Directors and Members 2

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Definition of Director

One who, or that which, directs; one who regulates,guides, or orders manager or superintendent.

One of a body of persons appointed to manage theaffairs of a company or corporation; as, the directorsof a bank, insurance company, or railroad company.

A part of a machine or instrument which directs itsmotion or action.

A slender grooved instrument upon which a knife ismade to slide when it is wished to limit the extent of

motion of the latter, or prevent its injuring the partsbeneath.

Duties and responsibilities ofDirectors

Directors' duties are a series of statutory, commonlaw and equitableObligations owed primarily by members ofthe directors to the corporation thatEmploys them. It is a central part ofcorporatelaw and corporate governance. Directors' duties areanalogous to duties owed by trustees to beneficiaries,and by agents to principals.

Directors owe duties to the corporation, and not toindividual shareholders, employees or creditorsoutside exceptional circumstances

Directors' core duty is to remain loyal to thecompany, and avoid conflicts of
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Interest

Directors are expected to display a high standard ofcare, skill or diligence

Directors are expected to act in good faith to promotethe success of the corporation

Acting within powersS.171 CA 2006

Directors are also strictly charged to exercise theirpowers only for a proper purpose. For instance, were

a director to issue a large number of new shares, notfor the purposes of raising capital but to defeat apotential takeover bid, that would be an improperpurpose.However, in many jurisdictions the members of thecompany are permitted to ratify transactions thatwould otherwise fall foul of this principle. It is alsolargely accepted in most jurisdictions that thisprinciple should be capable of being abrogated in thecompany's constitution.Directors must exercise their powers for a properpurpose. While in many instances an improperpurpose is readily evident, such as a director lookingto feather his or her own nest or divert an investmentopportunity to a relative, such breaches usuallyinvolve a breach of the director's duty to act in goodfaith. Greater difficulties arise where the director,while acting in good faith, is serving a purpose that isnot regarded by the law as proper.

The seminal authority in relation to what amounts toa proper purpose is the Privy Council decision ofHoward Smith Ltd v. Ampol Ltd.The case concernedthe power of the directors to issue new shares. It wasalleged that the directors had issued a large numberof new shares purely to deprive a particularshareholder of his voting majority. The court rejected


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an argument that the power to issue shares couldonly be properly exercised to raise new capital as toonarrow, and held that it would be a proper exercise ofthe director's powers to issue shares to a larger

company to ensure the financial stability of thecompany, or as part of an agreement to exploitmineral rights owned by the company. If so, anincidental result (even desirable) that a shareholderlost his majority, or a takeover bid was defeatedwould not itself make the share issue improper. But ifthe sole purpose was to destroy a voting majority orblock a takeover bid, that would be an improperpurpose.

Promoting companysuccess

S.172 CA 2006, "to promote the success of thecompany for the benefit of its members as a whole".It sets out six factors to which a director must haveregards in fulfilling the duty to promote success.These are:The likely consequences of any decision in the longtermThe interests of the companys employees

The need to foster the companys businessrelationships with suppliers, customers and othersThe impact of the companys operations on thecommunity and the environmentThe desirability of the company maintaining areputation for high standards of business conduct,


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and the need to act fairly as between members of acompany.

This represents a considerable departure from thetraditional notion that directors' duties are owed onlyto the company. Previously in the United Kingdom,under the Companies Act 1985, protections for non-member stakeholders were considerably more limited(see e.g., s.309, which permitted directors to takeinto account the interests of employees but thatcould be enforced only by the shareholders, and notby the employees themselves. The changes havetherefore been the subject of some criticism.Directors must act honestly and in bona fide. The test

is a subjective onethe directors must act in "goodfaith in what they considernot what the court mayconsideris in the interests of the company..." perLord Greene MR. However, the directors may still beheld to have failed in this duty where they fail todirect their minds to the question of whether in fact atransaction was in the best interests of the company.Difficult questions arise when treating the companytoo abstractly. For example, it may benefit a

corporate group as a whole for a company toguarantee the debts of a "sister" company, even ifthere is no "benefit" to the company giving theguarantee. Similarly, conceptually at least, there is nobenefit to a company in returning profits toshareholders by way of dividend. However, the morepragmatic approach illustrated in the Australian caseof Mills v. Mills (1938) 60 CLR 150 normally prevails:"[directors are] not required by the law to live in anunreal region of detached altruism and to act in the

vague mood of ideal abstraction from obvious factswhich must be present to the mind of any honest andintelligent man when he exercises his powers as adirector."

Independent judgmentS.173 CA 2006


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Directors cannot, without the consent of thecompany, fetter their discretion in relation to theexercise of their powers, and cannot bind themselvesto vote in a particular way at future board meetings.This is so even if there is no improper motive orpurpose, and no personal advantage to the director.This does not mean, however, that the board cannotagree to the company entering into a contract thatbinds the company to a certain course, even if certainactions in that course will require further boardapproval. The company remains bound, but thedirectors retain the discretion to vote against takingthe future actions (although that may involve a

breach by the company of the contract that the boardpreviously approved).

Care and skill

Traditionally, the level of care and skill a directormust demonstrate has been framed largely withreference to the non-executive director. In Re CityEquitable Fire Insurance Co [1925] Ch 407, it wasexpressed in purely subjective terms, where the courtheld that:"a director need not exhibit in the performance of hisduties a greater degree of skill than may reasonablybe expected from a person of his knowledge and

experience."

However, this decision was based firmly in the oldernotions (see above) that prevailed at the time as tothe mode of corporate decision making, and effectivecontrol residing in the shareholders; if they elected


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and put up with an incompetent decision maker, theyshould not have recourse to complain.

Loyalty and conflicts of interest

Directors also owe strict duties not to permit anyconflict of interest or conflict with their duty to act inthe best interests of the company. This rule is sostrictly enforced that, even where the conflict of

interest or conflict of duty is purely hypothetical, thedirectors can be forced to disgorge all personal gainsarising from it. In Aberdeen Ry v. Blaikie (1854) 1Macq HL 461 Lord Cranworth stated in his judgmentthat,"A corporate body can only act by agents, and it is, ofcourse, the duty of those agents so to act as best topromote the interests of the corporation whoseaffairs they are conducting. Such agents have dutiesto discharge of a fiduciary nature towards their

principal. And it is a rule of universal application thatno one, having such duties to discharge, shall beallowed to enter into engagements in which he has,or can have, a personal interest conflicting or whichpossibly may conflict, with the interests of thosewhom he is bound to protect... So strictly is thisprinciple adhered to that no question is allowed to beraised as to the fairness or unfairness of the contractentered into..."

S.175 CA 2006Keech v. Sandford (1726) Sel Cas. Ch.61Regal (Hastings) Ltd v Gulliver [1942] All ER 378

Cook v Deeks [1916] 1 AC 554


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Directors have a duty to prevent a company incurringa debt while it is insolvent.

Duty to act in good faith

Directors have a duty to exercise their powers anddischarge their duties in good faith in the bestinterests of the company.

Improper use of position

A director, secretary, officer or employee of acompany cannot improperly use their position to gainan advantage for themselves or someone else, or to

cause detriment to the company.Conflict of interest

Directors have a duty to avoid situations in whichthere is a real possibility of conflict between theirpersonal interests and the company's interests.

Definition of Members

Shareholder (stockholder) of a firm. In corporatelegislation, a member is generally defined as

(1) the subscriber to a firm's memorandum ofassociation (or articles of incorporation) who isdeemed to have agreed to become a member of thefirm, and whose name is entered in the firm's registerof members when the firm is registered (orincorporated).

(2) Every other person who agrees to become amember of the firm and whose name is entered in thefirm's register of members. Shareholders who join afirm at its inception are called founder members.


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Duties And responsibilities ofMembers

Members of a limited liability company (LLC) have

duties and rights that are inMany ways comparable to those of a partner in apartnership. The operatingAgreement of the LLC can impose further obligationsupon the members.

Fiduciary Duties

If a member of an LLC is also a manager of the LLC,then that member is in a position of trust. To protectother owners of the LLC, these members owe the LLCthe duty of loyalty and the duties of care.The duty of loyalty prevents a member fromcompeting with the LLC in another business. Amember must refrain from dealing with a person or

business with interests adverse to those of the LLCand must account for any benefits received from useof LLC property or from the winding up of LLC affairs.The duty of care requires a member to refrain fromgrossly negligent, reckless, or intentional misconduct.The duties of loyalty and care are similar inpartnership law. Managers of an LLC who are notowners are held to the same standard. However, amember who is not a manager of an LLC is not bound

by the same duties, since such a manager is notinvolved in the day-to-day activities of the company.


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Indemnity and Contribution Rights

The Uniform Limited Liability Company Act (UCCLA)provides that a member must be reimbursed for

payments made on behalf of the LLC and indemnifiedfor liabilities incurred by the member during theordinary course of the LLCs business. These rightsare similar to those provided to partners in a generalpartnership. However, most state statutes do notaddress indemnity rights. Similarly, the ULLCAprovides that members are required to makecontributions according to the agreement of theowners of the company, which is similar to rightsprovided in partnership laws. An operating agreementwill often set forth such indemnity and contributionrightsThe default rules regarding distributions to membersdiffer among the states. Some states provide thatmembers receive a share of distributions in the sameproportion as their contributions to the LLC (pro ratadistribution). Other states, including those that haveadopted the ULLCA, provide for equal distributionamong the members (per capita distribution). These

provisions can be altered in the operating agreement.

Transferring Interests

A member may transfer his or her financial rights toprofits and losses, and the right to receivedistributions, in all states. However, a member cannottransfer full ownership interests, such as thoserelated to the right to manage the company, withoutunanimous agreement of all of the other members.Rights related to transferability of interests can bemodified in the operating agreement.


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Documents

Directors and Members 2