Case Update: Federal Court Clarifies the Extent of Directors’ Duties
In Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra V Petra Perdana Berhad (2017), the Federal Court had delivered a landmark judgment clarifying the division of power between shareholders and directors.
Background
The shareholders had passed an ordinary resolution conferring mandate to the board of director to divest up to 10% of the shareholding. However, the actual divestment made by the board exceeded this mandate. The gist of the legal action is that whether the divestment was made in breach of the board’s directors’ duties to act the best interest of the company, given that it is contrary to the wish of shareholders.
Findings of the Federal Court
(1) Shareholders’ Resolution Cannot Override the Management Powers of the Board
The Federal Court held that shareholders cannot override the powers of management (i.e.: divestment) conferred by the articles of association on the board of directors simply by ordinary resolution. This legal position is reinforced by s.131B of the Companies Act 1965 (now s.211 of the Companies Act 2016), which state that “the business and affairs of a company must be managed by, or under the direction of, the board of directors.” Shareholders can only do so by altering the articles to remove the powers of the board or refuse to re-elect the directors whose actions they disapprove of.
(2) Subjective/Objective Test in deciding Good Faith and Best Interest of the Company
S.132(1) of the Company Act 1965 (now s.213 of the Companies Act 2016) provides that all directors shall exercise their powers in good faith and in the best interest of the company. The test to decide whether there is a breach of this duty is a combination of both a subjective and objective test. Firstly, the court will assess the state of mind of the director, whether the director considered the exercise of discretion is in the best interest of the company (subjective test). Secondly, the court will assess whether a reasonable man in the position of the director could have reasonably believed that the transactions were for the best interest of the company (objective test).
(3) Business Judgment Rule
The business judgment rule is contained in s.132(1B) of the Companies Act 1965 (now s.214 of the Companies Act 2016). This provides additional protection for a director by making a presumption that a director is acting with due care and skill if certain pre-conditions are fulfilled. It was held that the court will not second guess the merits of a commercial/business judgment made by directors as long as there is no fraud or breach of fiduciary duty or conspiracy. In this case, the Federal Court deemed the board minutes as “compelling evidence” that all members of the board had acted in good faith in collectively deciding on the sale of shares after consulting expert opinion.
Conclusion
Note that this Petra Perdana decision was decided under the Companies Act 1965. Although similar provision can be found in s.195(2) Companies Act 2016 which allows shareholders to make non-binding recommendations to the directors on management matters in a general meeting, s.195(3)(b) Company Act 2016 states that if the shareholders pass a special resolution and it is in the best interest of the company, such a recommendation would be binding on the directors. In light of this decision, it will be interesting to see how s.195 will be applied in the future for cases relying on Company Act 2016.
