Conceptually, a company is an artificial person and is a separate entity from the individuals who own, manage and support its operations. Companies have many of the same legal rights and responsibilities as a person, such as the ability to enter into contracts, own assets, hire employees, pay tax and incur liability.
However, given the separate and unique nature of a company, of course a human is required to direct its actions, strategic decisions and ultimately shape its identity in accordance with the purpose for which it was created. This task is undertaken by the appointed directors which are empowered by the Companies Act 71 of 2008 (the “Companies Act”) and Memorandum of Incorporation (“MOI”) of the company.
Directors are identified and appointed at the incorporation of a company and can also be appointed afterwards by shareholders or any other persons designated with that right. In the vast majority of cases, only shareholders appoint directors. However, the company’s MOI can give that right to other parties such as investors and creditors who insist on the right to appoint a director on the board.
Once a person accepts their appointment as a director, they become a “fiduciary” in relation to the company and are obliged to display the utmost good faith towards the company. To explain this very simply, the fiduciary duty means that the director must act in the best interests of the company when dealing on the company’s behalf – placing the company’s interests ahead of the director’s own interest in many instances.
The fiduciary duty is a concept developed in law as having the following duties (set out in Section 76(3) the Companies Act):
• the duty to act in good faith;
• the duty to act for a proper purpose;
• the duty to avoid conflicts of interests; and
• the duty to act in the best interests of the company.
The first element of good faith is quite subjective. This means that the courts will go through a process of enquiring whether the director genuinely believed that his/her conduct was in the best interest of the company.
When making this decision, courts will take into account:
• the relevant facts available to the director at the time;
• his/her level of skill;
• the expected level of diligence and care in such a situation; and
• whether their actions were reasonable.
A proper purpose is not defined in the Companies Act, however the courts’ approach is to test whether the directors exercised their powers for an objective purpose. The court will first look for factual evidence (i.e. objective evidence) for what the purpose of the director’s appointment was.
This will largely involve understanding the purpose of the company by looking at its MOI, shareholders agreement and historical decisions by shareholders and the board (through written resolutions). Once the courts understand what the purpose of the company was, and how the director’s appointment was intended to further that purpose, then they can test the director’s actions against that. If the director’s actions do not have any rational link to furthering the company’s purpose, their actions may be considered to have been for an improper purpose.
Directors’ fiduciary duties also extend to the duty not to place themselves in a position in which their personal interests’ conflict, or may conflict, with their duty to act in good faith. An obvious and important element of this duty is the obligation not to compete with the company and to avoid a conflict between a director’s interests and the interests of the company. Effectively, this means that every director has an automatic non-competition obligation with the companies that they serve.
A Director’s duties include acting in the best interests of the company, which means to act for the benefit of the company as a whole. There has been much debate as to what this means. However, this does not mean just acting in the best interest of the shareholders. Rather, this can also mean acting in the interests of “stakeholders” generally – including, at least, employees and creditors.
If there is a dispute around whether the decision taken by the director was in the best interests of the company, the courts will apply the “business judgement rule” by having regard to what the director believed at the time in light of their general knowledge, skill and experience.
The director will have satisfied the duty to act in the best interests of the company if he/she:
• took reasonably diligent steps to become informed about the matter;
• had no personal financial interest in the subject matter of the decision (and had no basis to know that any person/ entity related to the company had a personal financial interest in the company);
• had a rational basis for believing that the decision was in the best interests of the company.
Given the variable nature of directors carrying out their duties in practice, the Companies Act provides that they can only be expected to act with similar care, skill and diligence that would reasonably be expected of a person carrying out the same functions in relation to the company as those carried out by that director, having a similar level of general knowledge, skill and experience of that director.
The starting point is that all directors are expected to carry out their duties honestly, in good faith and for a proper purpose, without exception. However, the yardstick used to assess whether each duty was carried out effectively will differ on a case-by-case basis depending on the general knowledge, skill and experience of that particular director. This means that your actions as a director will effectively be tested in light of your ability and knowledge of the company and how it operates.
On that basis, it is accepted that not all directors have the same skill and experience, and not all directors have the same understanding of how companies function. Courts have acknowledged that it is not a prerequisite to have special business acumen in order to be a director, highlighting the subjective nature of the test.
If there is a dispute around whether the decision taken by the director was in the best interests of the company, the courts will apply the “business judgement rule” by having regard to what the director believed at the time in light of their general knowledge, skill and experience.
With this in mind, directors will be protected by the law if, relying on their skill and experience in hand, they approach company related decisions by taking intentional steps to become properly informed about a matter, are aware of and avoid any conflict of interest, and ensure and can provide evidence to the fact that there is a rational basis for believing that the decision taken was in the best interest of the company at that time.
If you still have questions on a Director’s duties or are unsure of what certain duties entail, consider obtaining advice in this regard.
