Company Law and Practice (CPL512S)

Unit 10 Duties and Liabilities of Directors

Duties and Liabilities of Directors

Introduction
Although the Companies Act 28 of 2004 does not assign any particular function to the board of directors, it is
normally accepted that the board is tasked with the management of the company or, at the least, to assume
responsibility for it. This arrangement implies that the directors have various duties they need to comply with.

The duties and liabilities of directors are primarily determined by their contracts (if any) with the company, the
company constitution, the Companies Act and the common law.

In this unit we will focus primarily on the duties imposed on a director under common law, namely the fiduciary
duty requiring a director to exercise his/her powers in good faith and for the benefit of the company, and the
duty to display reasonable care and skill in carrying out his/her office. We will also look at the liability of directors
towards the company and third parties.

Objectives
Upon completion of this unit you should be able to:

• explain the fiduciary relationship that exists between a director and his or her company
• list the various categories of director’s fiduciary duties
• explain what is meant by a conflict of interests
• state when a director will be exceeding the limitations of his or her powers
• motivate why a director will must maintain an unfettered discretion
• provide examples of directors failing to exercise their powers for the purpose for which they were
conferred
• briefly discuss a company’s possible remedies should a director breach his or her fiduciary duties
• summarise the effect of resignation on the director’s fiduciary duties
• discuss the director’s duty to act with care and skill and explain the standard by which the duty is
measured
• list instances when a director can be held personally liable towards others.
• apply the contents of this unit to solve problems

Additional reading
Bouwman N. (2009) “An Appraisal of the Modification of the Director’s Duty of Care and Skill” 21 SA Merc LJ 509.
(Pages 509-520).

Cassim, F.H.I, Cassim, M.F., Cassim, R, Jooste, R.D (2011). Contemporary Company Law. Claremont: Juta. (Pages
459-541).

Du Plessis J J. (2010). “A Comparative analysis of Directors' duty of care, skill and diligence in South Africa and in
Australia” Acta Juridica 263 (Pages 263-287).

Delport, P. (2011). The New Companies Act Manual. Durban: LexisNexis. (Pages 89-103).

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Unit 10 Duties and Liabilities of Directors

1 Sources of Duties
There are four sources from which the duties of directors arise: their employment contracts with the company (if
any), the company’s constitution (memorandum of association), the Companies Act and the common law. The
rights and duties created by contract are determined by referring to the specific contract. The duties imposed by
the common law are discussed after the next activity.

2 Fiduciary Duties in general

A fiduciary is a person who has control over the assets of another or holds the power to act on behalf of another.

A director stands in a fiduciary relationship to his/her company with the result that he/she has the duty to act in
good faith towards his/her company, to exercise his/her powers as director for the benefit of the company and
to avoid a conflict between his/her own interests and those of the company.

A person usually comes into a fiduciary relationship when he/she controls the assets of another.

A director cannot be relieved of his/her fiduciary duty in the articles of association, in a contract or in any other
way. In this regard the Companies Act provides that any provision in the articles or stipulation in a contract which
purports to exempt a director, officer or auditor of a company against any liability towards the company which
would normally result from their “negligence, default, breach of duty or breach of trust” is void.

This provision was introduced to put an end to an earlier practice to provide in the articles for the indemnity from
all liability other than dishonesty. It is in the existence of this duty that the company and its members find their
best protection against directors exploiting their office. If, as a result of a director's breach of his/her fiduciary
duty, the company suffers a loss or the director derives a benefit, the company may set the transaction aside and
recover the loss or benefit from the director.

3 The Fiduciary Duties of Director

A great variety of acts may amount to a breach of a director's fiduciary duties. The topic can be dealt with
conveniently under four headings, namely that directors:

▪ should prevent a conflict of interest

▪ may not exceed the limitations of their power
▪ must maintain an unfettered discretion
▪ should exercise their powers for the purpose for which they were conferred.

3.1 Conflict of interest

The duty to avoid a conflict of interest is perhaps one of the most important fiduciary duties of directors. In this
regard, there are three separate and independent but closely related legal principles, namely:

▪ the duty to prevent a conflict arising between one’s own interests and those of the company (the no-
conflict rule), and
▪ the duty not to make profit from the fiduciary’s position as a director (known as the no-profit rule).
▪ the duty not to usurp any contract, information or other opportunities that properly belongs to the
company and that came to him/her as director of the compony (known as the corporate opportunity
rule)

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The application of the no-conflict rule can be found in the following case:

Example:
In Robinson v Randfontein Estates Gold Mining Co Ltd (1921 AD 168) Robinson,
the chairman of the board, purchased a farm in his own name after his company,
which was anxious to acquire the farm, could not reach finality with the sellers. He
purchased the farm through an agent for £60 000 and thereafter sold it to the
company for £275 000. The court held that Robinson was not justified in making a
profit from his office nor in placing himself in a position where his personal interests
conflicted with the duties arising out of his fiduciary position. He was ordered to
repay to the company the profit of £215 000 which he had made.

The non-profit rule requires that directors may not retain any profit made by them in their capacity as directors
while performing their duties as directors. What is prohibited is usually secret profits. If a secret profit is made by
directors in the course or scope of the execution of their office as directors, they are liable to ‘account’ ie. hand it
over to the company. The application of this rule is illustrated below.

Example:
In Regal (Hastings) Ltd v Gulliver ((1942) I All ER 378 (HL)) Regal (Hastings) Ltd
was unable to purchase all the shares in X company. The directors and their
friends thereupon subscribed for 3 000 of the 5 000 shares in X. Subsequently all
the interests in Regal (Hastings) Ltd and in X were taken over by new shareholders
at a price which resulted in a profit for the directors on their investment in X. Action
was instituted against its former directors on behalf of Regal (Hastings) Ltd for the
improper profits they made out of their directorships. The action succeeded on the
principle as stated in the text above.

The corporate opportunity rule prohibits a director from usurping any contract, information or other
opportunities that properly belongs to the company and that came to him/her as director of the company. If a
director breached this rule, a director is liable to account to the company for any profits gained as well as any loss
or damage suffered by the company.

Example:
In Atlas Organic Fertilizers (Pty) Ltd v Pikkewyn Ghwano (Pty) Ltd (1981 2 SA 173
(T) 197) a managing director was held to have breached his fiduciary duties where
he sabotaged his company's chances to obtain a contract and later, after severing
connections with his company, took over that contract for his new company.

As a general rule, a director is not prohibited from serving as a director of other companies, apparently not even if
the other company is a competitor of the first company, but he/she then occupies an almost untenable position
in that he/she may not use or disclose confidential information of the one company for the benefit of the other.

A managing director actively employed is not free to hold a managing or even an ordinary directorship in a
competing company as the active engagement inherent in a managing directorship will of necessity involve
him/her in the situation of having to advance conflicting interests.

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3.2 Exceeding limitations of powers

A director has a fiduciary duty to observe the limitations of the powers of the company as well as the limits of
his/her own authority to act on behalf of the company.

Although companies are not required to state the objects of the company in their constitution this does not imply
that a director always has unlimited powers to represent the company in contracts of any nature. Companies are
free to restrict a director’s authority in its articles or in any contract entered into with the director.

Although the Companies Act provides that such restrictions cannot be raised against a third party dealing with
the company in order for the company to escape liability, a director who has incurred liability to the company
beyond the limitations of his/her powers, may be held liable for a breach of his/her fiduciary duty for any loss
suffered.

3.3 Failure to maintain and exercise an unfettered discretion

A director must consider the affairs of the company in an objective manner. He/she may therefore not contract
as director to act in a certain manner, and an undertaking to vote in a certain way cannot be enforced against a
director.

The practice of appointing a director as nominee representing certain shareholders or other interests within the
company is legally recognised but such a nominee is nonetheless obliged to exercise his/her discretion without
being fettered.

On the other hand the appointment as director by an outside party as a puppet or mere tool who has no idea
what he/she is doing is illegal and punishable as fraud. It has in fact been held that a director who resigned and
secured the appointment of a puppet in his/her place was still bound by the fiduciary and other duties of a
director.

3.4 Failure to exercise powers for the purpose for which they were conferred

Directors must exercise their powers in good faith and for the true purpose for which these powers have been
given to them, not to achieve some other (personal) result.

Examples of directors not using their powers for their true purpose include cases where the board of directors
used its power to issue unissued shares in order to ensure its continued control over the company instead of
using it for its true purpose, namely to acquire additional capital for the company; or where shares were issued to
secure sufficient votes for the directors to enable them to effect an amendment of the articles whereby certain
shareholders would lose their right to appoint and remove directors.

The company can have a decision taken by directors for improper purpose set aside.

4 Effect of Resignation on Fiduciary duties

The general rule is that a former director is not a fiduciary, since the director no longer holds the position from
which the fiduciary duty is derived. The fiduciary duties terminate when the directorship does.

It is, however, different where the competitive activities continued after resignation. For example, where a
director acquired confidential information whilst owning a fiduciary duty to the company, the director can be
held to account even after resignation. This also applies where a corporate opportunity is acquired after

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resignation, but the resignation was influenced by a wish to acquire that opportunity. In a nutshell, the fiduciary
duty to avoid a conflict of interest cannot be evaded simply by resigning.

5 The Duty to Act with Care and Skill

At common law, directors owe their company a duty to act with the required degree of care, skill and diligence.
The nature of this duty is delictual in nature. In this sense, the breach of this duty is seen as a wrong committed
against the company for which the company can claim for loss or damage suffered.

The standards according to which the degree of care and skill is to be measured depends on a consideration of
whether the director acted in the manner in which a reasonable person would have acted. When considering the
when the director acted as a reasonable person, the particular knowledge and experience of the director must
be imputed to that reasonable person in the circumstances.

The extent of a director's duty of care and skill depends to a considerable degree on the nature of the company's
business and on any particular obligations assumed by or assigned to him/her.

Executive and non-executive directors are expected to show the same degree of care. The court in Howard v
Herrigel NNO 1991 (2) SA 660 (A), held that it is unhelpful and even misleading to classify company directors for
purposes of ascertaining their duties to the company. The legal rules are the same for all directors.

The common law duty of care is measured according to the standard of a reasonably diligent person having both
(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the
same functions as those carried out by that director in relation to the company and (b) the general knowledge,
skill and experience that that director has. This test is slightly stricter.

In respect of duties that may properly be left to some other official, a director is, in the absence of specific
grounds for suspicion, justified in trusting that official to perform such duties honestly. He/she is entitled to
accept and rely on the judgment, information and advice of the management, unless there are proper reasons
for questioning such.

Obviously, a director exercising reasonable care would not accept information and advice blindly. He/she would
accept it, and be entitled to rely on it, but would give it due consideration and exercise his/her own judgment
accordingly.

A director who does not observe his/her duties of care and skill towards his/her company is liable for damages; if
in addition there had been a contract between the director and the company (as is usually the case with full-time
executive directors) he/she could be guilty of breach of contract as well.

6 Conduct Towards Members

A director’s duty to act in good faith towards the company and for the advancement of the company's interests
implies that the members as a group will derive their benefit from the well-being of the company. In this sense a
fiduciary duty rests on directors to promote the interests of members.

However, no fiduciary relationship exists between a director and individual members of the company. It is a
matter of impossibility for a director to maintain a fiduciary relationship towards both the company and the
individual members. The interests of a member and of the company may diverge with the result that a director
would be in an untenable position if he/she were to observe fiduciary duties towards both.

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7 Contracts Between a Director and the Company

The basic principle is that, due to his/her fiduciary position, a director may not place himself/herself in a position
of conflict of interest with the company. Should a director nonetheless contract with the company, the contract
may be voidable at the option of the company.

The voidability of the contract can be overcome either by the articles permitting contracts between a director
and the company or by obtaining the approval of the contract at a general meeting after full disclosure. For this
reason it has become usual in practice to include an exclusion clause in the articles authorising directors to enter
into contracts with their company under certain circumstances.

General notice

Repeated identical disclosures by a director who is a member of a business which regularly contracts with his/her
company can be avoided by a general written notice to the effect that he/she is a member of the business and is
to be regarded from then on as having interests in such contracts.

The general notice must indicate the nature and extent of the interest in the other undertaking and must be
brought up to date as circumstances change, otherwise contracts entered into after such a change will not be
covered. As the general notice lapses at the end of each financial year, it must be renewed annually. Failure by a
director to disclose his/her interest in these types of contract constitutes an offence and the contract may be
voidable, while the profits may be recoverable from the director.

8 Personal Liability Towards Others

Despite the fact that a company is a separate legal entity, a director may incur personal liability in certain
circumstances.

A director who has misused or kept money or property of the company when the company was formed and this
fact is discovered during the stage of winding up or judicial management is personally liable to return such to the
company. Similarly if a director knows that the business of a company is carried on recklessly or fraudulently (for
example if the director knows the company is insolvent and will not be able to pay its debts and continue to do
business) or is a party to such, can be held personally liable for the debts or liabilities of the company incurred
during such period.

Summary
In this unit you learnt that the common law imposes two important duties on a director, namely the fiduciary
duty requiring a director to exercise his/her powers bona fide and for the benefit of the company, and to the
duty to display reasonable care and skill in carrying out his/her office. The fiduciary duties of a director are
generally said to consist thereof that directors should prevent a conflict of interest, may not exceed the
limitations of their power, must maintain an unfettered discretion and should exercise their powers for the
purpose for which they were conferred.
The common law duty to prevent a conflict of interest is also reflected in the statutory provisions requiring a
director to give notice to the company of any interest he/she might have in a contract entered into by the
company.

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References
Cassidy, J. (2009). “Models for Reform: The Directors’ Duty of Care in a Modern Commercial World” tell LR 373.

Cassim, F.H.I, Cassim, M.F., Cassim, R, Jooste, R.D (2011). Contemporary Company Law. Claremont: Juta.

Davies, D., Cassim,F, H.I, Geach, W., Mongalo,T., Butler, D., Loubser, A., Coetzee,L., Burdette, D. (2014).
Companies and Other Business Structures in South Africa. Cape Town: Oxford University Press.

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