INTRODUCTION TO PARTNERSHIP AND COMPANY LAW

LAW 346 *

PROMOTERS AND PRE-INCORPORATION CONTRACT*

PROMOTERSBefore a company comes into being, there must be some person desiring incorporation to take the steps to incorporate it under the CA. The persons who undertakes to set up the co. and get it going Promoters.Under the CA there is no precise definition of promoter, only referred to under section 4(1) in relation to liability on a prospectus.In Twycross v Grant a promoter is defined as a person who undertakes to form a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose.

A person who carries out the procedures necessary to incorporate a company such as preparing and lodging the memorandum and article of association together with the other incorporation documents, is normally a promoter.*

Whether a person will in law be regarded as a promoter is a question of fact depending upon the circumstances of the case.

Need not be a natural person, can be a corporate person.

However, people who carry out their normal professional duty and act purely in a professional capacity are not necessarily promoters e.g. a lawyer who draws up the memorandum and article of association of the company.

Certain person are prohibited from being promoters see s. 130(1) of the CA.

Under section 16(1) a promoter is required to file to the Registrar and Official Receiver a statutory declaration in Form 48A before the incorporation of a company.

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Duties of promoters

A promoter is not an agent nor a trustee of the proposed company. Nevertheless, it is settled law that they stand in a fiduciary relation to the company the were creating. Case Erlanger v New Sombrero Phosphate Co.The fiduciary duty is based on the basis of their influence and control over the company they have created and the great potential that such influence and control could be abused to the detriment of the company and its members.

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Fiduciary duties means the promoters should act with utmost good faith and not to have conflict of interest with the company he is promoting. This means that -1) A promoter has a duty not to make any secret profit out of the promotion without adequate disclosure. If he receives or makes profit he must disclose it to (i) independent board of directors or (ii) existing/future shareholders.

Case : Erlanger v New Sombrero Phosphate (1878) - A promoter effecting the sale of his property to the company. The disclosure must be full, frank and explicit. Must contain at least information relating to the interest of the promoter and all material facts. A disclosure which is a half truth or partial truth can be defective and has no legal force.

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2) To disclose a commission/payment that he received upon transfer of property to the company. Even if the promoter has not received the commission or payment after the company is formed, the company itself may enforce the claim against the promisor on the ground that the promisor holds the claim as trustee for it.Case : Whaley Bridge Calico Printing Co v Green and Smith (1879)

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If a promoter contracts with the company whether as vendor / purchaser, the fact that he is contractor must be disclosed

Case : Habib Abdul Rahman v Abdul Cader (1886)- Two members of the company successfully sued to rescind a contract on the ground that there had been no disclosure.

To whom should be disclosed? all persons who are invited to become members.

If it is public co, disclosure via prospectusIf private co, via AGM or circular

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REMEDIES For Breach Of Promoters Duties Where the promoter has acted in breach of his fiduciary duty i.e. he fails to make full and proper disclosure of a profit made by him out of the promotion, the company has a wide choice of remedies available against him.

The fiduciary duty of a promoter is owed to the company , therefore the company would be the proper plaintiff in an action against the promoter. This rule is established in the case of Foss v Harbottle.

Promoters are jointly and severally liable for the secret profit the have obtained from their promotion.

If a promoter pays the whole of the secret profit to the company, he may seek to recover the proper contribution from his co-promoters (see Gluckstein v Barnes), unless the court strikes down his claim for policy consideration. *

The followings are the remedies available against the promoter who has acted in breach of duty:i-Rescission of contractii-Recovery of secret profitiii-Damages for breach of fiduciary duty.*

Rescission of Contract-Where a promoter has acted in breach of his fiduciary duty e.g. by selling his own property to the company and failing to disclose the transaction, the company may bring action for rescission (termination/annulment) of the contract and to recover the purchase price from the promoter.

-means the company must return the property and the promoter must return the profit he gained.

- An illustration of this principle is the case of Erlanger v The New Sombrero Phosphate Co. The company was successful in rescinding the contract for the purchase of an island and recovered the purchase price of 110,000 from the promoter.*

Rescission of a contract is an equitable remedy

The right to rescind however is lost if:a) After gaining knowledge of the true facts, the company affirms the contract; or

b) Restitution in integrum is no longer possible (the parties cannot be restored to their original position- for example the property had altered to an extent that it is not possible to have it in the same condition as when the contract was entered into) and there was no fraud committed by the promoter.

- case: Lagunas Nitrate Co. v. Lagunas SyndicateThe company extracted nitrates from the ground. The court refused to allow rescission because the condition of the land cannot be restored to its original state.*

c) or an innocent party has acquired rights to the property.-case: Re Leeds & Hanley Theatres of Varieties LtdRescission was not allowed since the property has been transferred to a third party.

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Recovery of the promoters secret profit.

As an alternative (where the co. affirm or rescission is impossible), the company can claim any secret profit made by the promoter on the basis of trust principle.

Gluckstein v Barnes a company was able to recover the sum of 20,000 as secret profit which was not fully disclosed by the promoter.

Whaley Bridge Calico Printing Co. v Green & Smith notwithstanding the fact that a co-promoter who had been promised had not received the secret profit, it did not prevent the company itself from enforcing the claim of the co-promoter for payment against the promisor, on the ground that the promisor held the claim as trustee for it.

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DamagesA company also may have a remedy in form of damages against the promoter for breach of fiduciary duty.

However, the company must prove that it has suffered loss.

The company may sue for damages for breach of fiduciary duty, fraudulent misrepresentation, deceit or negligence.

In Re Leeds & Hanley Theatres of Varieties Ltd., the promoters who had acted in breach of their fiduciary duties were held liable for damages to the company.The measure of the damages was the secret profit of the promoter.

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PRE INCORPORATION CONTRACT Pre-incorporation contract = contracts made before a company is incorporated.

At Common law a company cannot enter into a contract before it is incorporated. The reason for this rule is that, before its incorporation the company has no legal personality and has no contractual capacity.

Therefore, if a contract is made in a companys name before its incorporation, the company is not liable (not bound) and cannot enforce the contract. *

Case: Kelner v Baxter3 persons made a contract to purchase goods on behalf of a company. The goods were supplied and used by the company which was incorporated after the purchase. The supplier could not recover the price from the company since there can be no contract with a non-existent company.

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Nevertheless, s 35(1) of the CA has overcome the difficulties under the common law by allowing the company to ratify contract created before its incorporation.

Provided 2 conditions are satisfied (Case: Cosmic Insurance Corporation Ltd. v. Khoo Chiang Poh)i) Contract entered into by any person on behalf of the company before its corporationii) The co. must ratify it after its formation

Effects:Once the pre-incorporation contract is ratified, the Co. is bound by the contract and is entitled to the benefit of the contact from the date the contract was made (retrospectively).

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Ratification of contract : expressly or impliedlyIn Thai Hwa Realty Sdn Bhd. v. Ketua Pengarah Hasil Dalam Negeri it was held that ratification under s. 35(1) could have been implied by some act showing an intention to adopt that pre-incorporation contract either by silence or by mere acquiescence or by a company resolution.

Failure to ratify the contract.Section 35(2) The person who acted in the name or on behalf of the company to make the contract will be personally bound by the contract and entitled to the benefit thereof.*

MANAGEMENT OF COMPANIESDIRECTORS

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A company being an artificial person cannot act in its own person. It may only act through the agency of natural persons.The AOA of a company typically entrust the management of the company to a body of persons called directors.Every co. incorporated in Malaysia must have at least two directors, both of them must have his principal or only place of residence in Malaysia: s. 122.Upon incorporation, their names must be specified in the cos Constitution (MoA or AoA) s 122(3)*

There is no comprehensive definition of director. A director is an officer of the company within the meaning of s. 4(1) of the CA. Furthermore, the word director is defined by s. 4(1) as including:Any person occupying the position of director of a corporation by whatever name called;Any person in accordance with whose directions or instructions the directors of a corporation are accustomed to act; andAn alternate or substitute director.

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A director is not an employee of the company (unless he has entered into a separate contract of employment as a salaried executive) but rather an agent of the company.

In practice there is an important distinction between non-executive director and managing or executive director:

-non-executive director take part in the collective decision of the board of directors, but has no other functions except by express delegation.

-managing or executive director in addition to taking part in board meetings they also work, usually full time, in the management of the company.

As a director is an agent of the Co, he is in fiduciary position towards the co.

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Appointment of DirectorsWhen a new co is formed its first two directors must be named in MoA or AoA: 122(3).As for the subsequent appointment (existing co), the CA does not prescribe the manners in which the directors are to be appointed. That is left generally to the AOA of the co.Normally, they are elected by the members at the AGM of the co. However the MOA and the AOA may for instance provide that a certain person or body will have the power to appoint the directors of the companyThe constitution of the company may provide that the BOD has the power to appoint a new director either to fill a vacancy to add to the number of directors ( e.g. article 68 of Table A). But any new appointment must not exceed numbers specified in AoA.*

Private company with as small no. of members may have articles providing that the directors shall be appointed by the members.

A wholly owned subsidiary company may by its articles authorise its holding company to appoint and remove its directors.

Sometimes holders of debenture stock are given the right to appoint a director, or the appointment of directors is granted to an outsider in a separate agreement.

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Term of office specified in the constitution

BUT there are limits:

Director aged 70 yrs old may only hold office until the next AGM (i.e. must be re-elected annually)

In a listed co, no directors can hold office for more than 3 yrs w/o being re-elected (KLSE requirement)

May resign at any time by giving proper notice to the co.

Art 72(e), Table A : a director may resign by giving a written notice of resignation to the co.

H/ever, none can resign if that resignation will cause the number of directors to be less than 2 s 122(6)

Such resignation is invalid

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Qualifications of DirectorsWho can be appointed?Must be a natural person and of full age s. 122(2). Full age refers to a person who has attained the age of majority i.e. 18 yrs old.Must have his principal or only place of residence in Malaysia s. 122(1)An undischarged bankrupt may not (except with the leave of the court by which he was adjudicated bankrupt) be a director of or otherwise concerned in a management of a company. *

iv)S. 130 where a person is convicted whether within or outside Malaysia:a. of any offence in connection with the promotion, formation or management of a corporation;b. of any offence involving fraud or dishonesty punishable on conviction with imprisonment for 3 years or more; orc. of any offence under s. 132(breach of statutory duty to act honestly), 132A (abuse corporate info)or s. 303 (personal liability for wrongful trading).That person may not (except with the leave of the court) be a director or a promoter or is in any way whether directly or indirectly concerned or takes part in the management of a corporation within a period of 5 years after conviction or, if he is sentenced to imprisonment, after his release from prison.The persons who are disqualified under s. 130 may apply for the leave of the court by giving not less than 10 days notice to the Registrar, and the Registrar may oppose the granting of the application.*

Share qualification of directors.

There is no obligation expressly imposed by the CA for a director of a company to have any share qualification.

A company however, may provide in its MOA or AOA that the directors must obtain a certain number of shares in order to qualify as directors see article 71 of Table A: the shareholding qualification of directors may be fixed by the company in the general meeting.

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The objectives of having a shareholding qualification are: 1) to impose upon the directors a personal interest in the affairs of the company so that the directors have an added incentive to ensure the financial success of the company, and 2) to make it attractive to shareholders to see that the directors are risking their own money as well as that of the members.

The requirement if imposed must be satisfied within 2 months (or such shorter period as the AOA may provide) from his appointment taking effect: s. 124(1) See Holmes v Keyes.

A director shall vacate his office , if he has not within the period of 2 months obtained his qualification, or if after obtaining it he ceases at any time to hold his qualification : s. 124(3)

A person vacating office under this provision is incapable of being reappointed until he has obtained his qualification.*

Age qualification

Private co no age limit

Under s. 129 of the CA, for public co ( + its subsidiaries) no person over the age of 70 shall be appointed as a director

The office of the director will become vacant at the conclusion of the AGM commencing next after he attains the age of 70. (Must vacate his office).

But an appointment or reappointment of a director aged 70 or more may be made by passing a resolution by a majority of not less than 3/4 of members entitled to vote in the AGM. A 14 days notice specifying his age must be given to the members prior to the AGM.

Nevertheless, the AOA or MOA may exclude this age qualification.

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Removal of Directors: How can a director be removed?The directors may be removed from office due to the disqualification under the statutory provision or under the terms of the AOA.

i) Removal by other directorsFor public co, s 128(8) prohibits directors to remove other director BUT for private co, possible for the Constitution to have provision that allows such action

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ii- Removal by members

Public co s 128(1) : members may remove a director by ordinary resolution in the general meeting, before the expiration of his period of office.

This will apply regardless anything stated in the MoA, AoA or any contract entered into with the director. The office of the director becomes vacant on the passing of the resolution.

However, where the director was appointed to represent the interest of a particular class of share holder or debenture holder, the resolution to remove the director does not take effect until a successor has been appointed.

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S. 128(2) & (3) if the statutory power is to be exercised , a special 28 days notice of the resolution must be given.

The director has the right to be heard on the resolution at the meeting.

The director has the right to make his defense both by written representation circulated to the members and by addressing the meeting before a vote is taken.Although the AOA may not exclude the right of removal , they may provide an independent right of removal without giving special notice under s. 128(2). *

The proper procedure must be followed whether a director is removed in accordance with the articles or under s. 128.

Procedure : notice of intention must be given (by the members)to the co at least 28 days before the meeting [or any no. of days specified in the AOA)Co must later notify the said director of the intention

He has the right to have representations sent to all members and to speak at the meeting

Only need ordinary resolution to remove him

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Case : Soliappan v Lim Yoke FanAOA of the co provided that a director may be removed give 7 days notice before the GM. P sent notice of a resolution to remove directors 3 days before the GM. At the meeting P was purportedly elected as a director after Ds had been removed.Ds refused to vacate the office.Federal Court held that s. 128 was not mandatory. The power to remove directors under that section co-existed with any power contained in the articles. t/4 it is not necessary to give 28 days notice; the removal could be effected in accordance with the AOA.Based on the facts, proper notice had not been given Ds had not been properly removed, consequently Ps were not properly appointed as directors.*

Private co. the procedure for removal of directors governed by the AOA. E.g. article 69 of Table A provides for removal of directors through ordinary resolution and the position is deemed to have been vacated in certain situation such as absence without leave for 6 moths, failure to declare his interest in contract entered into by the company.

If the AOA do not provide for a removal of the director of a private company, a special resolution would be first necessary to alter the AOA to provide the necessary authority. If not the members could wait until he retires via rotation clause in the articles and not reappoint him.*

DIRECTORS DUTIESThe law impose certain duties upon the directors:Fiduciary dutiesDuties of care, skill and diligenceStatutory duties.*

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1) Fiduciary DutiesDirectors occupy a fiduciary position in relation to the company must exercise their power in good faith in the interest of the company as a whole.

S. 132 (1) of the CA A director of a company must at all times exercise his powers for a proper purpose and in good faith in the best interest of the company.*

The fiduciary duties of the directors are:i-to act bona fide in the companys interest;ii-to exercise his powers for proper purpose;iii-to avoid any conflict of interest between his duty to the company and his personal interest.

i.Duty to act bona fide in the companys interest.A director is said to bona fide in the interest of the company when he act in what he honestly considers to be the companys interest not some other partys interest.The phrase honestly was considered in Marchesi v Barnes & Keogh. Gowan J stated that:To act honestly refers to acting bona fide in the interest of the company in the performance of the functions attaching to the office of the directors.

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In Re W & M Roith Ltd.Roith the director and controller of the company entered into an agreement with the co to provide payment of pension for wife upon his death. Claim for pension was made after his deathHeld: Co not obliged to pay. When the directors made such decision, they were not considering the interest of the co (-the co did not derive any benefit from the agreement)

Percival v Wright the interest the company directors have to consider is the interest of the members of the company as a whole, not the interest of individual members.

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In recent years, companys interest also refers to employees interest, although earlier on it was not so as can be seen from the decision in Parke v Daily News Ltd the court held the directors were in breach of their duty to the company when they considered the employees interest above that of the company.Nowadays, the UK CA requires directors to have regard for the interest of the employees in general. Similar position in Singapore.When the employees benefit, it would advance the interest of the company as a commercial entity.No such specific provision under the Malaysian CA, but para 7 of the Third schedule of the CA empowers the company to establish and support various facilities for the benefit of the employees and past employees as well as their dependents, and to provide for pension and allowances [may be applied under s. 19(1)(c)].*

However, if the company goes into a state of insolvency, the creditors interest will have to be taken into account as well. The directors then owe a duty to the creditors to see that the assets are managed in such a way that the interest of the creditors are not at risk.

In Walker v Wimbourne, the court found the companys directors in breach of their duties to the company and its creditors in guaranteeing loans for another company in the group at a time when the company was itself in serious financial difficulties. *

ii-to exercise his powers for proper purposeThe requirement under s. 132(1) also embodies the rule that the directors must act for proper purpose.The powers given to the directors must not be exercised for any improper purpose.Improper means beyond the scope of, or not justified by, the instrument creating the powers.If the power is exercised for improper purpose, he is in breach of his fiduciary duty even if the directors insist that they honestly believed it in the interest of the company.*

The court will consider two factors when it has to decide whether the directors power has been exercised for a proper purpose or not:the objective for which the power was grantedThe purpose for which the power was exercised by the directors

The directors are in breach of their duty if they exercise their power for a purpose other than the purpose for which the power was conferred on the director.*

Case: Re Duomatic Ltd.The directors made payment to a former director as compensation for loss of office. They were not aware that the UK Companies Act required them to notify the shareholders before doing so. The payment was thus unlawful. The court held that although the directors had acted honestly due to their ignorance of the law, the directors were liable for misapplication of the companys fund

Example: directors have the power to issue shares in order to enable them to raise money or secure other advantages for the company. An issue of shares contrary to these purposes may be set aside.*

In Howard Smith Ltd. V Ampol Petroleum Ltd.Both the Plaintiff and Defendant companies were involved in attempt to take over RW Miller (holdings) Ltd. Ampol Petroleum had enough shares to block Howard Smiths bid. The board of directors of RW Miller favoured Howard Smith, and issued shares to them with the intention of reducing Ampols share holding so that they could not block the takeover bid (attempting to reduce to a minority position, a member who hold a majority of voting power). Ampol challenged the validity of the shares issue. Millers directors claimed they issued the shares as the company needed more capital. They had honestly thought it would be in the best interest of the company if Howard Smith succeeded.The Court held that the directors had breached their duties by improperly exercising their powers and the issue of shares to Howard Smith was invalidated. Although the company could make use of the additional capital, the issue of the shares was not because of that, but due to the fact that they wanted Howard Smith to succeed in their takeover bid.

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A director may not issue shares to others to change the balance of power within the company by destroying the existing majority. Even where there is absence of self interest, the issue of shares will not be valid.

Thus, where the directors issue shares to themselves to maintain control over a company, the court will definitely set aside such issue even though full value had been paid on the shares: Punt v Symons.*

iii-To avoid conflict of interest.

A director should not put himself in a position where his personal interests conflict with the interest of the company. He is not allowed to make use of his position as a director to obtain profit for himself.

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Sec 132(2) CA 1965-A director or officer of a company shall not, without the consent or ratification of a general meeting:-a) use the property of the company;b) use any information acquired by virtue of his position as a director or officer of the company;c) use his position as such director or officer;d) use any opportunity of the company which he became aware of, in the performance of his functions as the director or officer of the company; ore) engage in business which is in competition with the company, to gain directly or indirectly, a benefit for himself or any other person, or cause detriment to the company.

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Case: Aberdeen Railway Co. v Blakie Bros.A railway company entered into a contract with a firm partners for the supply of iron seats. One of the partners of the firm was a director of the company. The company sought to avoid the contract. One of the reason given was that one of the partners was a director of the company at the time of the contract. The court held that the company could avoid the contract even if it was made on fair terms.

In Guinness Plc v Saundersa committee of the company had without authority, awarded a director of a company remuneration of 5.2 million in return for his services in a successful takeover bid. The court rejected the claim by the director that he had a right to the money. The court pointed out that a fiduciary must not place himself in a position of conflict, and may not profit from his position except to the extent allowed by the articles.

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Conflict of interest could arise in the following situations:

Where the director compete with the companyWhere the director use corporate property, information or opportunityWhere the director contract with the company

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Competing with the company.

A person may be a director of more than one company as long as he discloses any potential conflict that can arise out of his position in those companies. He cannot allow one companys interest to have priority over the other.

A director cannot compete with the company for whom he acts. He cannot set up a competing business to take any property or benefit that properly belongs to the company of which he is a director or if he takes for himself any business advantage for which he was negotiating for his company.

A director would be in breach of his duties if he set up a competing firm to take advantage of contracts that should have gone to the company.

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Case: Cook v DeeksTCC tendered for a contract with a railway company. TCC had four directors, and three of them could not get along with the fourth. When the contract was awarded, the three directors set up a company and diverted the contract to the new company. Being the majority they were also able to pass a resolution from TCC ratifying their conduct. The fourth shareholder brought an action against the other three claiming that they were in breach of the duty and they had to account their profits to TCC.

The court held that the directors were in breach of their duties when they set up a competing company to take over the contract that should have gone to the company in which the four of them were directors. The profits belong to TCC.*

Even after he resigned, a director is still liable for the breach especially if the resignation is due to the fact that he wants to take the opportunity himself. Case: Canadian Aero Services Ltd. v OMalleyThe court held that the President and the Vice President of the company liable where, after having negotiated a contract on behalf of the company, they resigned, formed a new company and acquired it for the new company. *

Even where a director gets a contract where his company has no chance of obtaining, he is liable for breach of duty because the opportunity came to him by virtue of his position in the company.Case: Industrial Development Consultant Ltd. v. CooleyThe defendant was the managing director of IDC. IDC attempted to obtain a contract with EGB, but the company was not interested in contracting with IDC., They were, however, interested in engaging the defendant personally. The Defendant resigned from IDC using ill health as an excuse, and them began working on a project IDC was interested in. IDC sued to recover all profits that the defendant had obtained under his contract with EGB.*

The court held that although IDC would not have obtained the contract, the defendant was in breach of his duty to IDC because he did not fully disclose to IDC all information he obtained in the course of his dealings with EGB, as such he was liable to account all profits he had made to IDC.*

Using companys property, information or opportunit

A companys property, information and opportunity are all assets of the company. A director may not use them for his own benefit.A director may not use the companys money or assets to make profit for himself. All the money or assets must be used only for the companys benefit.A director also may not use information acquired by virtue of his being the companys director for his own benefit.

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In Grove v Flavel the court held that a director who knows that his company is facing the risk of insolvent liquidation is acting improperly when he uses that information to protect himself and other companies of which he is director from the consequences of that liquidation to the detriment of the creditors.

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Any misuse of trade secrets and other confidential information amounts to conflict of interest, therefore, breach of duty.In Thomas Marshall (Exporters) Ltd. v Guinle G, the managing director of a company, had without the companys knowledge began to trade on his own in competition with the company. The company sought an injunction to stop him from disclosing the or using the companys confidential information or trade secrets.The court held that the director had breached his fiduciary duties when he used information belonging to the company that is regarded as confidential.

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A director also may not make a secret profit by reason of opportunities acquired as a result of his position.

An example of companys opportunity is in Cook v Deeks where the court held that as the opportunity to obtain the contract came to the directors in their capacity and by virtue of their positions as directors to the company, they were bound to hold the contract on behalf of the company.

In Mahesan v Government Officers Co-Operative Housing Society Mahesan was a director of the society. He bought a land for the society knowing that the purchase price was raised exorbitantly to include the commission paid to him. The court held that the society was entitled to sue Mahesan for damages since he had breached his duty by taking the bribe.*

Contract with the companyA director cannot enter into a contract with the company may try to get the best deal for himself.

In Transvaal Lands Co. v New Belgium (Transvaal) Land & Development Co.Two directors of TLC were also shareholders of NB. One of them Samuel was also a director of NB. On Samuels recommendation, TLC board agreed to purchase certain shares of NB. After the purchase TLC discovered the two directors interest in NB and sought to have the contract rescinded. The court held that there was a conflict of interest in Samuels case as both the director and shareholder of NB, with the duty to act in TLCs best interest.

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Under common law the court decided in Hely Hutchinson v Brayhead Ltd. that the failure to disclose would cause the contract to be voidable at the instance of the company i.e. the members may choose to ratify it or not in the general meeting. The director, thus, would be accountable for any profits made.*

S. 132(2) of the CA a director will be in breach of duty if he has material interest in a contract with a company.

However, S. 131(1) of the CA requires a director to disclose the fact that he has an interest in a contract with a company, whether it is direct or indirect to avoid being in breach of his duty.[ direct= the director contracts personally, indirect= the contract includes family interest or the interest of another company in which the direct is its director or shareholder].

S. 131(4) General notice of disclosure of interest to board of directors meeting.

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S. 132E- a director who enters into a substantial property transaction with his company must have that transaction approved by the members in the general meeting. S. 131(8) - If a director fails to disclose his interest , he would be liable for not more than 7 years imprisonment, or RM150,000, or both. *

At common law, where there is a possibility of a conflict of interest, directors may avoid breach of duty by making full disclosure to the company. In Furs Ltd. v Tomkies, it was noted that: No director shall obtain for himself a profit by means of a transaction of which he is concerned on behalf of the company unless all the material facts are disclosed to the shareholders and by resolution a general meeting approves of his doing so, or all the shareholders acquiesce.

Therefore, a director may be able to enjoy the profits he obtained out of his position as a director by disclosing his intention and all material facts to the shareholders and getting their consent. If the share holders refused to consent, the director can resign and take the opportunity. He will no longer be liable as he had disclosed his intention.

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Only when the director has not disclosed or failed to get the companys consent that the profits he obtained are regarded as secret profit, and as such he has to account for them.

A directors duty continues to bind him even after he no longer holds the office. This will be so where the director has during his term of office committed acts amounting to breach of duty and (i) resigns or secure his release in order to reap the benefit of his breach of duty, or (ii) after his resignation or release, commits similar acts which, if he was still a director, would amount to breach of duty on his part.*

To whom the fiduciary duties are owed?- to the company as a whole and not to the individual members : Percival v Wright

Remedies for breach of fiduciary duties:The company may sue for damages or for return of specific property. Refer to Mahesans case

The company may claim any secret profit that the director made. Refer to Furs case.

The exercise of power which is in breach of the directors duties may be declared to be invalid. Refer to Howard Smiths case.*

2)Duty of Care, Skill & DiligenceS. 132(1A) of the CA requires that a director of a company must exercise reasonable care, skill and diligence. The standard required to be discharged by a director is assessed based on:The knowledge skill and experience which may be reasonably expected of a director having the same responsibilitiesAny additional knowledge, skill and experience which the director in fact has *

The duty of care, skill and diligence of a director was summarized by Romer J in Re City Equitable Insurance Co Ltd. (1925) : A director must act honestly and exercise care, skill and diligence

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Duty to be Skillful/Skill required of a directorRomer J in Re City Equitable Insurance Co. Ltd. said that:A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge & experience.

This means that there is no minimum standard of skill for a director. The less knowledge he has, the less skill is expected from him. Hence, the skill (+ standard) varies with knowledge and experience. If he has special skill/qualification (e.g. lawyers or accountants, he is expected to use that skill for the company)

The Companies Act also does not prescribe any minimum qualifications before a person can become a director, neither does the common law.

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Since there is no minimum standard of skill required of a director, a company cannot expect more out of a director if they have appointed directors who are without skill.In RE Brazilian Rubber Plantation and Estate Ltd., directors who undertook the management of a rubber company in complete ignorance of anything to do with rubber industry were held not liable for losses arising from rubber speculation. (t/4 if the directors were familiar with rubber business they must give the company the advantage of their knowledge and experience when transacting the companys business).

The general rule has been that as long as the directors act honestly within the powers conferred to them, they are not liable for any errors of judgment: per Hatherley LC in Turquand v Marshall.*

Unfair to expect an unqualified person to show much skill in the performance of his duties as a director.

However, if a director posses any special qualification, he is expected to use that skill for the company. So an accountant cannot defend himself by saying that he is not a competent accountant. He will have to show some reasonable skill at par with his qualification and experience.*

Duty of care

A director must exercise a duty of care towards the company once he has accepted the position. The standard is of a reasonable care. It means that a director should take as much care in the affairs of his company , as he would reasonably take in his own affairs. If he act in his companys affairs in a way no reasonable man would do in his personal affairs the company can take action.

Re City Equitable there is no single standard of care. A director is only required to display that degree of care that would be reasonable for a person of his experience and qualification.

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There are certain general principles that may be applied to the directors in relation to duty of care:a.A director must take the trouble to discover what his rights and obligations are under the AOA and the law, and if necessary to take legal advice when in doubt.b.A director is entitled to delegate his duties. If there is no reasonable ground for suspicion, the director is justified in trusting the delegate to perform such duties honestly.

In Huckerby v Elliot the appellant was a director of a gaming club that had operated without the necessary licence. She was charged for negligent in allowing the club to contravene the law. Her defense was that the running of the club was done by her co director, whom she thought must have obtained the necessary licence. The court held that she was not guilty , as it was proper for a director to leave matters to the relevant officials, so long as there was no reason for her to distrust the officer. *

However, if there is reasonable cause to suspect, a director is under a duty to make reasonable enquiries. If he does not do so, then he has to accept responsibility for the companys loss.

The liability of executive director (who is fully employed and involved in the day-to-day management of the co.) and non-executive director (less involved in the management and only attends board meetings, depends on executive director for information on what is happening in the company.) will be different.

Daniels v Anderson CEO liable for negligence for not having made enquiries based on auditors report. The non executive however, had not been negligent, as they had not received any information to the contrary.*

A director is generally not responsible for the act or omission of his co-directors even if he did not attend board meeting. Where he attends board meeting he must be liable for any decision made in his presence. Where decisions are made in his absence, he will not be liable unless he authorized the act or has agreed to accept liability for it.A director must make enquiries when called upon to pay away the companys money.

Re railway & General Light Improvement Co.A director noted for a certain payment and signed cheques without knowing exactly what the money was for and without making enquiries which a person of ordinary care in his position would have made was held to be negligent.*

Duty of Diligence

S 132(1) requires director to use reasonable diligenceBUT degree of diligence required is not specified Determined based on case law, i.e Common lawTraditionally : directors are not required to give continuous attention to the affairs of co. Duty arose intermittently while performing his functions Romer J in Re City Equitable Fire stated that - a director was not bound to attend all board meetings, but he ought to attend board meetings whenever, in the circumstances, he is reasonable able to do so.

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Case: Re Forest of Dean Coal Mining Co.Directors are bound no doubt, to use reasonable diligence having regard to their position, though probably an ordinary director, who only attends at the board meeting occasionally cannot be expected to devote as much time and attention to the business as the sole managing partner of an ordinary partnership but they are bound to use fair and reasonable diligence in the management of the companys affairs, and to act honestly.

Directors generally need not attend all meeting of the board. In Re Marquis of Bute the director attended one meeting in two years held not negligent. But In Re Denham- a director who had not attended any board meeting in four year was held to be negligent in the discharge of the duties of his office.

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3) Statutory Dutys. 131(1) imposes a duty upon the directors to disclose their interest (whether directly or indirectly) in contracts with the company.S. 132(1). A director of a company must at all times exercise his powers for a proper purpose and in good faith in the best interest of the company.S. 132(2) - a director must not make improper use of any information obtained by virtue of his office to obtain advantage for himself either directly or indirectly or to cause detriment to the company.- s. 132(3) imposes liability on any officer who commits breach of fiduciary duty. He is not only liable to the company, but if found guilty can be imprisoned for five years or fined RM30,00.*

4.S. 132C - Directors must seek approval of the company in general meeting before they can dispose or execute any transaction for the disposal of a substantial portion of the companys undertaking or property.

5.S. 132D - A director must seek approval of the company in general meeting before exercising any power of the company to issue shares.

6.S. 167 duty to ensure that the companys account are properly kept. The directors are required to present a loss and profit account and balance sheet showing a true and fair view of the companys financial position at the companys annual general meeting. This account will be able to tell the shareholders of the company how it is being managed. Directors are required under s. 171(1) to take reasonable steps to ensure that the company accounts comply with the Act.

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Sec 132(2)*

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AUDITORS*

The Companies Act provides for compulsory appointment of auditor to check the companys affairs and report them to the shareholders. Such an inspection by an independent body like auditor is the only guarantee that the shareholder has against any misappropriation of their money*

Appointment of AuditorsThe directors usually appoint the first auditor of a company within three months of the companys incorporation.

If the directors fail to do so, the company in general meeting may appoint the auditor in accordance with s. 172(1) of the CA. The first auditor is to be appointed before the first annual general meeting (AGM) and that auditor shall hold office until the conclusion of the first AGM.

Under section 172(2) appointment of auditor shall be made at each AGM, and the auditor appointed shall hold office until the conclusion of the next AGM of the company.

If the office of the auditor becomes vacant ( e.g. due to death, resignation or removal) the directors of the company may appoint an approved company director to fill the vacancy, but while such vacancy continues, the surviving or continuing auditors may act s. 172(3).*

According to s. 9(6) a person must give his consent in writing before he can be appointed as an auditor.

Those who appoint the auditor normally decide the remuneration that he should receive. It may be the general meeting, the board of directors, or the CCM. Normally the general meeting delegates such powers to the board of directors.

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Qualification of a companys auditorTo become an auditor of a company, a person must be approved as a company auditor by the Minister of Finance according to s. 8(1) of the CA.An approved company auditor is one that has been approved by the Ministry of Finance to act as an auditor and has the necessary qualification and satisfies the minister that he is of good character and is competent to perform the duties of an auditor under the Companies Act.He must be registered as a public accountant with the Malaysian Institute of Accountant (MIA) under the Accountants Act 1967, be at least 21 years old and considered as a fit and proper person.*

Where a firm of accountants is appointed as company auditor, all members of the firm must be approved company auditors according to s. 9(4)(a).

The auditors role in a company is to report on the companys account, as such he is required to be independent of the company. He must not be closely related to the company, nor can he be in a position where officers of the company can have influence on him.

As such, under s. 9(1)(b) a person is not qualified to be an auditor if he owes the company or its related companies an amount more than RM2,500.

Under s. 9(1)(c) he must not be an officer of the company, a partner, employer or employee of an officer of the company, or a partner, employee of an employee of an officer of the company, or a shareholder, or his or her spouse is an officer of the company.

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Under s. 9(1)(d) a person is not qualified as a companys auditor if he is responsible for or if he is the partner employer or employee of a person responsible for the keeping of the register of members or the register of holders of debenture of the company.*

Termination of OfficeResignation of Auditors.

An auditors appointment last until the end of the following year AGM.Although an auditor may resign before his term ends, according to s. 172(14) he may not resign if he is the sole auditor of the company. His resignation also must be made at the AGM.If he wishes to resign, he must give notice in writing to the board of directors, who will then convene a general meeting as soon as possible. At this meeting his resignation will take effect only after a new auditor has been appointed by the general meeting.*

Removal of AuditorsUnder s. 172(4) an auditor may not be removed except by ordinary resolution at a general meeting where special notice (of at least 28 days) have been given. The company is required to send the notice to the auditor and Registrar of Company as soon as they receive it. The auditor may, within 7 days after receipt of the notice make explanation in writing to the company as to any accusation made against him. He can then request the company to send copies of his explanations to all members entitled to attend the general meeting. At the meeting he may request for his explanation to be read, and he may speak to defend himself.The company cannot refuse to sent the written explanation to the members unless, on the application of the company, the Registrar orders otherwise.*

S. 172(7) - When an auditor has been removed from office at a general meeting, another auditor appointed at a general meeting may replace him. The appointment of a new auditor must be made by a resolution passed by a majority of not less than of the members of the company who are entitled to vote (in person or by proxy).

If an auditor has not been appointed in the meeting, the meeting may be adjourned to a date not earlier than 20 days and not later than 30 days after the meeting to remove the director. At the resumption of the adjourned meeting, the person who has been nominated by notice to the company at least 10 days prior to the meeting may be appointed as auditor my ordinary resolution.

If the company does not appoint another auditor, the Registrar of Company is empowered to appoint one for the company s. 172(8).*

Rights and Duties of AuditorsIn relation to the function of an auditor, Lord Denning in Fomento (Sterling Area) Ltd. v Selsdon Fountain Pen Co. Ltd. Stated that:His vital task is to take care to see that errors are not made, be there errors of computation, or errors of omission, or downright untruths.

The rights and duties of an auditor are laid down under s. 174 of the CA.

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Rights of Auditors S. 174 of the CA gives the auditors the following rights/powers:The right of access at all reasonable time to the accounting book/records (including the registers) of the company and to obtain necessary information and explanation from any officers of the company as well as from any auditor of a related company s. 174(4).

The right of access at all reasonable time to the accounting book/records (including the registers) of a subsidiary company and to obtain necessary information and explanation from any officers and any auditor of a subsidiary company s. 174(5).

The right to attend any general meeting of the company and to receive any notices and other communications relating to any of these meetings. He also has the right to speak in these meeting in his capacity as an auditor s. 174(7)

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S. 174(9) provides that an officer of a company who refuses or fail without lawful excuse to allow an auditor access to any accounting books and other records of the company in his custody or control, or refuses or fail without lawful excuse to give any information or explanation when required to do so, or in any way hinders, obstructs, or delays an auditor in the performance of his duty, he is guilty of an offence that is punishable by imprisonment for two years, or a fine of RM30,000 or both.*

Duties of Auditors A - Statutory Duties of Auditorss. 174(1) Every auditors shall report to members on accounts required to be laid before the company in the general meeting and on the companys accounting and other related records. (if it is a holding company report to the members on consolidated accounts).(ii) s. 174(2) (a) In the report the auditor shall consider whether the accounts or consolidated accounts are in his opinion properly drawn up - (i)so as to give a true and fair view of the matters required by section 169 (loss and profit account);(ii) so as to give a true and fair view of the company's affairs in accordance with the provision of the CA; (iii) in accordance with the applicable approved accounting standards.

- (b) the auditor also must state whether the accounting and other records and registers required under the CA to be kept by the company are properly kept in accordance with the provision of the CA.

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(iii)s. 174(3) it a duty of an auditor to form an opinion as to each of the following matters and state particulars of any deficiency, failure or shortcoming:a.whether he has obtained all information and explanation;b. Whether proper accounting and other records kept by the companyc.whether the returns received from branch office adequated.whether the procedure and method used adequate.

(iv)The auditors report shall be attached to or endorsed on the accounts or consolidated accounts, and shall, if any member so requires, be read before the company in general meeting and shall be open to inspection by any member at any reasonable time.*

S. 174(8) If an auditor in the course of the performance of his duties discovers any breach or non-observance of any of the provision of the CA , and the matters has not been or will not be adequately dealt with by the comment in his report, or by bringing them to the attention of the directors, he must report the matters in writing to the Registrar of Company. If he fails to do so, the auditor is guilty of an offence that is punishable by imprisonment for two years, or a fine of RM30,000 or both. *

B Duty to carry out audit

Before an auditor can form an opinion on whether the companys accounts provide a true and fair view of its position, an audit must be carried out. In carrying out audit, particularly where the companys accounts are complex, an auditor is required to devise procedures to assists in the detection of errors or fraud : Pacific Acceptance Corp. Ltd v Forsyth*

C-Duty to Report to members.The main duty of the auditor is to investigate and form an opinion on the adequacy of the companys accounting and other records. This was described by Lord Oliver in Caparo Industries Plc v Dickman & Ors.It is the auditors function to ensure, so far as possible, that the financial information as to the companys affairs prepared by the director accurately reflects the companys position in order, first to protect the company itself from the consequences of undetected errors, or, possibly wrongdoing (by, for instance declaring dividends out of capital) and, second, to provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the companys affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided.*

The auditor has then to report to the members of the company on the accounts required to be laid before the company in the general meeting. The auditors are required to state in his report whether in his opinion the accounts are properly drawn up and are in accordance with the provisions of the CA so as to give a true and fair view of the financial position.

This does not mean that auditors cannot communicate their findings to and seek explanations from the officers of the company. In particular, if fraud is uncovered or suspected, the auditor is under a duty to report promptly the matter to the directors or management rather than wait until the general meeting, if the matters are of such character that it is sufficient to reveal to them or if it is in the interest of the shareholders that the matter is merely reported to the directors or management - Pacific Acceptance Corp. Ltd. v Forsyth

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Case: WA Chip & Pulp Co. Pty. Ltd v Arthur Young & Co.Johnson, the companys finance and administration manager, made certain unauthorised drawings between 1978 and 1980. The drawings were advances for travel purposes which exceeded actual claims. Johnson also used a facility whereby employees could used the companys name to obtain trade discounts for personal purchases. By September 1980 there was in excess of $64,000 outstanding.*

The companys auditors became aware of Johnsons drawing early in 1978. They discussed the matter with Johnson and one of his subordinates but not with any of his superiors. The auditors decided both in 1978 and 1979 to leave the issue for the next year. Finally, as part of the 1980 audit, Johnsons personal account was brought to his superiors attention. Johnson was suspended and subsequently disappeared.The court held that the auditors were negligent because of their failure to take action over Johnsons account until 1980 audit. They breach their duty even though they did not suspect Johnson of fraudulent dealings.

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D Duty to be independent

The CA reinforces the requirement that auditors be independent, by disqualifying certain categories of persons connected with a company, from being appointed as its auditors. The purpose of this is to ensure that the shareholders receive unbiased opinion of the true and fair view of the companys position.In Re Transplanters (Holding Co.) Ltd., Wynn-Parry J stated:Once a man takes upon himself a position of auditor he must stand aloof and divorced from the aims, objects and activities of the company. *

This does not mean that an auditor must sever all connections with the company. Auditor must guard against a conflict of interest.

Auditors are entitled to seek assistance from the companys directors, accountants and other employees in carrying out their functions. Auditors, however, are in breach of their duty if they rely on them for information on which they are required to form their own independent opinion.

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Case: Dominion Freeholders Ltd. v Aird.An auditor prepared an erroneous report. The company brought an action against him for breach of his contractual duty of care and he sought to join the companys accountant as a co-defendant. This was on the basis that the accountant had supplied him with incorrect information and was in breach of duty owed to him. The application was rejected. Jacob JA stated:They (auditors) must not rely or depend on company officers for information or representations in respect of matters upon which they are required in the course of their duties to reach an independent conclusion, and, if they do so rely, they cannot shed their responsibility by casting the liability on to the company officer, or officers concerned. *

E- Duty of Care and SkillAn auditor has a common law duty to exercise reasonable care and skill in the performance of his duty. A failure to use reasonable care and skill would make the auditor liable for breach of contract and negligence.Liability in contract : In Pacific Acceptance Corp. Ltd. v Forsyth, Moffit J stated that:It is beyond question that when an auditor, professing as he does to posses the requisite professional skills, enters into a contract to perform certain tasks as auditor, he promises to perform such tasks using that degree of skill and care as reasonable in the circumstances as they then exist.*

Liability in negligence: Professional owe a duty of care to their clients. An auditor who uses less than the required degree of care and skill is liable to the company for any loss suffered as a result but is not liable only because of failure to detect errors or frauds.*

What is the standard of care expected? In one of the early cases: Re Kingston Cotton Mill Co. (No.2)The auditors failed to detect certain frauds perpetrated by the companys director. The relied on false certificate supplied by the director as to the value of the stock without calculating the stock in trade at the beginning of the year. An action was brought against the auditors, seeking to recover the loss caused by wrongful payment of dividends.Held: the auditors were not in breach of duty. The standard of care does not require them to take stock. They were entitled to rely on the managers certificate as there were no grounds for suspicion and the manager was widely regarded as a man of good character and trustworthy. Just because the auditors could have discovered the fraud had they valued the stock themselves, did not mean that they were in breach of duty.*

The standard of care and skill expected from auditors now is higher than was the case in the past.Case: Re Thomas Gerrard & Sons Ltd.The companys managing director had over a period of years, been making obvious alteration to invoices received from suppliers. Whilst some of these invoices had come to the attention of the auditors, they just relied on the stock taking procedure set up by the managing director, without investigating the matter any further. Soon after discovery of the true situation, the company went into liquidation. The liquidator brought an action against the auditors.*

Fenwick J held that the auditors were liable to the company because once altered invoices had been discovered, the auditors were put on enquiry and it was not sufficient that they merely sought assurances from the managing director. The ought then to have examined the suppliers statement and where necessary, to have communicated with the suppliers and then should have informed the board. This case did not involve an isolated failure of detection but had gone on for many years. The auditors had therefore failed in their duty to exercise reasonable care and skill.*

A leading case dealing with present day standards of care of auditors is Pacific Acceptance Corp. Ltd. v Forsyth.It was found that the auditors had not check the mortgages but had relied on Thomsons solicitors to ensure that they were properly executed and registered. The auditors were held to be in breach of their duties because they did not satisfy themselves by proper means that the intended mortgages were properly executed and registered. This was especially the case because reliance was placed on the solicitor acting for the borrower. It was not enough to accept certificates from solicitors, without examining the original documents or making searches at the Title Office. *

AWA Ltd. v DanielsThe New South Wales Supreme Court held that the auditor failed to exercise reasonable care and skill in a number of respects. The court found that the auditor was aware that:- for about two months in 1986, while AWA changed it record keeping system, no proper accounting reports in relation to foreign exchange trading were being kept;-Senior AWA managers had not heeded his warning that the companys internal control in relation to foreign exchange trading were inadequate;-the foreign exchange trading was not typed into AWAs computerised account;

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-foreign exchange trading was both a high audit risk area and a high commercial risk;-foreign exchange trading was an area where internal controls are critical;-AWAs exposure to foreign exchange losses was high.Held: Given the auditors awareness of the above matters, his failure to warn promptly the companys directors of the deficiencies in the accounting records and inadequate internal control meant the he breached his duty to exercise reasonable care and skill.

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Duty/Liability of Auditor to Shareholders and OutsidersA remedy available to shareholders and outsiders, where auditors fail to exercise reasonable standard of care, is an action for the tort of negligence. In order to succeed, outsiders must first established that the auditors owe them a duty of care in carrying out the audit and in making their reports.

At first professionals like auditors, owed a duty of care only to their client i.e. the company not to outsiders who relied on their statement. This is illustrated by the case of Cadler v Crane, Christmas & Co. Ltd. It was held that a firm of accountants was not liable to outsider investors who had relied on a negligently prepared report. This was because there was no contract between the accountants and the outsiders and they were under no duty of care.*

However, since the case of Hadley Byrne v Heller, the law has significantly developed. Lord Morris said:If someone possessed a special skill undertakes to apply that skill for the assistance of another person who relies on such skill, a duty of care will arise.

*Snaddock & Associates Pty Ltd. v Parramatta City Council the High Court of Australia held that the duty to take reasonable care arises whenever a person gives information or advise to another upon a serious matter in circumstances where speaker realises or ought to realise, that he is being trusted to give the best of his information or advise as a basis for action on the other party the speaker comes under a duty to exercise reasonable care *

Auditors will only be liable to outsiders in negligence if the are aware or should have been aware, that their report may have been used by a particular outsider.

In Arenson v Cassan Beckman Rutley an auditor in his capacity as an expert, was requested to value the shares of the company for the purpose of determining a fair value to be paid for the shares under a contract of sale. On the basis of the auditors valuation, the shares were sold at a price far below another valuation later made by the auditor. The seller brought an action for negligence against the auditor alleging that the original valuation had been made negligently. The court held that the expert who valued the shares, knowing the valuation was to be used by the buyer and seller in calculating the price for the shares, was liable to them both if he or she made the valuation negligently.*

The principle has been further extended in New Zealand in the case of Scott Group Ltd. v Mcfarlane. The auditors of a company negligently prepared an audit report on the company which was filed with the Registrar of Companies. This report was relied upon by outsiders who made a takeover bid for the company. The New Zealand Court of Appeal held that the auditors owed a duty of care to person whom they knew or ought to have known would rely on the lodged accounts which they had audited. The auditors ought reasonably to have been aware take a takeover may occur and in such an event, the lodged account would be relied upon. The court however rejected the contention that an auditors duty of care extended to anyone who examines the annual returns at the Registrars Office.*