A.Attenuation of Directors Fiduciary Duties

A.Attenuation of directors’ fiduciary duties

The fiduciary duties owed by directors may be narrowed by the unanimous agreement of the shareholders.[1]

In the special situation where the shareholders are the directors, the shareholders’ acquiescence to a course of conduct can affect the practical content of the fiduciary duties, including any question of whether directors acted with a reasonable degree of care and diligence and whether they made improper use of their position.[2] However, the doctrine of the attenuation of the fiduciary duties is not absolute as was shown in the Australian case of Levin v Clark.[3]

The doctrine is supportable on the basis that there is no oppression of a minority when there is unanimous consent of the shareholders, however the law in the United Kingdom has not developed in line with Australian authorities.[4] It is therefore no longer clear upon which principles the attenuation of fiduciary duties may arise, or whether there may be a fraud on the minority arising from the attenuation of the fiduciary duties.

The operation of the Duomatic principle together with the doctrine of attenuation of fiduciary duties seems to indicate that there is no fraud on the minority (since there was at least unanimous informal consent at the time), however there is no authority on the question whether, notwithstanding there being no minority at the time, there was nevertheless a fraud on the minority (perhaps arising from conduct which was a cause of there being no minority), alternately, ‘oppressive conduct’ pursuant to section 232 of the Corporations Act and consequently there was no valid ratification by the shareholders.[5]

It may also be relevant to consider whether an applicant shareholder is estopped from resiling from their previous position which permitted the Duomatic principle to operate[6] however there would not appear to be a question of a destruction of the rights of a person who was unaware of a relevant ratification proposal[7] since the Duomatic principle can only operate if the shareholders are fully informed.[8] Accordingly, unless it is established that the shareholders are fully informed, neither the operation of the Duomatic principle, nor independently the doctrine of ratification could result in a valid ratification resolution.

Corporate opportunities

There is inconsistent authority which indicates that if a company, fully informed, takes a specific decision to not pursue a corporate opportunity and assents to a director pursuing the same opportunity, the director will not breach their fiduciary duties to the company on the basis that the director’s fiduciary duties have changed.[9] The decision in Queensland Mines Ltd v Hudson[10]has been doubted on the basis that disclosure to the board of directors is insufficient to ratify a breach of fiduciary duties[11] and only a fully informed general meeting of the shareholders can ratify the breach.[12]

The question whether directors should have the power to ratify a breach of fiduciary duties is considered in Chapter 5.

Amendments to a company’s constitution

A company’s constitution may modify the fiduciary duties owed by directors at common law.[13] The question arises in the context of a company incorporated under the Corporations Act, whether the constitution authorises certain conduct of the directors which would otherwise be a breach of their duties.

In Angas Law Services Pty Ltd (in liq) v Carabelas,[14]the High court left open the question as to whether different considerations may apply to the content of the duties owed by directors in the context of a prospective authorisation given by shareholders. There is accordingly significant uncertainty as to the law in this respect.

Proposition
It is a proposition advanced by this thesis that the principles which govern the attenuation of fiduciary duties are unclear.

I.attenuation of directors’ fiduciary duties by ratification or authorisation[MR1]

The fiduciary duties of a director may be prospectively attenuated by the company’s constitution or the unanimous approval of the shareholders.[15]

In relation to the attenuation of a director’s fiduciary duties, the distinction between an executive and non-executive director has not been determined to be a proper basis for determining the scope or content of a director’s fiduciary duties.[16] The principle was criticised by Professor Austin in the context of unremunerated part-time directors where the relationship is non-commercial.[17] The position argued for by Professor Austin has not been accepted in Australia. One reason advanced for avoiding the executive and non-executive distinction is that these terms do not explain the ‘particular facts and circumstances in which the individual fiduciary has been placed’[18]and further that ‘[t]he role of a director as a fiduciary must be determined having regard to the position in which the individual person is placed in the corporate architecture in which [the director] reside[s].’[19]

In Levin v Clark,[20] Jacobs J stated:

The fiduciary duties of directors spring from the general principles, developed in courts of equity, governing the duties of all fiduciaries ... Among the most important of these circumstances are the terms of the instrument governing the exercise by the fiduciary of his powers and duties and the wishes, expressed directly or indirectly, by direction, request, assent or waiver, of all those to whom the fiduciary duty is owed.[21]

B.Attenuation by the shareholders

The fiduciary duties owed by ‘nominee[MR2]’ directors may be narrowed by the unanimous agreement of the shareholders.[22] This broad principle was recently doubted in the UK in obiter in Cobden Investments Ltd RWM Langport Ltd[23] where the Court stated that,

[w]hether it is possible for the shareholders by unanimous assent to allow a nominee director actually to subjugate the interests of the company to those of his appointer is doubtful.[24]

The principle is really that the interests of the company are paramount and that a nominee director may take into account the interests of the appointer.

There is support for the definition of ‘nominee director’ as being ‘[p]ersons who, independent of the method of their appointment, but in the performance of their office, act in accordance with some understanding, arrangement or status which gives rise to an obligation (in the wide sense) to the appointor.’[25]

In the special situation where the shareholders are the directors, the shareholders’ acquiescence to a course of conduct can affect the practical content of the fiduciary duties, including any question of whether directors acted with a reasonable degree of care and diligence and whether they made improper use of their position.[26] However, the doctrine of the attenuation of the fiduciary duties is not absolute as was shown in the Australian case of Levin v Clark.[27]

The doctrine is supportable on the basis that there is no oppression of a minority when there is unanimous consent of the shareholders, however the law in the United Kingdom has not developed in line with Australian authorities[MR3].[28] It is therefore no longer clear upon which principles the attenuation of fiduciary duties may arise, or whether there may be a fraud on the minority arising from the attenuation of the fiduciary duties.

It may also be relevant to consider whether an applicant shareholder is estopped from resiling from their previous position which permitted the Duomatic principle to operate[30] however there would not appear to be a question of a destruction of the rights of a person who was unaware of a relevant ratification proposal[31] since the Duomatic principle can only operate if the shareholders are fully informed.[32] Accordingly, unless it is established that the shareholders are fully informed, neither the operation of the Duomatic principle, nor independently the doctrine of ratification could result in a valid ratification resolution.

C.Amendments to a company’s constitution or a shareholders’ agreement

A company’s constitution may expressly or impliedly[33] modify the fiduciary duties owed by directors under the general law[34] by making the fiduciary duties [MR4]less onerous.[35] In order that there be a relaxation of fiduciary duties, it is necessary that the constitution be amended for this purpose since ‘[e]quity has no power to relax its own strict rule further than and inconsistently with the express relaxation contained in the [constitution]’.[36]

A shareholders’ agreement may also have the effect of attenuating the fiduciary duties of the directors.[37]

The principles of attenuation are supported by the statement in Hospital Products[38] that ‘the fiduciary relationship cannot be superimposed upon a contract in such a way as to alter the operation which the contract was intended to have according to its true construction.’[39]

The question arises in the context of a company incorporated under the Corporations Act, whether the constitution authorises certain conduct of the directors which would otherwise be a breach of their duties.

A distinction should be drawn between small and large proprietary companies.

Small proprietary companies

It has been argued in relation to small proprietary companies that:

[i]n a small company where management and ownership often coincide in the same persons some aspects of the conflict principle seem unnecessary. In practice, the constitution of such a company will usually provide that a director can hold a paid office or place of profit under the company (see below). Even if the constitution does not so provide, in a company in which all members are directors who employ one of their number for reward, the necessary authority could be regarded as impliedly given by all the members.[40]

A proprietary company may include section 194 of the Corporations Act into its constitution permitting a director with a material personal interest that relates to the affairs of the company to disclose the interest under section 191 and vote on a resolution in relation to the matter.

Large proprietary companies

For practical reasons of the day-to-day running of a large company’s business, it is considered to be common for the company’s constitution to alter the content of a director’s fiduciary duties by relaxing the general rule that a director cannot act when they have a conflict of interest, or conflict of duty.[41]

Example of typical modifications to the fiduciaries include:

directors are not disqualified by their office from contracting with or holding any other office under the company;
a contract entered into by or on behalf of the company in which a director is in any way interested cannot be avoided because of that interest;
a director contracting with the company or being interested in a contract is not liable to account to the company for any profit realised by the contract by reason only of the directorship;
the above provisions are subject to the qualification that the nature of the director's interest must be disclosed at the first meeting of the directors when it becomes relevant to do so;
a director may vote in respect of any contract or arrangement in which he or she is interested;
a director may be counted in ascertaining whether a quorum is present at the meeting at which the contract or arrangement is considered; and
a director may participate in the execution of any instrument by or on behalf of the company concerning a transaction in which he or she is interested.[42]

Where an interested director can vote under the authority of the constitution he or she is still subject to the duty to vote with a view to the benefit of the company as a whole unless relieved of that duty in some way.[43]

A contract by which a business opportunity belonging to the company is diverted to some other firm controlled by a director would not be authorised by a constitutional provision in the form outlined above.

Such a provision contemplates a director voting in respect of a contract or arrangement in which he or she is interested. As will be seen later in [9.150] , in the case of a public company s 195 reduces that freedom. Constitutions of some listed companies made in compliance with former ASX LR 3L(6) may still prohibit directors from voting in regard to any contract or arrangement, or proposed contract or arrangement, in which the director has, directly or indirectly, a material interest.

Nominees directors

In Levin v Clark[44] the company’s constitution, coupled with the terms of a sale and mortgage, was held to constituted an attenuation of the fiduciary duty of the directors which was sufficient to permit the directors to act primarily in the interests of the mortgagee and thereby did not require the directors to act for the benefit of the company as a whole.

Corporate opportunities

There is inconsistent authority which indicates that if a company, fully informed, takes a specific decision to not pursue a corporate opportunity and assents to a director pursuing the same opportunity, the director will not breach their fiduciary duties to the company on the basis that the director’s fiduciary duties have changed.[45] There are different judicial views on whether the decision in Queensland Mines Ltd v Hudson[46]stands for a broad or narrow principle.[47]

Academic writing on the question of whether the constitution must contain an express authority indicates that ‘in the absence of authorisation in the constitution, there is significant doubt whether a board can permit a director to pursue a corporate opportunity that the board determines is not of interest to the company’.[48]

Directors of competing companies

Given that there is no prohibition established by the Corporations Act against a person being a director of 2 or more competing companies, the Courts have adopted a practical approach to considering the extent of the fiduciary duties owed by a director to a company.

The principle derived from the early case law is that it will not be a breach of fiduciary duty for a person to be a director of 2 competing companies, provided that confidential information is not divulged.[49] Reservations have been expressed about this principle in Australia[50] and in the United Kingdom.[51]

The following qualifications to the principle have been developed:

The contract of employment of an executive officer (including an executive director) may be subject to an express or implied term that the employee must provide his or her services exclusively for the employer.[52] But that express term may simply reflect the fiduciary responsibility, with the consequence that a breach of that term may lead to liability to account for profits rather than the lesser liability to pay damages. It appears that an executive director who may be subject to an implied term of employment of the above kind ceases to be subject to any obligation not to compete once he or she has resigned.[53]
It is a breach of duty for a director to ask the company's customers to cease to deal with the company and to deal with the director in a competing business.[54]
A director may be restrained from using information which it would be a breach of duty by an employee to disclose during the course of his or her employment, and must not divulge information of one company to the other company, or use it for the benefit of the rival company.[55]

In Western Areas Exploration Pty Ltd v Streeter (No 3),[56] Justice Heenan considered the authorities which referred to London v Mashonaland Exploration Co Ltd v New Mashonaland Exploration Co Ltd[57] and determined the preferred approach in the following passage:

Rather, it is a recognition that the plaintiff's interests must be respected by the defendants and that it will be a breach of fiduciary duty for the defendants to act if there is a real or possible conflict of interests between their own personal interests, or the interests of some third person, and those of the plaintiff unless this is authorised by the terms of their engagement or is the subject of express assent by the plaintiff. This is the preferable sequence for analysis of the obligations rather than by commencing with the inevitably polemical proposition that a director is entitled, in certain circumstances, to be a director or other officer of a second corporation whose business competes with that of the other corporation of which he is also a director.[58]

In the later case of Links Golf Tasmania Pty Ltd v Sattler[59]the court reviewed the earlier cases, including Western Areas Exploration,[60] and concluded relying upon the decision in Bell v Lever Brothers[61]that the principleapplies only to the extent that merely because a person is a director of two competing companies they are not in a position of “real sensible possibility of conflict” but particular facts might mean that the person does have such a conflict. The Court also concluded that this principle which allows a person to be a director of two competing companies “is a very high-level one that could be used only as the broadest of starting points for the resolution of issues arising in a particular case”.[62] This means, according to the court, that a person who is a director of two competing companies will not necessarily be regarded as having a real sensible possibility of conflict but the facts of a particular case may lead that person to be in breach of duty.

In the result, it appears that:

there is no general and absolute principle to preclude a non-executive director from being appointed to the board of a competing company;
an executive director may be bound by an express or implied term in a contract of service which will exclude acceptance of such a position, breach of that term leading to equitable accountability and not merely common law damages, but the constraint imposed by the term may be avoided by resignation;
both before and after resignation, an executive or non-executive director is constrained by the law with respect to confidential information, which is at least as onerous in the director's case as in the case of an employee; and
directors who use their position on the competing company board to act oppressively may be amenable to relief under Pt 2F.1 .[63]

The law in this area remains under development.

Shareholder authority

Proposition
It is a proposition advanced by this thesis that the principles which govern the attenuation of fiduciary duties by authorisation and ratification are unclear.

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[1]See especially Levin v Clark [1962] NSWR 686; Japan Abrasive Materials Pty Ltd & Ors v Australian Fused Materials Pty Ltd (1998) 16 ACLC 1172.