AN ISSUE OF ABSOLUTION - SECTION 391 OF THE COMPANIES ACT

Date01 December 2003
Published date01 December 2003
Introduction

1 There is an obvious tension in the imposition of directors’ duties. Whilst directors being the management, and therefore the eyes, ears and brain of the corporate person, must be given sufficient discretion to take on entrepreneurial (and hence risky) ventures with a view to profit maximisation, there is also the need to curb excesses, as the potential or opportunity for mismanagement, negligence and fraud is omnipresent. The situation is complicated somewhat by the fact that the company is really an aggregate of different interest groups with divergent expectations.1 It is therefore not surprising that the duties that are imposed, in equity and at law, on the directors of a company, collectively and individually, are varied and complicated. Additionally, a number of specific statutory obligations are overlaid on these duties, breaches of which may attract sanctions that are civil, criminal or both. In recent times, there has been a renewed interest in directors’ duties, the impetus for which is a draft of a statement of the general duties of a director, originally prepared by the UK Law Commission,2 further developed by the Company Law Review Steering Group (CLRSG),3 and which Singapore’s Company Legislation and Regulatory Framework Committee (CLRFC) has recommended adopting.4 This paper is however not about core directors’ duties.5 On the contrary, this short article considers section 391 of the Companies Act (Cap 50), arguably the statutory nemesis of directors’ duties.

2 Section 391 is based on section 448 of the English Companies Act 1948 (currently section 727 of the Companies Act 1985), and gives jurisdiction to the court hearing the case to relieve an officer from liability for negligence, default,6 breach of duty or breach of trust.7 The English provision began life as section 328 of UK’s Companies Act 1907, which owed its genesis to section 3 of the Judicial Trustees Act 1896.9 This latter section conferred jurisdiction on the court to relieve from personal liability, wholly or partly, a trustee, who is or may be personally liable for breach of trust but who has nevertheless “acted honestly and reasonably, and who ought fairly to be excused” therefrom. It was thought that, as the path of a director was being made more precipitous legislatively, a similar exculpatory section was necessary10 in respect of directors, so as not to unduly discourage honest men from accepting the office of the director. Section 32 applied not only in proceedings against a director of a company for breach of trust, but also in proceedings for negligence. The section was subsequently reproduced as section 279 of the English Companies (Consolidation) Act 1908, which extended the courts jurisdiction to “director, or person occupying the position of director”. The 1908 Act was repealed by the

Companies Act 1929, and section 279 was replaced by section 372 which extended the scope of the exculpatory provision significantly so that it now applied in “any proceedings for negligence, default, breach of duty or breach of trust” against not only directors, but also managers, officers and auditors of a company. Additionally, a direction that the court should, in determining whether a director or others ought to be excused, consider all the circumstances of that person’s appointment, was included. Section 372 remained substantially unchanged under its later guises as section 448 of the Companies Act 1948,11 and finally section 727 of the current Companies Act 1985.

3 Similar provisions can be found in the companies legislation of Australia,12 New Zealand13 and Canada.14 Curiously, whilst the potential significance of the relieving provision cannot be denied, academic discussion in the different jurisdictions on its operation has been somewhat lacking.15 In recent times, however, exculpatory clauses in England specifically have emerged from the shadows but escaped twice from being seriously dissected under the legal microscope until the CLRSG’s consultation paper16 in 2000. First, the Law Commission in their report, Fiduciary Duties and Regulatory Rules (1995),17 considered whether the court should be given a general discretionary power to relieve all persons who stand in a fiduciary position from breach of duty and whom the court considers to have acted honestly and reasonably. The Law Commission decided against this but expressed the view that there is a need to take a global look at such exculpatory clauses. Some years later, the Law Commission18 again had occasion to look at exculpatory provisions, this time specifically section 727 of the Companies Act 1985, and in the context of presenting a case for a statutory statement of directors’ duties under general law. Whilst admitting that section 727 is “an important part of the background to this project”,19 the Law Commission nevertheless declined to review it and “proceeded on the basis that the interpretation given to the section in Re D’Jan20 will be upheld by later decisions”. This article considers

the relieving provision and makes a number of observations about its role and scope.

The rationale

4 Before we consider the threshold conditions for the extension of the exculpatory lifeline, it would be appropriate to ask what the rationale for the section is. Conceptually, the exculpatory provision does seem to evidence some amount of schizophrenia — whereas legal duties and obligations are imposed on directors in the interest of shareholders and the public, yet it is accepted that some breaches are excusable. The question “when is it acceptable to breach one’s duty” is obviously a difficult one to answer. One of the avowed fears expressed at the turn of century was that an exculpatory provision was necessary to attract the most qualified individuals to sit on corporate boards, for otherwise, “honest men will be deterred from accepting office and rogues will not”.21 This argument is somewhat puzzling, for its premise appears to be that directors accept office with the expectation that they will inevitably fail in their obligations. Why else would they be deterred otherwise? It is also doubtful if the argument remains relevant to the executive directors of the modern company, who are appointed to their positions and paid handsome sums of money precisely because it is thought that they are capable of doing a good job. Surely what goes into the doing of “a good job” must be subject to the constraints imposed by the law and not in spite of it.

5 It might be of interest to point out that not all on the Reid Committee were convinced by the need to introduce the provision. Mr Edgar Speyer, a member of the Committee, expressed his reservations thus:

“Having had twenty years’ experience of business life in the City of London … I am more than ever impressed with the following defects and abuses22… I am convinced that until the law is altered … and directors are made personally liable for negligence the other abuses, flagrant as they are … will

continue to exist unchecked … The suggestion that men will not so easily accept directorships … is … no answer. It is not directors who need protection, but the public.”23

6 Nevertheless, it was concern over the inadvertent transgression of any of the myriad provisions of the companies legislation and the consequent incurrence of personal liability, which may then appear unwarranted because of the lack of bad faith or intent, that resulted in the inclusion of the relieving provision in the companies legislation. This appears borne out by several of the comments made in the 1907 Parliamentary Debates. For example, Member of Parliament Hills thought that “the duties of a director were complicated and that the present Act extended and still further complicated them. They could not expect a man leading a very busy life to make no mistakes, and it would be hard if in certain cases where a perfectly innocent mistake was made he should be held responsible in his pocket”.24 Thus, the rationale for the exculpatory provision lies perhaps in its role as a “mitigating device”,25 one that serves to strike a fairer outcome through the discretionary amelioration of liability for a director’s breach of his obligations.

The threshold conditions for relief

7 To exercise its discretion,26 the court must be satisfied not only that the officer has acted honestly and reasonably, but also that, having regard to all the circumstances of the case, he ought fairly to be excused.

Honesty

8 What amounts to honesty for the purposes of section 391 and its overseas equivalents has not been the subject of much judicial discussion. In Re J Franklin & Son Ltd,27 Crossman J suggested that honesty equates a motivation to act in the interests of the company. The case involved a resolution of the company in general meeting that Mrs Franklin, a director of the company, should receive remuneration. The resolution was later found to be invalid because the meeting was

inquorate as one of the two members present had not been registered as such. The liquidator sought to recover the payment and the directors applied for relief under section 372 of the Companies Act 1929. Crossman J made the following observation:

“I read the word “dishonestly”28 in the section as meaning without any direct motive. If they had done this in order to assist Mrs Franklin recklessly, but without considering the interests of the company at all, I think that they might well be said to be dishonest”29

Relief was, however, in the circumstances refused.30

9 Some controversy exists as to whether the requirement is to be assessed from a subjective or objective standpoint. In Re Produce Marketing Consortium Ltd (In Liquidation),31 Knox J described the approach demanded by the relieving provision as an “essentially subjective approach”. Responding to this observation, Robert Reid QC in Coleman Taymar Ltd v Oakes32 qualified that, in his view, this subjective approach...

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