The recent spate of corporate scandals, both locally and internationally, have brought to the forefront the role played by Directors, with particular emphasis being placed on the rights and responsibilities owed by Directors to their various stakeholders.
For the purpose of this article, I have outlined below, in brief, some of the duties imposed on Directors under the Companies Act №7 of 2007 (‘the Act’). They are as follows:
Duty to act in good faith and in the best interest of the company
Section 187 of the Act imposes a duty on a director of a company to act in good faith and in what that person believes to be in the best interests of the company.
A director of a company, which is a wholly owned subsidiary of another, may, if expressly permitted to do so by the subsidiary company’s articles of association, act in a manner which is in the best interest of the parent company, even though it may not be in the best interests of a subsidiary company of which he is a director.
Duty to act in a manner that does not contravene the provisions of the Companies Act or the articles of association of the company
Section 188 of the Act prohibits a director of a company from acting or agreeing to the company acting in a manner that contravenes any provisions contained in the Act or in the articles of association of the company.
Duty of a director to exercise care and skill
Section 189 of the Act imposes a duty on a director to exercise a degree of care and skill that could reasonably be expected of a person of his knowledge and experience, and prohibits a director from acting in a manner that is reckless or grossly negligent.
Duty when relying on the advice of professionals and experts
In terms of Section 190 of the Act, a director of a company may rely on information and advice given by an employee of the company, a professional advisor or expert or any other director or committee of directors in which the director did not serve, so long as the information falls within the ambit of their designated authority or within the professional advisors’ or experts’ competence. However, in these above-mentioned circumstances, the director may rely on such information only if the director acts in good faith, makes proper inquiry where the need for inquiry is indicated in the circumstances and has no knowledge that the reliance is unwarranted.
Duty of a director relating to disclosure
(i) Transactions in which the director is interested
Section 192 of the Act requires a director, who has an interest in a transaction or proposed transaction to which the company is a party, to immediately cause the interest to be recorded in the Interests Register and disclose the nature and extent of his interest to the board of directors of the company. Failure to do so is an offence punishable by a fine.
A director is deemed to be interested in a transaction if the director is a party to the transaction or a director will or may derive a material benefit from the transaction or if a director has a material financial interest in another party to the transaction.
A general disclosure in terms of the law is sufficient disclosure for the purpose of the provision discussed above.
(ii) Director’s interest in shares
Section 200 of the Act requires a director who has a relevant interest in a share issued by the company to disclose the nature of that interest to the board of directors of the company and to ensure that the particulars of that interest is recorded in the Interests Register.
The section also requires a director to disclose to the board, any subsequent acquisition or disposal of a relevant interest in shares issued by the company.
According to the definition set out in section 198 of the Act, a director is deemed to have a “relevant interest” in a share issued by the company if that director-
1. is the beneficial owner of the share;
2. has the power to exercise or to control the exercise of any right to vote attached to the share;
3. has the power to acquire or dispose or control the acquisition or disposal of the share,
4. has the power at any time to do any of the above under or by virtue of any trust, agreement, arrangement or understanding relating to the share (whether or not that person is a party to it).
The aforesaid interest maybe inter alia, express or implied, direct or indirect, legally enforceable or not.
A director would also have a relevant interest where a person (whether or not a director) has a relevant interest for the reasons set out above, and
1. that person is obliged to act in accordance with the instructions or wishes of that director in relation to:
(i) the power to exercise or to control the exercise of any right to vote attached to the share; or
(ii) the power to acquire or dispose or control the acquisition or disposal of the share;
2. a director of the company has the power to exercise or control the exercise of any right to vote attached to twenty per centum (20%) or more of the shares of that person;
3. a director of the company has the power to acquire or dispose or control the acquisition or disposal of twenty per centum (20%) or more of the shares of that person.
(iii) Disclosure of Age
Section 212 of the Act requires a person appointed or proposed to be appointed as a director, to disclose his age if he has reached the age of 70 years, or any lower age as may be required by the articles of the company. This requirement does not apply to when a director is reappointed, if disclosure had been made upon a previous appointment.
A director failing to give notice of his age, acts under an appointment which is invalid by reason of his age or has his appointment terminated as a result of his age will be guilty of an offence and liable on conviction to a fine.
(iv) Prohibition on the Disclosure of Information Acquired in the Capacity of a Director
Section 197 of the Act imposes a duty on a director of a company to not disclose or make use of any information acquired in his capacity as a director or employee of the company unless it is-
i. for the purpose of the company;
ii. is required by law;
iii. is authorised by the board of directors of the company and the particulars are entered in the Interest Register;
iv. in any other circumstance in which the company’s articles of association authorise the director to do so.
Duty of directors to conduct a solvency test
Reasons for introduction of Solvency Test
A statutory duty is imposed on the directors under the law to resolve in certain specific circumstances that the company would be solvent after the taking place of an event. While a company is not required to be solvent on every day it trades, the Solvency Test must be carried out in the instances that are specified in the Act.
The Solvency Test
In terms of section 57 (1) of the Act, in order to satisfy the Solvency Test;
(a) a company must be able to pay its debts as they become due in the normal course of business ; and
(b) the value of its assets must be greater than the value of its liabilities and the stated capital
Section 57(2) of the Act provides for the mandatory considerations that the directors of a company should have regard to in determining whether the company satisfies the Solvency Test. These are:
(a) the company’s most recent financial statements;
(b) all circumstances that they know or ought to know which affect the value of the company’s assets and liabilities.
The board may also take into account a fair valuation or other method of assessing the value of the assets and liabilities.
The Solvency Test must be met if the company proposes to;
(a) make a distribution or redeem a share at its option;
(b) redeem shares at the option of the shareholders or on a fixed date;
© purchase the shares of its shareholders;
(d) give financial assistance to purchase its own shares;
(e) reduce the shareholder liability where such reduction is deemed to be a distribution;
(f) enter into an amalgamation.
Duty of directors on insolvency
Section 219 of the Act imposes a duty on a director, who believes that a company is unable to pay its debts as they fall due, to summon a meeting of the board of directors to decide whether the company should apply to court for the winding up of the company or to carry on business. If at such meeting the board decides not to apply for the winding up of the company, and the company subsequently goes into liquidation, the court has power to order the directors who voted for the carrying on of the business to be personally liable for any loss incurred by a creditor as a result of the company carrying on business. The court will make such an order only if there were no reasonable grounds for believing that the company was able to pay its debts as they fell due at the time of the above mentioned meeting of the board of directors.
Duty of directors on serious loss of capital
Where it appears to a director that the net assets of a company are less than half its stated capital (stated capital being the amount received or receivable on the issue of the company’s shares), Section 220 of the Act requires the board of directors to summon an extraordinary general meeting of shareholders within 20 days of that fact becoming known to the director. The notice calling the meeting has to be accompanied by a report prepared by the board of directors giving the nature and extent of the losses, the cause of the losses and the steps being taken by the company to prevent or recover the losses. This meeting should be held no later than 40 working days from the date of calling such meeting.
Where the board of directors fails to comply with this section, every director who permits or authorizes this failure is guilty of an offence punishable by a fine not exceeding Rupees Two Hundred Thousand (Rs. 200,000/-).
Disqualifications to hold office of director
Under Section 213, a person who has been convicted of an offence under the Act which is punishable with imprisonment, or has been convicted of an offence involving dishonest or fraudulent acts, or has been adjudged insolvent, or has been adjudged to be of unsound mind is disqualified from being appointed or continuing as a director for a period of 5 years from the date of conviction or adjudication (except with leave of court). A person acting as a director in contravention of this section is guilty of an offence, the penalty being a fine of Rs. 1 million, 5 years’ imprisonment or both.
Section 214 empowers the court to make an order prohibiting a person from acting as a director for a period of up to 10 years in any case where that person is prohibited from being a director under section 213, or while being a director of a company has persistently failed to comply with the provisions of this Act, or has been convicted of an offence involving dishonest or fraudulent acts in a country outside Sri Lanka, or was a director of a company which became insolvent and that person’s conduct as a director of that company or any other company makes him unfit to be a director of a company.
Resignation of only remaining director
Where there is only one remaining director of a company, Section 208 imposes a prohibition on that director from resigning until he has called a meeting of the shareholders to receive notice of the resignation and to appoint a new director.
Conclusion -Director’s liability to third parties/civil liability
Under Sri Lankan law, the general principal applicable is that directors of companies are managers or agents or trustees of the company though they are not, in a strict sense, any of those.
In their capacity as agents of a company they enter into contracts not for themselves but for the company. As agents of the company of which they are directors, they incur no personal liability on such contracts, provided it is made clear that they are acting on behalf of the company. They must however act within the scope of their authority.
If a director acts in excess of his authority or without authority and a third party acting upon such authority has no actual or constructive knowledge of the lack of authority, the director would be liable to the third party for breach of express or implied warranty of authority and may be deemed to have incurred personal liability.
The party would therefore have recourse to both the Company and the particular director.
In the context of the requirement of a director to exercise his powers bona fide and for the benefit of the company, any negligent advice or misstatement, or any act which goes beyond the limits of the articles of association of the company or the failure on the part of the director to disclose the full extent of the director’s interest, or the making of any imprudent investments etc give rise to personal liability.
Furthermore, as mentioned above, under the Companies Act there are several requirements that are the responsibility not of the company itself but the directors. Most of such requirements are in respect of maintenance of books and records and filing of requisite returns with the Register of Companies. Failure to comply with such requirements renders directors liable to default fines, the amounts of which vary in each instance.
However a director is not liable if he had reasonable grounds to believe that a competent and reliable person was charged with the duty of seeing that the requirements were complied with or he has taken reasonable steps to ensure compliance with the requirements. Thus delegation by the board of directors to an appropriate official of the company would normally be deemed to be a reasonable step.
It is hoped that, with the abovementioned provisions coming into effect, a degree of transparency and accountability will ensure in the corporate sector of this country.
(First published in The Banker Magazine)
The author is a founding partner at LexAG Legal Consultants. He is an attorney-at-law and former Director (Legal and Enforcement) at the Insurance Regulatory Commission of Sri Lanka. Email: [email protected]