#7404 - Directors’ Duty Not To Make Secret Profits - Business Associations I

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

Consider:

1. Is the director personally liable?

2. Is the transaction enforceable/reversible?

3. 3^rd parties?

• 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.

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.

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...