Director Duties Company Law

Achem Pte Ltd (Achem) was in the business of trading in industrial chemicals. The company was founded by Heng and Tan. Both were directors and shareholders of the company. Other than Heng and Tan, the other shareholders include Heng’s and Tan’s relatives and some of these relatives were also employees of Achem. Employee turnover was low and every employee was treated as part of one big family.

After several years, Tan decided to sell his 55% stake in Achem to Union Pte Ltd (Union) because he was excited about a different business opportunity. Initially, Tan had planned to sell his shares to Union and exit Achem’s board. Heng and Union thought it would be useful to keep Tan on Achem’s board as he had many business contacts. He agreed to remain as director of Achem on account of his friendship with Heng and received nly a nominal director’s fees per annum. [Tan – non-exec Dir, diff standard expected] Union was, at the time it was negotiating with Tan on the purchase of his shares, a company in expansion phase. Its investment in Achem was only a small part of its expansion plan. Union was also deliberating on whether to expand its operations in Vietnam. As Union knew it was going to apply for a bank loan to fund its investment in Vietnam, it discussed with Heng and Tan, on the understanding that they were to remain as directors of Achem, whether they could agree to procure Achem to stand as guarantor for Union’s bank loan [duty to retain discretion, is this best interest of company? Equiticorp?]. Heng and Tan signed a contract with Union stating they would procure Achem to stand as guarantor for Union’s bank loan. It turned out that eventually Achem did not stand as guarantor because Union shelved the plan to expand in Vietnam.

After Union took over the company, the board of directors of Achem comprised Heng, who was also Achem’s Chief Executive Officer (CEO) and two non-executive directors, namely, Ong and Tan. Ong was Chief Financial Officer (CFO) of Union. The two non-executive directors left the running of the company to Heng and met up with him every month to receive management reports concerning the company. [duty of reasonable care, skill, diligence, AWA case. CFO – subjective test under Lim Weng Kee]. In one of these monthly meetings, Achem’s board exercised their power to issue a small number of shares to employees through an employee share scheme. Heng was one of the beneficiaries under the employee share scheme and so he abstained from the vote. Ong and Tan voted in favour of the resolution. [proper purpose?]

Achem required the use of a warehouse and supporting logistics services to store and transport its chemicals. One of Heng’s duties was to oversee the general operations of Achem. In 2010, Heng awarded a major warehousing contract to Swift Logistics Pte Ltd (Swift). Mary, a manager who reports to Heng, has worked for Achem for 20 years and is known to be very experienced. She was one of 20 employees reporting directly to Heng. It turned out that Swift overcharged Achem substantially over a period of time. This was because Mary had failed to verify the quantity of chemicals Swift claimed in its invoice against the quantity stated in Achem’s own records before paying Swift. Mary was authorized to pay on invoices issued by Swift. Achem ended up paying Swift for large quantities of chemicals that were not stored and transported by Swift. Heng, who was very

busy, left Mary to work independently. He did not notice the discrepancy between Achem’s warehousing expenses and inventory levels. [duty of care, etc. s157C?] Achem started to do badly in 2012. In order to create the illusion of a successful and profitable company, Heng created documents showing fictitious sales transactions that never took place. Because of this scam, Achem’s financial statements revealed a profit for 2012 and the board recommended a dividend payment to shareholders. [s157(1) “honesty”, “good faith” CL]

Hoping to reverse Achem’s fortunes, Heng decided to order huge quantities of a new specialty chemical, a surfactant, from Germany which he forecasted would sell very well in Asia. Unfortunately, Heng’s sales forecast was not met. Because the chemical compound was unstable and had a short shelf life, Heng had to dispose of them hurriedly and caused the company a loss of $1 000 000. His action compounded Achem’s financial problems. [skill/diligence – subj test. Business Judgment Rule. S339(3)?] Heng knew that article 90 of Achem’s article of association exempted him from breach of duties he might commit against the company. In addition, Achem had bought an insurance policy which insured him against liability for breach of duties he might commit against the company. However, Heng, who was truly sorry about what he had done, decided to go to the general meeting to ask for ‘forgiveness’. He, together with some of his relatives and employees, passed an ordinary resolution to ratify Heng’s breach of duties.

He was quite confident that with article 90, an insurance policy and the members’ ratification, he could put the past behind him and concentrate on turning Achem around. [s172] Unfortunately, Achem’s business never recovered. It is now undergoing insolvent liquidation and the liquidator has brought all the above matters to light. Discuss the possible breaches of duties that all the directors of Achem may be liable for, the consequences of the breaches of duties and the extent to which the directors may be able to obtain relief from liabilities should they be found to be in breach. You may assume certain facts, where necessary, in order to reach a conclusion.

Duty to act in good faith for the best interest of the company “agreeing to get for Union, a guarantee by Achem”

The duty to retain discretion where directors cannot undertake not to exercise their powers or where they agree to act in accordance with the instructions of another person, was breached by both Heng and Tan when they signed a contract with Union stating that they would procure Achem to stand as guarantor for Union’s bank loan. By signing this contract which did not seem beneficial to Achem given the facts of the case (since Union wanted the loan for an investment in Vietnam which Achem  had nothing to do with), they would be unable to act ir even decide to if this was in the best interests of the company. Further, giving this guarantee will cause Achem to incur huge liability for Union, with no known benefit to Achem. The directors would also have breached their duty to act in the interests of the company under the common law.

The consequence would be a rescission of the contract if the Achem decided to file a civil suit. As Union eventually decided to shelve the plan, Achem suffered no loss and the contract did not actually take effect. No relief is required for Tan and Ong on this issue.

Further, by agreeing to get a guarantee for Union (their holding company), the directors have breached their duty to act in the interests of “the company”. In the Equiticorp case, it was held that directors of a company cannot act for the benefit of another company even if it was related, unless by so acting the company in which they are directors will ultimately benefit. We are not told if procuring the guarantee would do so ultimately.

Issue: Whether or not the creation of the fictitious sales transactions was a breach of Heng’s A director has a duty to act honestly (s157(1) and in good faith (common law).

Whether or not there was a breach of this duty depends on whether Heng had acted honestly. , and in the company’s interest. Creating documents to show fictitious sales transactions is clearly dishonest.

He may also have breached his duty to act in the best interests of the company. On the one hand, it may be argued that Heng had acted in the interest of Achem’s shareholders, since the fraudulent financial statements did result in a dividend payment recommendation. This is aligned with the basic principle that the interests of a company are generally those of its members.

On the other hand, Greenhalgh v Arderne Cinemas Ltd shows that directors need not always do what the majority of the members desire. Instead, they should act in the interests of the company “as a whole” and that their decisions should generally benefit and not harm the company. By providing fictitious results, Heng is essentially mortgaging the company’s long term prospects for short term gains, and hence could not be said to be acting honestly and in the best interest of the company.

On balance, although it is disputable if Heng has acted in the interest of the company, S157 CA states that directors must at all time act honestly in discharging their duties. From our facts, it is clear that Heng was dishonest as he falsified the sales record, and hence very likely that he has breached this duty as well as the common law duty to act in good faith.

For Ong and Tan, they may breached their duty to act with reasonable care, skill and diligence by not noticing the fictitious transactions. In particular, Ong being a CFO would be held to a higher standard of care. In Lim Weng Kee, the test consists of both an objective and subjective limb. While it may be reasonable for Tan to not have been able to see the transactions were fictitious, it would be expected of Ong to have noticed any discrepancy. (see below).

Consequences

Should Heng be found guilty of the above breach, there are 3 consequences which may befall him. Firstly, he would be liable for damages i.e. any profit (in terms of dividends received as a shareholder) made by him or for any damage suffered by the company (such as costs of dividends paid out) as a result of the breach (S157(3)A CA). Secondly, he might also be liable to a fine (not exceeding $5000) and an imprisonment term (not exceeding 12 months) (S157(3)B CA). Lastly, he may also be disqualified as a director (S154(2)B CA).

On the one hand, it could be argued that the loss was a result of Heng’s failure to exercise reasonable care, skill and diligence. Applying S157(1) CA and Lim Weng Kee v PP (2002), in the effort to reverse Achem’s fortune by ordering huge quantities of surfactant, Heng might have incurred more risk than what a reasonable director would take (“objective test”). Moreover, the fact that he was the founder of Achem implied that he had the expertise in trading industrial chemicals. This suggests that Heng ought to have known the perishable nature of the surfactant and was bound to an elevated duty of care (“subjective test”). In this respect, Heng would have breached his duty to exercise care, skill and diligence.

For Ong and Tan, what is required of them under the objective test is found in the AWA case. As this is a specialised contract, it might have been reasonable for them to rely on Heng’s expertise. So there is no breach of a duty of exercising reasonable skill. S157C…(1) “another director” (2) “good faith” but need for in inquiry? Arguably yes, because company already doing badly, new product and large investment. On balance, while they were being kept informed by monthly reports, they left “the running to Heng”, and in this case did not even question him, which is a breach of duty the minimum standard required in particular with respect to reasonable care and diligence.

On the other hand, assuming that Heng or the other directors made the business decision based on his best judgement, the “Business Judgment Rule” as illustrated by Vita Health Laboratories Pte Ltd & Others v Pang Seng Meng (2004) could be applied. In our case, although Heng had caused Achem to incur a loss of $1,000,000 based on his unsuccessful sales forecast, his decision to order huge quantities of surfactant could merely be a bad commercial decision rather than a negligent decision and that would not constitute a breach.

On balance, given that Heng imported a large quantity of a specialty product, which was newly released, unstable, and had a short shelf life, notwithstanding any good intentions, it shows that Heng is taking on a larger amount of risk than usual, which  any reasonable director might not have taken. Hence, it is more likely that Heng has breached his duty of care.

There is also a possible breach of s339(3) if Heng entered into the transaction “knowing…that there was no reasonable or probable ground of expectation” that Achem could pay the debt. On the facts, Achem was doing badly and not making a profit, but it is not conclusive whether they were in a hopelessly insolvent situation as we are not told what the liabilities of the company are.

Consequences

In the event that there is indeed a breach, there are 4 possible consequences. Firstly, the director could be made to pay damages to the company. In this case, Heng would be ordered to make good the $1 million loss Achem has incurred. Although the company can seek the same remedy through common law or statute, it must be noted that no double claims could be made. Secondly, he might also be liable to a fine (not exceeding $5000) and an imprisonment term (not exceeding 12 months) (S157(3)B CA). Next, the contract might be rescinded to return both contractual parties to a position before the contract. However, assuming that the seller was unaware of any breach, and given that the goods were perishable, this remedy might not be possible and is unlikely. Lastly, Heng may also be disqualified as a director (S154(2)B CA).

Issue: “the invoicing for the Swift transactions”

Whether Heng’s delegation of functions to, and reliance on, Mary is a breach of his duty of care, skill and diligence.

On the one hand, S157C(1) CA enables Heng to rely on Mary as she is an “employee” of Achem whom Heng believes on reasonable grounds to be reliable and competent in relation to the matter of verifying the quantity of chemicals Swift claimed in its invoice to Achem’s inventory records. From our facts, Mary is known to be a very experienced Manager who has worked for Achem for no less than 20 years, thus is someone a director could reasonably rely on.

Furthermore, S157C(2) CA is fulfilled since the facts did not show that Heng had not acted in good faith when he relied on Mary (S157C(2)a), that the circumstances surrounding the discrepancy did not indicate the need for an inquiry from Heng (S157C(2)b) since Mary was known to be a very experienced Manager, and that Heng’s reliance on Mary was warranted (S157C(2)c) as she was authorized to pay on invoices issued by Swift.

On the other hand, applying PlanAssure PAC v Gaelic Inns Pte Ltd, Heng’s ability to delegate duties does not absolve him from the need to properly supervise the performance of the delegated function. In other words, although Mary was delegated numerous responsibility, Heng still needed to play a supervisory role instead of letting Mary work independently. The case did not provide information if facts indicate that Heng left Mary to work without supervision and “independently”or not.

On balance, given that tThe courts are generally reluctant to take to task a director, who has in good faith, delegated his functions competent subordinates (Vita Health Laboratories Pte Ltd and others v Pang Seng Meng), unless there is an abdication of responsibility. and that the case was unclear on whether Heng’s supervisory role, it is more likely that there was no breach of duty by Heng. As Heng did not even supervise her, on balance it is a breach of his duty to act with reasonable care, skill and diligence.

Issue: Whether the directors’ failure to notice the discrepancies in Swift’s invoice is a breach of his duty of care, skill and diligence.

All directors must exercise skill, care and diligence in the performance of their duties. Whether or not there was a breach in this duty depends on the standards expected of the directors, and whether they have lived up to it. Applying the “objective” test, it is likely that a reasonable director would not have been so involved in the day-to-day running of the business to know that there were recording and payment errors. Hence, it is reasonable to expect that the directors might not pick up on such errors when going through the books.

However, given that Ong is the CFO of Union and Tan was the founder of Achem, they can be expected to have a higher degree of skill, and hence a higher standard of care could be expected of them. Under the subjective rule, Ong and Tan might be expected to spot the discrepancy and conduct further inquiries.

Consequences

In the cases of delegation and failure to notice the discrepancies, assuming that the court rules that there is a breach, there are 3 possible consequences. Firstly, the directors would be liable for any damage suffered by the company (S157(3)A CA). Secondly, they might also receive a fine (not exceeding $5000) and an imprisonment term (not exceeding 12 months) (S157(3)B CA). Lastly, they may be disqualified as a director (S154(2)B CA).

Nevertheless, according to S4(1)(A) CA, Mary is deemed to be an officer of Achem, because, as a Manager who reports directly to Heng, she is deemed to be a person employed in an executive capacity by Achem. In failing to verify the records, she had failed to use reasonable diligence in the discharge of her duties S157(1) & is thus liable under S157(3)under the common law for damages to Achem in terms of the amount overcharged by Swift & guilty of an offence & liable upon conviction to a fine not exceeding $5000 or an imprisonment term not exceeding 12 months.

Mary has the option of persuading Achem to ratify her breach which would waive Achem’s right to sue her for damages. Furthermore, if Achem were to sue her for damages, Mary has the option of applying for relief under S391(1) CA from the court if it is proven that she had acted honestly & reasonably when verifying Swift’s invoices. However this does not render her immune from the criminal liabilities in S157(3).

Duty to act for a proper purpose

Issue: Whether the sale of shares to Union by Heng & Tan had breached their duty to act for a proper purpose

According to Howard Smith Ltd v Ampol Petroleum Ltd, when a director exercises the power to issue shares, the proper purpose is to raise funds for the company. In this case, the original intent of Heng & Tan was to exercise their power to sell Tan’s shares to Union with the proper purpose of raising funds for Achem, as Tan had intended to sell his shares to Union & leave Achem’s Board. However, when Union had offered Heng & Tan the opportunity to remain as Directors of Achem in exchange for Tan’s 55% stake in Achem, with the purpose of Achem acting as a guarantor for Union’s bank loan, & Heng & Tan had agreed to this arrangement, this had deviated from the proper purpose of Heng & Tan’s power to issue shares.

In applying the “but for” test, Heng & Tan would not have sold Tan’s 55% stake to Union, but for Union’s agreement in allowing Heng & Tan to remain as Directors of Achem.

Hence Heng & Tan had breached their duty to act for a proper purpose.

Issue: Whether the issue of shares by Achem’s Board (Ong & Tan) to its employees had breached the board’s duty to act for a proper purpose

Directors have a duty to act for a proper purpose. According to Howard Smith Ltd v Ampol Petroleum Ltd, when a director exercises the power to issue shares, the proper purpose is to raise funds for the company. But it is not limited to that. In particular, their power to issue shares could be only be exercised for a number of reasons to be considered “proper”.

Applying the Howard Smith v Ampol two-stage test (1) the legal purpose of the issuing of shares (in this case it was to raise funds (and possibly to incentivise employees)). (2) the actual purpose of the issue of shares (In this case, the board  exercised its power to issue shares with the purpose of providing its employees with a financial incentive through an employee share plan). , Since step 2 is in line with step 1, there is no breach and that is considered to be a proper purpose of share issuance.

But there could be mixed purposes here. Was it also affected by other factors such as Heng getting a higher share proportion? For mixed purposes, the but-for test needs to be applied to find out the true purpose for the exercise of the power. However, if the true purpose behind the share issuance was for Heng to entrench his control of the company by issuing himself more shares, then the directors would have breached this duty. Since Heng is an employee of the company and might be one of the beneficiaries of the share issue, he could use it to increase his share holding.

On balance, it is more likely that there was no breach because there was only a small number of shares issued, and hence unlikely to alter any share configuration, even if Heng did receive any shares. Moreover, Heng abstained from voting when this decision was made, which lends weight to the argument that he is not attempting to alter the shareholding. Therefore, the directors had not breached their duty to act for a proper purpose.

Consequences

Assuming that there is a breach, there are only 2 consequences. Firstly, the breach would still be ongoing, given that the shares are issued. Hence, the court could grant an injunction to remedy the breach. Next, if the company suffers any losses from the issuance of the shares, such as the payment of dividends to stocks which would not otherwise exist, the directors could be liable to compensate the company for that.

Reliefs

Although Article 90 of Achem’s M & A indemnifies Heng from any liability arising from his breach of duty, S172(1) CA has the effect of rendering it void. In addition, although Achem’s ratification for Heng’s breach would waive Achem’s right to sue

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Heng for damages, this does not render Heng immune from the his breach of statute law (such as his failure to act honestly) and the corresponding criminal liabilities that arises from it such as the one in S157(3)B and disqualification as a director in S154(2)(b)B. Furthermore, depending on the terms of Heng’s insurance policy, some of the breaches might be covered. For instanceHowever, if the no policy would allows claims him to make a claim for his failure to act honestly. , then he may obtain relief in this respect.

Ratification? For common law duties, breaches can be ratified by general meeting of shareholders. Heng can vote – subject to equitable limitation doctrine. Unless it would be deemed unfair to the creditors.

CONSEQUENCES

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As there is an overlap between the duty of care stated in the statute and the general law duty of care in terms of the standards to be applied, Heng may be subjected to criminal sanctions by ACRA and civil actions such as damages claims by Achem. With reference to s157(3), Heng would be liable to Achem for damages suffered by them as a result of the breaches of s157(1) ,which is $1,000,000 loss for the disposal of the surfactant. For the invoice and Achem’s inventory discrepancy, he would be liable to Achem to make up for the additional amount paid to Swift. Heng would also be liable to a fine not exceeding $5,000 or imprisonment not exceeding 12 months. The court may make a disqualification order in addition to the sentence imposed.

For breach of s339(3), the director would be liable to fine and imprisonment. Further, under s340(2), the director in question may be personally liable for the debt he incurred. On the other hand, for breaches of common law duties, the directors will be liable for damages and account of profit only. with s391 allows the court could to decide whether it would be fair, considering all the circumstances of the case, to grant relief for officers of a corporation, depending whether their act was honest and reasonable. Ong, being the CFO of Union, should have be more sensitive to reports given to him and would have identified the untallied records like any reasonable officers would. Hence it would be unlikely for him to receive relief from the court.

Tan would probably receive relief, given the limited knowledge he has about the company records, his act was of the expected reasonableness.

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If Heng can prove that he rationally believed that his judgment was in the best interest of Achem, he might succeed in defending himself and be relieved from above-mentioned liabilities (s391(1)). However, in all the above cases, it cannot be said that he acted honestly, which is a key factor for relief under s391.

Based on s172(1), provisions exempting or indemnifying directors for breach of duty are void except when the company s172(2)(a) takes out indemnity insurance for directors. A common exclusion is where the officer has been dishonest or has committed a willful breach of duty. As Heng was being fraudulent in this instance to not disclose the true financial status of the company, he will unlikely be able to obtain relief from the indemnity insurance. With Article 90 and the members’ ratification, it would only work for Heng if Achem engages in a civil claim where the company or the court is still allowed to waive the breach through a resolution. If criminal duties against Heng were started, it would be impossible for him to put the past behind him should he be able to ‘seek forgiveness’ from members of the company.