you could have got a loan for example.

• The 4 directors the courts. Mr Garten wasnt a director so no fiduciary duty but he was a solicitor so he has a fiduciary duty to the company in this role but he was not held accountable for the profit because the transaction he had with the board because he subscribed to the shares at their request. It is not within the boards power to do this- BOD have the share power. BOD by inviting him were consenting and approving to what would otherwise would be a breach of solicitor implied relationship.

• The court held that the directors got the information and the opportunity to subscribe solely because of the nature and scope of their office.

• Directors resollution said opportunity could not be afforded but directors were all involved in this resolution and limited evidence about alternatives and they all benefited in it. No deceipt or fraud, maybe could not have taken opportunity for fraud, no ratification and plaintiff won. The solicitor did not need permission.

Lord Russell of Killowen:

• The rule of equity which insists on those, who by use of a fiduciary position make a profit, being liable to account for that profit, in no way depends on fraud, or absence of bona fides; or upon questions on considerations as whether the profit would or should otherwise have gone to the company, or whether the profiteer was under a duty to obtain the source of the profit for the company, or whether he took a risk or acted as he did for the benefit f the company, or whether the company has in fact been damaged or benefited by his action.

• The liability arises from the mere fact of a profit having, in the stated circumstanced been made.

Present case

• Profit was made.

• The profitable shares were acquired by reason and in course of their office of directors of Regal – the scheme was for the benefit of Regal and its shareholders through Regal’s shareholding in Amalgamated.

• Thus the directors were standing in a fiduciary relationship to Regal in regard to the exercise of their powers as directors, and having obtained these shares by reason and only by reason of the fact that they were directors of Regal and in the course of the execution of that office, are accountable for the profits which they have made out of them.

• They could have protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting. In default of such approval, the liability to account remains.

• The solicitor who also took up shares and was not a director does not have to account or profits.

Renouncing an Opportunity

• Regal v Gulliver: In general it will be irrelevant if the company is unable to exploit the business opportunity, for example, due to a lack of funds.

• Peso Silver Mines v Cropper: However, where the board makes a bona fide rejection of opportunity through sound business judgment, there will NOT be a breach of fiduciary obligations, if these opportunities are subsequently exploited in a private capacity.

• Also refer to Queensland Mines

7.475 Peso Silver Mines v Cropper

Facts

• Peso was actively exploring mining claims in the same area as Dickson, a prospector. Seeking to sell his claims, D approached Dr Aho, a consulting geologist retained by a number of mining companies including Peso. Dr Aho suggested D offer the claims to Peso. The board of Peso rejected the offer. A short time later, Dr Aho approached Cropper (a director at Peso) to suggest that they form a syndicate to acquire D’s claims. A company was formed to do so. C did not disclose this interest to the board of Peso until 2 years later following which he was asked to transfer them to Peso. C refused. Peso commenced action for a declaration that C held these interests upon a constructive trust, as property acquired as a result of his position as a director of Peso.

• Rejected an offer made to the company then some months later the entity that offered the opportunity to the company offered it to a member of the board, Dr Cropper. He accepted and it proved to be profitable. The board of the company came at odds with itself. The board emphatically rejected the opportunity and this was only one member of the board and he got the opportunity a lot longer after resolution and he didn’t solicit the opportunity. It was only because he was in the mineral rights area. Different to Regal. He was offered the opportunity in his own right. The directors in Regal all took up the opportunity that they had rejected for the company.

• Opportunity could not be taken because board was against it. Court found no deceit or fraud. No disclosure or ratification. Defendant won.

Cartwright J:

• Peso, having rejected the offer, threw the opportunity into the free market – available to anyone who wished to take advantage of it. In this case it was C which was perfectly legitimate.

• Held that it was NOT the case that C obtained the interests by reason of the fact that he was a director of the appellant and in the course of the execution of that office. C was approached as an individual member of the public whom Dr Aho was seeking to interest as a co-adventurer.

• Therefore there was no connection between his position as director and his interest acquired with Dr Aho. Thus he was under no liability.

Bull JA:

• An out-and-out bona fide rejection of...

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