SELF-DEALING AND NO-PROFIT RULES: COMPANIES ACT 2016
| Author | LOH Siew Cheang LLB (University of Malaya); Managing Partner, Messrs Chooi & Company + Cheang & Ariff, Advocates and Solicitors. |
| Date | 01 December 2020 |
| Published date | 01 December 2020 |
The codification of the various facets of the core obligation of utmost loyalty with respect to directors in the Companies Act 2016 (Act 777), have given rise to controversies in interpretation and application in the context of the duty of disclosure in conflict of interest cases – disclosure at formal board and general meetings is mandatory because of the word “shall” in the relevant provisions. The literal approach is problematic and inconsistent with the legislative scheme of the Act. Research into legislative history and case law from other jurisdictions do not support the literal approach. Equity operates functionally and its emphasis is on substance and not form.
1 The issues concerning the core duty of loyalty of a director are as contentious today as before. The core duty is multifaceted and one of the facets is that a director must not put himself in, or must avoid, a situation in which his interest, direct or indirect, may conflict with the company's interest.2 The no-conflict principle embodies two underlying themes often described as the “self-dealing” rule and the “no-profit” rule.3 The constituent elements of the two rules are different4 but the principles
2 In the context of the Companies Act 20165 (“CA 2016”), the self-dealing rule (s 221) may be described as the rule against “transactional conflicts”6 and the “no-profit” rule (s 218) as the rule against “situational conflicts”.7 This article traces the legislative development of the two rules in Malaysia, the judicial approach to the statutory provisions, the differences in application of principles between recent and earlier authorities, their relationship with the general statement of duty of directors in s 213 of the CA 2016 and the remedies that are available.
3 The self-dealing and no-profit rules developed out of the wider no-conflict principle in equity.8 The constitution of a company may relax the strictness of the rules subject to the director complying with certain requirements, which usually include disclosure of his conflicting interest and not to vote on the subject matter. Compliance with the requirements enables the disinterested directors or the general meeting, as the case may be, to make an antecedent informed decision whether to give their consent to the subject matter or not. Where antecedent consent is given, it does not excuse the director from acting in the best interest of the company and for proper purpose.9 Alternatively, the company, upon discovery of the breach of the requirements, may elect to forgive the errant director by affirming or ratifying the transactions.
4 Early case law did not regard the nature and the extent of the conflicting interest as being relevant to the application of the principle.10 As equity is flexible, case law in the later part of the 20th century excluded theoretical and rhetorical conflicts.11 Currently, the no-conflict principle
5 The self-dealing rule is to prevent a director from being swayed by considerations of personal interest,14 which may arise from a director being a member or creditor of the counterparty.15 In such cases, the director has a duty and interest conflict. If he is also a director of the counterparty, he also has a duty-to-duty conflict.16 In group companies, multiple directorships are common and the breach of the duty-to-duty conflict usually arises when the director advances the interest of one principal to the detriment of another principal in disregard of the separate legal entity principle.17 In cases where the interest of a company is inextricably tied to the continued well-being of the group of companies, the directors may consider the interest of the group as a whole.18
6 The no-profit rule is to preclude the director from misusing or abusing his office to gain a personal advantage.19 If he derives a gain by reason or in virtue of his fiduciary office or otherwise within the scope of that office,20 he breaches his core obligation of loyalty. Differences in judicial opinion exist with respect to the extent equitable principles should be moulded and applied flexibly in particular to factual settings to test whether there had been a misuse or an abuse of office for personal advantage. The approach in England focuses on the fiduciary-based relationship to find liability, and in some cases, a merit-based common-sense
7 The self-dealing and no-profit rules have found their way into the CA 2016 on a piecemeal basis. Sections 218 and 221 of the CA 2016, like their ancestors, create an additional duty of disclosure on the part of interested directors in contracts or proposed contracts with the company and the use of their office to make personal gains. The breach of the additional duty is punishable by law.
8 The statutes that preceded Merdeka Day and the formation of Malaysia (“the Repealed Statutes”)23 did not prohibit a director from being directly or indirectly interested in a contract or proposed contract with the company. This was probably because it was recognised that the articles of association commonly allow directors to be interested provided the directors declare their interest at a board meeting.24 It was also recognised that the common law does not provide for sanctions against directors for failure to disclose their interest. To inspire disclosure or deter non-disclosure, the Legislature introduced penal sanctions against non-disclosure. Section 151 of the Straits Settlement Companies Ordinance 1940,25 which was taken from s 149 of the UK Companies Act 1929,26 first introduced criminal penal sanction for non-disclosure in respect of self-dealing.
9 In 1963, the Malaysian government established a committee to advise on the form and content of a new statute to replace the existing laws.27 The committee was assisted by J C Finemore, draftsman of the
10 Section 131 of the CA 1965 reaffirmed the requirement of disclosure by interested directors in contracts or proposed contracts at a board meeting.32 It was taken from s 123 of the New South Wales (“NSW”) Companies Act 1961. The disclosure rules were made more elaborate and provided for a stringent criminal sanction – imprisonment for one year or a fine of RM2,000.33
11 Section 131 of the CA 1965 was not intended to save the company from a bad bargain but to uphold good internal management and promote informed corporate dealings.34 The imposition of a penalty against defaulting directors also did not alter the ensuing consequences under the common law – the contract is voidable and the company may elect to avoid or affirm the contract after having acquired knowledge of the breach.35 If the company elects to affirm the contract, the election is an affirmation of the contract in its entirety under the common law.36 Subsequently, s 131(7B) was introduced, adopting the civil consequence at common law that the contract is only voidable. Following the repeal of the CA 1965, the disclosure provision is now housed in s 221 of the CA 2016.
12 The no-profit rule was introduced in the CA 1965 and the first version of s 132 was taken from s 124 of the NSW Companies Act 1961 save that it had an extra provision in s 132(4) dealing with improper gains obtained from dealings with shares or debentures or options of the company. In August 2007, s 132(2) of the CA 1965 was amended by expressly setting out five sets of circumstances pursuant to which the gains were classified as improper gains. Significantly, s 132(3)(a) of the CA 1965 provided for a private cause of action against the defaulter for profit made by the defaulter or damages suffered by the company. In this context, the preservation of existing laws under s 132(5) in the CA 1965 appeared to be duplicitous.37
13 The current no-profit rule is found in s 218 of the CA 2016. The statutory private cause of action provision in s 132(3)(a) was deleted,38 as well as the provision relating to the preservation of existing laws in s 132(5) contained in the repealed CA 1965. Further, s 218 is not strung together with the general statement of directors' duties and the duty of care and skill,39 which are now housed in s 213 of the CA 2016. Section 218, like ss 221 and 213, is intended only to impose a criminal sanction against a defaulting director.
14 Self-dealing under s 221 may be authorised in advance by non-interested directors provided there is disclosure of the extent and nature of the conflicting interest. In the absence of disclosure, the company may elect to avoid or affirm the contract upon discovery of the breach under s 221(10). The discretionary powers on the part of disinterested directors to give antecedent consent and to affirm the contract is a departure from the common law where only the company in general meeting may do so. Nonetheless, s 221 must be read down for there are contracts or proposed contracts which require the approval of shareholders in general meeting. In such cases, full disclosure must be made to the company in general meeting.40
15 Under the no-profit rule in s 218, only the company in general meeting may give its consent antecedently or...
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