A timely reminder of a corporate director’s duties

The remarkable ascension of Pakatan Harapan to the seat of Malaysian government was launched on a platform of accountability and good governance. In one of its first acts, the newly anointed government has commenced the inquiries into various entities that were a core focus of its campaign, with an alacrity and determination that has unsettled corporate Malaysia.

Through the establishment of various committees and task forces, the government is scrutinising and revisiting the allegations of the flagrant abuses of corporate powers and the unrestrained actions of rogue directors that have been whispered of for years. The intense media coverage detailing in graphic detail how a well-connected few appear to have been grossly enriched has incensed Malaysia’s urbane electorate.

While the truth of any of this remains to be uncovered, narratives such as these have dominated public discourse, and are flourishing through a newly empowered mass media, as well as on social media.

In the 2000s, the extraordinarily public exposé of the Enron scandal revealed the extensive fraud perpetrated by its executives and prompted the US Congress to enact the Sarbanes-Oxley Act, forever changing the landscape of corporate America.

In Malaysia, the spectacular unmasking of issues surrounding entities like the Port Klang Free Zone, and more recently 1MDB and Felda Global Ventures, ignited a catharsis and galvanised a nation to vote for reform.

Perhaps now more than ever is it a timely reminder that the officers and decision makers of corporations cannot hide behind the veil of incorporation in order to obscure facts, circumvent laws and advance their own personal interests.

Acting in a company’s best interests

Malaysia has a robust body of laws, both in statute and in case law, dealing with directors’ duties.

It should be noted that directors in particular are yoked with a solemn duty to protect the interests of the corporation. Additionally, Malaysia has a code on corporate governance, updated in April 2017, which sets the effective leadership standards which directors and senior management should adopt in governing the company.

In terms of fundamental duties, Section 213 of the Companies Act 2016 codifies the sacred trifecta: A director must at all times act for proper purposes, in good faith and in the best interest of the company (emphasis added). The law thus confers upon directors the weighty burden of fidelity.

The Court of Appeal provides some illustration of what this means. In the case of Zaharen Hj. Zakaria v Redmax Sdn Bhd (2016), a company, Redmax, sued its two former directors for breach of their fiduciary duties in unlawfully paying funds out from Redmax’s coffers to third parties. The payments were based on fictitious transactions and false documents and enabled the senior director to enrich himself by siphoning off a portion of the amount to be paid out.

To summarise the complex case, the senior director had essentially claimed he was empowered to make payments by Redmax. The junior director claimed he was merely “following orders” when signing off on the dubious transactions, and was subordinate to his senior, and so his hands were tied.

The Court of Appeal found that the payments were not in the best interests of Redmax, and as such entered judgment against the senior director. With regards to the junior director, the court held that he could not rely on such justifications as “following orders”, because the role of the director is a fiduciary one, and a director has a legal duty to protect the interests of the company.

In a remarkably lucid explanation, the Court said a director:

“…has to give his all to serve in the best interest of the company of which he is a director. As a fiduciary, the company is backed up by the statutory provision to expect nothing less from its directors. Gone are the days when a company director can be heard to say that he was a sleeping director and expect to escape liability.”

Therefore a director cannot abandon her legal duty to act in the company’s best interests even at some cost to herself, such as the threat of reprisal. Her fiduciary duty extends to questioning the status quo, and to ensure that all proper diligence is conducted before a decision is made.

In discharging her duties, a director must exercise reasonable care, skill and diligence, failing which she may be liable to a penalty of up to 5 years imprisonment, or a fine up to three million ringgit, or both.

It is an onerous duty, and a heavy responsibility, and in 2016 the law was changed to enhance the penalty, thus reaffirming that fiduciary burden.

The Court has made clear that no director can seek shelter under the excuse that she was browbeaten, or uninformed, or that she had relied entirely on people more familiar with the matters at hand, or that her independent views were not sought.

The Redmax case also reminds us that a director must distance herself from any potential or material personal interest in any subject matter for which a business judgment must be made. Section 221 of the Companies Act states that such interest, even if it is indirect, must be disclosed to the board. Section 222 further forbids such interested directors from voting for a contract dealing with that interest; otherwise such a contract is voidable.

The Charterbridge test

The law in fact assumes that a director will act in the best interests of the company. However, that assumption is defeated if there had been no proper purpose, or if the director acted in bad faith, or with a conflict of interest.

The guiding principle on what is in the best interests of a company has entered the canon of common law through the landmark English case of Charterbridge v Lloyds Bank, and has earned the moniker of the “Charterbridge principle”. It is a test that invites a judge to consider “whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company”.

Cases such as Redmax, as well as others such as Lucky Bright Star v Joanne Yeoh and Balda Solutions v Foo Wan Seng, have consistently ruled that the assumption is rebutted where a director acted recklessly, did not act at all, or failed to alert the board to matters detrimental to the company.

We do not have to consider highly complex situations to see what fails the Charterbridgetest; in the Lucky case for example, a director approved the purchase of lands intended to be developed for luxury condominiums despite the fact they were not legally approved for such development.

Notwithstanding that she acted on the advice of counsel and on the instructions of her CEO, the court in Lucky still found that her failure to exercise independent judgment rendered her deficient in discharging her duties as director with reasonable care, skill and diligence.

Other duties

The law imposes other duties on the director as well, such as the duty to abstain from improper use, acquisition or disposal of the company’s property without the consent of, or ratification by, the company.

Any loans, payments and related transactions involving directors are highly regulated under the Companies Act, consistent with the notion of the director as fiduciary.

Similarly, the service contracts of directors of public companies, and in particular their benefits and remunerations, must be made available for shareholder inspection.

Tax-free payments to directors by a company are unlawful without prior shareholder approval, as is any compensatory payment for loss of office. A director’s transactions with the company, for example for the sale and purchase of shares, requires shareholder approval.

The case for good corporate governance

The law confers these onerous duties and burdens on directors precisely because they and those who act in that capacity are responsible for the company and accountable to its stakeholders and regulators. The liabilities are many and the bar for failure is set low. Referring once more to the Court in Redmax, the learned judges held that a director’s duties:

“…appear onerous but that is to be expected as he is part of the alter ego of the company. He is a fiduciary, a trustee. It is not his business to act like a rogue, much less to act to the detriment of the company.”

Which is why a director should also follow good corporate governance practices, in addition to observing the duties under law which are in fact the minimum standards.

Compliance with laws is mandatory. However, unlike in Sarbanes-Oxley, compliance with the code on corporate governance in Malaysia is voluntary but a strong business case can be made for good corporate governance. It instils in companies “the required vision, processes and structures to ensure long term sustainability”.

Best practices include maintaining a board’s independence, cultivating board diversity, ensuring transparency in directors’ remuneration, establishing independent audit and risk committees and meaningful disclosures by the directors.

These best practices should be performed simultaneously with the observation of the legal duties, because a company which has a robust corporate governance is better equipped to deal with lapses in directors’ duties.

It is clear that directors are held to a very high standard. As fiduciaries of the companies they lead, their acts and omissions can have an enormous influence on the wellbeing of the company, just as the acts and omissions of a government can have on the well-being of a nation.

The nation has a new board of directors, elected on a platform of accountability and transparency. Companies, like governments, are only as good as the people who lead them. Reform of the corporate sector begins with directors; it is hoped that they take to heart the reminder to directors given by the Court in Redmax: you must give it your all to serve.

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SYED NAQIZ SHAHABUDDIN is senior partner of Naqiz & Partners, and a member of the 1MDB committee established by the Council of Eminent Persons. -Mkini

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