Articles

Secret Profits

The Professional Accountant July/August 2009
By Alastair Morphet

The question which arises with the introduction of the new Companies Act 71 of 2008, is having regard to the provisions of section 75 of the new Act, what is happening to the rule on corporate opportunities as has developed in the common law?

To try and summarise the position at common law at present, allow me to quote from Dr Hans C Hirt writing in the 2005 JBL 669 ("The Law on Corporate Opportunities in the Court of Appeal") at page 672:

"The no conflict rule can be described as the principle that directors, as fiduciaries, must not place themselves in a position in which there is a conflict between their duties and their personal interests. Liability under the no-conflict and the no-profit rule is strict. Thus, in the absence of informed consent of the company, the director, as a fiduciary, will be held liable, even though the conflict between the duty to promote the company's interest and the personal interest is hypothetical. The no-profit rule can therefore be described as an absolute proscription to exploit corporate opportunities, and the underlying approach is firmly based on the notion of prophylaxis."

In the writer's opinion this is very much an elegant summary of the law applying in the United Kingdom. This needs to be contrasted with the approach in the United States, where in a far more flexible approach the court considers the nature of the business opportunity, the capability of the company to exploit it and the bona fides of the director involved. The first question must be “what is the law in South Africa at present”, and then a consideration of what impact the introduction of the new section 75 will have on that common law.

In Phillips v Fieldstone Africa (Pty) Ltd [2004] 1 All SA 150 (SCA) Heher JA writing for the Court produced a precise statement of the law relating to the breach of fiduciary duty and its consequences (paragraph 29 ff). The learned Judge cited the decision of Robinson v Randfontein Estates Gold Mining Company Limited 1921 AD 168 and in particular the provision that where there is a legal relationship involving a position of confidence with a duty to protect the interests of the other person, the agent cannot make any profit from his agency save the agreed remuneration; all such profit belongs not to the agent but to his principal.

Indeed, Heher JA quotes Regal (Hastings) Limited v Gulliver [1967] 2 AC 134 and Canadian Aero Service v O'Malley [1974] 40 DLR (3d) 371 (SCC) to the effect that the rule is a strict one which allows little room for exceptions. The learned Judge goes on to state that the defences open to a fiduciary who breaches his trust are very limited: only the free consent of the principal after full disclosure will suffice. Because the fiduciary who acquires for himself is deemed to have acquired for the trust, once proof of a breach of a fiduciary duty is adduced it is of no relevance that the trust has suffered no loss or damage, or that the trust could not itself have made use of the information or opportunity or probably would not have done so (at paragraph 30 of the Phillips case).

In paragraph 31 Heher JA quotes Lord Upjohn in Boardman v Phipps [1966] 3 All ER 721 (HL):

"Finally, having established accountability it only goes so far as to render the agent accountable for profits made within the scope and ambit of his duty."

In the more recent Supreme Court of Appeal case Da Silva v CH Chemicals [2009]1 All SA 216, the Court (per Scott JA) summarises the law:

"Such an opportunity is said to be a "corporate opportunity" or one which is the "property" of the company, if it is acquired by the director, not for the company but for himself, the law will refuse to give effect to the director's intention and will treat the acquisition as having been made for the company. The opportunity may then be claimed by the company from the delinquent director." (At paragraph 18)  

However, in Blackman's Commentary on the Companies Act (ed Jooste, Everingham et al, Looseleaf, Jutas, Cape Town at page 8-166-1) the learned authors having cited Robinson's case, supra, state that this states the rule too narrowly. "The position would seem to be that, while in the case of certain opportunities some particular relationship between the director and the company is necessary, in other cases it is the relationship between the company and the opportunity that denies the director the right to take the opportunity for himself". They cite the passage by Goldstone J in Sibex Construction v Injectaseal CC:

"I am not to be taken as laying down any order of liability to be read as if it were a statute. The general standards of loyalty, good faith and avoidance of a conflict of a duty and self interest to which the conduct of a director or senior officer must conform must be tested in each case by made factors which it would be reckless to attempt to enumerate exhaustively. Among them are the factor of position or office held, the nature of the corporate opportunity, its ripeness, its specificness and the director's or managerial officer's relation to it, the amount of knowledge possessed, the circumstances in which it was obtained and whether it was special or, indeed, even private, the factor of time in the continuation of the fiduciary duty where the alleged breach occurs after termination of the relationship with the company and the circumstances under which the relationship was terminated, that is whether by retirement or discharge." (1988 (2) SA 55 (T) at 66)
 
From this point of departure Blackman stipulates that there at least three situations is which the duty attaches to the director. Firstly, where a director has a duty to acquire the opportunity for the company or has a duty to assist the company in acquiring it. This relates to the mandate given to the director by the company to pursue this opportunity for the company.

The second is where the director seeks to usurp an opportunity which the company is actively pursuing or which at least as far as the company's directors as a whole are concerned, be said to belong to the company. The third situation is where the director obtains any business opportunity as a result of using the company's asset or of information which he has obtained in his capacity as a director of the company.

What then is the position under the new Companies Act? Section 75, after dealing with the type of companies where this provision will not apply, provides in subsection (4) that at any time, a director may disclose any personal financial interest in advance by delivering to the board or the shareholders a notice in writing setting out the nature and the extent of his personal financial interest, to be used generally for the purposes of this section.

In subsection (5) it provides that if he has a personal financial interest in respect of a matter to be considered at a meeting of the board, then he must disclose the interest and its general nature before the matter is considered at the meeting. He must disclose to the meeting any material information relating to the matter and known to him. He may disclose any observations or pertinent insights if requested to do so by the other directors, but if he is present at the meeting he must leave immediately after making the observations or providing the material information; that is he must not take part in the consideration of the matter but he will constitute part of the quorum but not be regarded as providing sufficient support for the resolution. He must not execute any document on behalf of the company in relation to that matter unless specifically directed to do so by the board.

In section 75(6) if a director acquires a personal financial interest in an agreement/matter in which the company has a material interest, after the agreement or other matter has been approved by the company, the director must promptly disclose to the board or to the shareholders the nature and extent of that interest and the material circumstances relating to his or a related person's acquisition of that interest.

A decision by the board or a transaction approved by the board is valid despite any personal financial interest of a director if it was approved in the manner contemplated in this section or has been ratified by an ordinary resolution of the shareholders (section 75(7)).

In other words, there is no express provision in section 75 for there being an accounting of profits to the company in any matter where a director has a personal financial interest.

The liability of directors is set out in section 77. It needs to be understood that in the new Companies Act these provisions apply to prescribed officers of the company as well, so to the extent that there is liability for a director, there will be an equal liability for a public officer or general manager of the company who is not legally a director.

Section 77(2) provides that a director may be held liable in accordance with the principles of the common law relating to a breach of a fiduciary duty, for any loss, damages or costs sustained by the company as a consequence of any breach by the director of a duty contemplated in section 75.

Subsection (2)(b) provides that he may be held liable in accordance with the principles of the common law relating to delict for any loss, damages or cost sustained by the company as a consequence of any breach contemplated in section 76(3)(c) (that is a breach of his duty of care, skill and diligence); any provision of the Act not otherwise mentioned in this section or any provision of the company's Memorandum of Incorporation.

In respect of a breach of section 75, what the director would have breached is the failure to provide adequate disclosure in accordance with section 75. The section nowhere prescribes that he must disgorge the profit he has made from any transaction in breach of this section.

The question then becomes can the common law prevailing now prior to the introduction of Act 71 of 2008 carry on applying in respect of secret profits? Section 77(3) provides that a director of a company is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director having committed certain acts on or behalf of the company, but none of these relate to the a director having appropriated a corporate opportunity for personal gain.

In the scope of the new Act, to the extent that the director's theft of a corporate opportunity for his personal gain, has been a breach of section 75, then the amount of the damage which the company suffers would be the extent of the profit he had made. But then instead of suing the director on the basis set out in Regal (Hastings) Limited v Gulliver (supra), the company's action will actually be a civil action for damages suffered as a result of the failure to disclose in terms of section 75. It is not so much a disgorgement of the profit that the former director has made, it is using the profit he has made to assess the quantum of damages the company has suffered.

However, the important point that really needs to be noted in this regard is that provided the director has made full and proper disclosure in accordance with the requirements of section 75, he will not be liable: disclosure of his material interest will relieve him of any liability under Regal (Hastings) Limited v Gulliver. This is very much the principle that light and truth make good any wrong: however, in the writer's opinion there is certainly a degree to which taking that corporate opportunity for oneself is a fundamental breach of the director's fiduciary duty to the company. Disclosure is not sufficient to make that breach go away – in the writer's assessment the common law is that set out by Lord Cranworth LC in Aberdeen Rail Company v Blaikie Brothers:

"No fiduciary shall be allowed to enter into engagements in which he has or can have a personal interest conflicting or which possibly may conflict with the interests of those whom he has bound to protect." [1843-60] All ER 249 (HL)

When this matter came before the Court of Appeal more recently, in Re: Bhullar Bros Limited [2003] EWCA CIV 424; [2003] BCC 711 at [27], Jonathan Parker LJ considered that in a case where a fiduciary exploited a business opportunity for his/her own personal benefit, the relevant question was not whether the party to whom a duty was owed had a beneficial interest in the opportunity, but whether the fiduciary's exploitation of the opportunity was such as to attract the application of the rule stated by Lord Cranworth LC in Aberdeen Rail Company.

It is that issue about "possibly may conflict" which drew the consideration of Lord Upjohn in Boardman v Phipps (supra). In Bhullar Bros the Court of Appeal felt that the real question is to test for a "real sensible possibility of conflict" between the director's fiduciary duty and the company's possible opportunity. But under the new Companies Act, the question now is has there been proper compliance with the requirements of section 75?