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DIRECTORS AND OFFICERS' LIABILITY.doc

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DIRECTORS AND OFFICERS' LIABILITY.doc

     DIRECTORS AND OFFICERS’ LIABILITY

INTRODUCTION

The role of directors and officers in South Africa came under scrutiny in The

    King Report on Corporate Governance dated 29 November 1994. In chapter 5

    the report sets out some general guidelines for directors. It is worth highlighting these guidelines in this introduction as they cover the whole spectrum of directors' duties and obligations:

    * "Directors should ensure that they have the time to devote to carry out properly their duties and responsibilities to the company.

    * Directors should be informed about the financial, social and political milieu in which the company operates.

    * Directors must be satisfied that they are in a position to make informed decisions.

    *****

    * Directors must never permit a conflict of duties and interests.

    * Directors must disclose potential conflicts of interest at the earliest opportunity.

    * Directors must act independently of any outside fetter or instruction.

    *****

    * Directors must act with enterprise and always strive to increase shareholders' value while having regard to the interests of all stakeholders.

    * Directors must ensure that all interested parties are fully informed of any material matter affecting the company's business with openness and substance over form being their guideline.

    * Directors must exercise utmost good faith, honesty and integrity in all their dealings with or on behalf of the company.

    *****

    * Directors must exercise the care and skill which can reasonably be expected of a person of their expertise.

    * Directors must always act in the best interests of the company and never for any sectoral interest.

*

    Directors must ensure that the company's strategy and structure has been collectively agreed by the board.

    *****

    * Directors must insist that board papers and information are given to them timeously so that they have time to study them and make properly informed decisions.

    * Confidential matters of the company, learned in their capacity as a director, should be treated as such and not divulged to anyone without the authority of the company.

    * If a director is in doubt about any aspect of their duties they should obtain independent professional advice.

    *****

    * Directors must ensure that the company prepares annual budgets against which the company's performance can be monitored.

    * Directors must ensure that procedures and systems are in place to act as checks and balances on the information being received by the board.

    * Directors must ensure that the board monitors the performance of executive management against budgets, business plans, industry norms, prior year's performance etc.

    * Directors must ensure that the company has an affirmative action plan in place to advance members of disadvantaged communities in the business of the company as in most cases it will be necessary for the long term survival of the company".

These guidelines reflect the legal obligations of the director.

    A director's or officer's liability may arise from various duties under common law or statute. We deal with the position under both common law and statute and refer in particular to the Companies Act 61 of 1973. We will also highlight certain other statutes under which directors and officers may incur liability and deal briefly with the potential liability of a director or officer under criminal law. This is a publication of a general nature and treatment of the subject matter cannot be and is

    not exhaustive. There will be other potential liabilities of directors or officers with which we have not dealt and readers are requested to consult their legal advisor if in doubt.

THE DIRECTOR AND OFFICER OF THE COMPANY

    Section 208 of the Companies Act 61 of 1973 provides for the appointment of directors and requires every public company to have at least two directors and every private company to have at least one director. A director is defined in the Companies Act as follows:

    ""Director" includes any person occupying the position of director or alternate director of a company by whatever name he may be designated".

Henochsberg on the Companies Act describes the directors of a company as

    those persons who, in terms of its articles are empowered to exercise all its powers, excluding those powers which are required to be exercised by the company in general meeting.

    A "director" includes a non-executive director and all the principles discussed in regard to a director apply equally to both executive and non-executive directors. In dealing with the non-executive director The King Report, chapter 6 paragraph 11, says the following:

    "As each director on appointment becomes a fiduciary in relation to the company and in their dealings on its behalf it is unhelpful to classify directors as executives or non-executives for the purpose of ascertaining their duties to the company or when any specific or affirmative action is required of them. It, therefore, cannot be said that because someone is a non-executive director of a company that their duties are less onerous than they would have been if they had been an executive director. Whether the enquiry be one in relation to negligence, reckless conduct or fraud, the law is the same for all directors. Thus, in any particular case one of the factors relevant to judging the conduct of a director might be their access to information and the justification for relying upon the reports they receive from others, whether or not they have been classified by the company as an " executive" or " non-executive" director".

    The company is an artificial legal entity and can only function through human agency in the form of the company's board of directors. This human agency has been described in the case law as the "directing mind and will" of the company. Thus, a company, through the board of directors, may incur delictual or contractual liabilities as well as statutory liabilities. The directors incur no civil liability for the wrongful conduct of the company merely because they are directors unless they themselves have perpetrated or have wrongfully failed to prevent such conduct. Directors or officers may be personally liable to third parties, ie shareholders or creditors, for injury or damage caused by their own wrongdoing.

    A director stands in a fiduciary relationship to the company, and owes his or her fiduciary duties to the company and not to individual members, creditors, subsidiaries or employees. Fiduciary duties also attach to officers of the company who are not directors, but the nature and extent of these will depend on the particular position of the officer in relation to the company.

    Finally, directors' positions between themselves and the company may be governed contractually. In the absence of such a formal contract their appointment gives rise to an implied contract that their position will be governed by the articles of the company.

THE COMMON LAW

    Duties and obligations of directors and officers exist under common law. The core duties and obligations of the director derive from the common law duty to show good faith to the company. The duties rest on the director individually and not on the board of directors, ie he or she is required to comply with the duties personally and failure to do so attracts personal liability.

A director's common law duties include the following:

* The duty to act with requisite care and skill.

* The duty to act within their powers.

    * The duty to retain their independence and to exercise their powers for the benefit of the company.

    * The duty to avoid conflicts, especially in regard to the director's own personal interests.

    Breach of the director's common law duties could entail personal liability of the director to the company for loss caused to the company as a result of the breach and may include an obligation to restore to the company the property lost or to account to it for profits.

    In addition, a breach of such duties could result in a common law claim by a member or shareholder known as the member's derivative action. This action may be brought by a member against a director or shareholder who controls the majority of the board and who has caused the company to suffer losses as a result of conduct which is either fraudulent or ultra vires. This right of action is recognised in order to prevent recalcitrant directors, through their control of the board, blocking a member's attempt to see to it that the company's rights against the directors are enforced.

STATUTORY DUTIES AND PROVISIONS

    A number of sections in the Companies Act deal with the duties and obligations of directors and could impose liability.

Indemnity of Directors

Section 247 deals with a director's liability to the company

    "247 Exemption from or indemnity against liability of directors, officers or auditors of a company -

    (1) Subject to the provisions of subsection (2) any provision, whether contained in the articles of a company or in any contract with a company, and whether expressed or implied, which purports to exempt any director or officer or the auditor of the company from any liability which by law would otherwise attach to him in respect of any negligence, default, breach of duty or breach of trust of which he may be guilty in relation to the company or to indemnify him against any such liability, shall be void: provided that this subsection shall not be applicable to insurance taken out and kept by the company as indemnification against any liability of any director or officer towards the company in respect of any negligence, default, breach of duty or breach of trust.

    (2) The provisions of subsection (1) shall not be construed as prohibiting a company from indemnifying any director, officer or auditor in respect of any liability incurred by him in defending any proceedings, whether civil or criminal, in which judgment is given in his favour or in which he is acquitted or in respect of any such proceedings which are abandoned or in connection with any application under section 248 in which relief is granted to him by the Court".

    This section prevents a company from exempting or indemnifying directors from their legal liability to the company for negligence, default, breach of duty or breach of trust. The company may however take out insurance as indemnification against any liability of directors towards the company and may indemnify such directors against costs incurred in defending any related proceedings provided they are successful in such defence.

Effect of Amendment

    The directors are, as it were, on their own should they attract liability to the company for negligence, default, breach of duty or breach of trust. In regard to insurance, the company may effect its own insurance covering its own losses caused by such actions by an individual director but the company may not release or indemnify the director, even if it has effected its own insurance. Obviously an insurer would then be entitled to proceed with a subrogated action against the

    individual director. The recent amendment to Section 247 merely confirmed that a company may take out insurance to indemnify itself against any negligence, default, breach of duty or breach of trust by a director, but the amendment did not address the validity of insurance taken out by the company on behalf of its directors protecting such directors against liability arising out of their breach of duty. The King Report, in its recommended statutory amendments, recommended that:

    24.3 There should be a provision for additional insurance cover for directors and officers at the company's expense to cover any conduct on their part which contributed to a failed audit, save for gross negligence or recklessness.

    The amendment referred to clearly did not address this issue but in our view there would be no objection to the company assisting the directors to effect their own insurance against such liability by increasing the directors' emoluments to pay the premiums or for the company to effect such insurance on their behalf citing the individual directors as the insured.

Relief of Directors

    In addition to this, The King Report recommends that statutory amendments should be brought about to reduce the directors' exposure for breach of duty of care and skill where they acted in good faith. Clause 24.6 provides as follows:

    "A director should not incur liability for a breach of the duty of care and skill where they have exercised a business judgment in good faith in a matter in which their decision is an informed and rational one and there is no self-interest".

Section 248 of the Companies Act provides as follows:

"Relief of directors and others by Court in certain cases -

    (1) If in any proceedings for negligence, default, breach of duty or breach of trust against any director, officer or auditor of a company it appears to the Court that the person concerned is or may be liable in respect of the negligence, default, breach of duty or breach of trust, but that he acted honestly and reasonably, and that, having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused for the negligence, default,

    breach of duty or breach of trust, the Court may relieve him, either wholly or partly, from his liability on such terms as the Court may think fit.

    (2) Any such director, officer or auditor who has reason to apprehend that any claim will be made against him in respect of any negligence, default, breach of duty or breach of trust, may apply to the Court for relief, and the Court shall on any such application have the same powers to grant relief as are by subsection (1) conferred upon it with reference to proceedings referred to in that subsection".

    We are of the view that this section applies to claims by both the company and by third parties against directors and officers acting in their capacity as such for negligence, default, breach of duty or breach of trust.

    This section enables total or potential relief from liability to be granted where a director can show that he or she acted honestly and reasonably albeit negligently or in breach of duty or breach of trust. The relief may be granted on such terms as the court deems fit. The section does not however override the provisions of s424 to which we refer below.

Derivative Actions

Section 266 of the Companies Act provides as follows:

"Initiation of proceedings on behalf of company by a member-

    (1) Where a company has suffered damages or loss or has been deprived of any benefit as a result of any wrong, breach of trust or breach of faith committed by any director or officer of that company or by any past director or officer while he or she was a directory or officer of that company and the company has not instituted proceedings for the recovery of such damages, loss or benefit, any member of the company may initiate proceedings on behalf of the company against such director or officer or past director or officer in the manner prescribed by this section notwithstanding that the company has in any way ratified or condoned any such wrong, breach of trust or breach of faith or any act or omission relating thereto.

    This section supplements the shareholder's common law derivative action to which reference is made above. It makes provision for a shareholder, aggrieved by the inaction of the board of directors of the company, to initiate proceedings on behalf of the company to compel a director or officer to make good damages or loss to the company. A member may only initiate proceedings on behalf of the company if he or she has served a written notice on the company calling on it to institute such proceedings within one month from date of service of the notice, and the company thereafter fails to do so.

    Another section of the Companies Act which is of considerable interest to directors or officers is Section 417 which provides for the summoning and examination of persons as to affairs of the company in the winding up of the company. Section 417(1) provides as follows:

Enquiry into Company's Affairs

    "Summoning and examination of persons as to affairs of company -

    (1) In any winding-up of a company unable to pay its debts, the Master or the Court may, at any time after a winding-up order has been made, summon before him or it any director or officer of the company or person known or suspected to have in his possession any property of the company or believed to be indebted to the company or any person whom the Master or the Court deems capable of giving information concerning the trade, dealings, affairs or property of the company".

    This section is extremely wide and could expose directors or officers of a company to extensive examination and interrogation regarding the affairs of the company and the conduct of the company's business. The constitutionality of the provisions of Section 417 has been upheld by the Constitutional Court (see

    Bernstein v Bester NO 1996 (2) SA 751 (CC)), with the exception of the provision in Section 417(2)(b) that "any answer given to any such question may thereafter be used in evidence against him". This latter provision has been held to be constitutionally invalid in relation only to criminal proceedings against the person concerned except where the relevant charges relate to the giving of perjured evidence or a failure to answer lawful questions fully and satisfactorily (see

    Ferreira v Levin NO 1996 (1) SA 984 (CC)). It is often in the course of Section 417 enquiries that liability in terms of Section 424 is exposed.

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