THE FIDUCIARY DUTIES OF DIRECTORS TO 'STAKEHOLDERS'
The Stakeholders
Academics have an on-going debate on "stakeholders". Farrar and Hannigan see this as that of identifying the groups of interests with stakes in a company and "whose position should be reflected in the way in which management conducts its responsibility."1 This debate, they say, surrounds the company's accountability to its shareholders, employees, creditors, suppliers, customers and the community in which the company’s operations are located.
But, "[g]iven the reluctant recognition of those groups most intimately connected with the company, namely the employees and creditors, it is not surprising that company law has been slow to embrace broader stakeholder concerns."2
The German Stock Corporation Act of 1937expressly pointed to ‘stakeholders’ when it stated that directors must pursue the interest of the shareholders, the company’s labour force, and the public interest.3 The revised 1965 Act omitted this formula. Some states of the United States of America have enacted “stakeholder statutes”. The first was passed in Pennsylvania in 1986 and provides that “in discharging their duties, directors may ‘in considering the best interests of the corporation, consider the effects of any action upon employees, upon suppliers and customers of the corporation, and upon communities in which offices or other establishments of the corporation are located, and all other pertinent factors’.”4
But Hopt sees this American position as “part of the political take-over game”, the effect being to considerably broaden the directors’ discretion in trying to block take-overs, “despite or even against the interests of the shareholders.”5
The Hampel Committee Report on Corporate Governance (1998) noted the reluctance in identifying directors' responsibilities towards stakeholders in the United Kingdom, and found that to do so would actually mean identifying stakeholder groups and the director's accountability to each. "The result would be that the directors were not effectively accountable to anyone since there would be no clear yardstick for judging their performance."6 The Report admitted that by "developing and sustaining these stakeholder relationships" directors would be better able to meet their legal duties and business objectives to shareholders.
In Lonrho Ltd v Shell Petroleum Co. Ltd7 Lord Diplock said that the company's interests are not exclusively those of shareholders, but include creditors, employees and shareholders. There is also the argument that the directors’ duties should also encompass responsibility to the community, the environment, charitable and other good causes and the national interest.8 Another is that ‘stakeholders should be restricted to those with an economic stake in the company. The broad definition of the term, however, seems to indicate that there should be some level of social responsibility in the corporate world.
In light of all this, stakeholders, for the purposes of this paper, will
be taken to mean directors, shareholders, creditors and employees.
Directors as Fiduciaries
The corporate governance (director) is believed to be in a fiduciary position and therefore accountable to all those persons and groups with a ‘stake’ in the company. This, according to Berle and Means9, mean they must: pay a "decent amount of attention" to the business; be in a position of fidelity to the interests of the corporation, and, exercise "at least reasonable business prudence." Sealy believes directors came to be in this fiduciary position as during the times when companies were unincorporated, the deed settlement made the directors trustees of the funds and property, so the court called on them to account on this strict basis. “Judges back then seemed to reason that directors had accepted an appointment or ‘trust’, thus they were ‘trustees’ and accountable for ‘breaches of trust’.”10
In International Corona Resources Ltd. v LAC Minerals Ltd11 Sopinka, J noted three characteristics of a fiduciary relationship.
1. The fiduciary has scope for the discretion of some discretion or power;
2. The fiduciary can unilaterally exercise that power or discretion
to affect the beneficiary’s legal or practical interests;
3. The beneficiary is peculiarly vulnerable to or at the mercy of
the fiduciary holding the discretion or power.
For Sopinka, J, every corporate director and most corporate officers fit that description. “The directors, being the ‘brain’ of the corporate organism, exercise enormous power over corporate destiny and they are therefore fiduciaries.”12
In Moore International (Canada) INC. v Carter13 a distinction was made between a vice-president and a director on the one hand and a “senior salesman” on the other. The former was found to be fiduciaries and the latter not. This fiduciary duty of the director is to act for the benefit and advantage of the company.14
It is clearly established therefore, that director’s (corporate management) are imposed with fiduciary duties which limit their virtually exclusive poser to manage the affairs of the company. Both the common law and statute provides for the preservation of this fiduciary relationship between corporate governance and the stakeholders.
But is this level of accountability satisfactory in an era where the corporate form prevails?
This is the fundamental question that this paper seeks to answer in relation
to the position in the Commonwealth Caribbean, with particular emphasis
on the Companies Act of Barbados.
Directors Duties to Creditors
In general terms, directors do not owe duties to creditors while the company is solvent since their duties are owed to the company itself. However, in certain circumstances, particularly when insolvency is imminent, directors have to consider the position of creditors, and it is incumbent upon them to ensure that they “do not favour particular creditors – they must treat creditors equally.”15
Glasbeek argues that when the courts hold directors responsible to creditors it is not always clear whether they did so because the directors acted without proper regard to the corporation’s interests when they disregarded the interests of the corporation’s creditors, or “whether it is because the directors failed in their obligations to creditors tout court.”16 He found that in Canada, directors were confronted by legal responsibilities that impose a burden on them to look to creditors’ interests when exercising their powers on behalf of the corporation.
In Liquidator of West Mercia Safetywear Ltd v Dodd17, Dillon L.J stated that directors owe duties towards their company's creditors, or "if it is put more cautiously, that their duties, though owed to the company, include an obligation to have regard to the interests of its creditors. This duty is sometimes described as a duty of 'care', and sometimes - but not always - expressed to arise only in circumstances of actual or imminent insolvency; and there is also some confusion whether it is conceived of as owed to future creditors or only to the company's existing creditors."
Sealy18 in commenting on that decision said delinquent directors are held accountable under time-honoured principles, "thus the homily from the bench about 'duties' as director is not out of place."19 In the case cited above, a director was held by the Court of Appeal to have committed a 'fraudulent preference and an act of misfeasance' for contributing to the assets of the liquidator by diverting money from the company to another bank account to reduce an overdraft which he had personally guaranteed.
Dillon's statement in the instant case should be compared with that which he made in Multinational Gas & Petrochemical Co. v Multinational Gas & Petrochemical Services Ltd.20 five years earlier. In this latter case he said no duty was owed to future creditors. "The directors indeed stand in a fiduciary relationship to the company…and they owe fiduciary duties to the company, though not to the creditors, present or future or to individual shareholders."
In West Mercia21 he qualified his earlier statement by saying it had been made in the context of a solvent company, while in Multinational Gas22, the company was insolvent. Dillon approved part of the judgement of Street C.J. in Kinsela v Russell Kinsela Pty Ltd.23 when he said:
In a solvent company the propriety interests of the shareholders entitle
them as a general body to be regarded as the company when questions of
the duty of directors arise…But where a company is solvent the interests
of the directors intrude…It is in an impractical sense that their
assets and not the shareholders' assets that, through the medium of the
company, are under the management of the directors…
Similar remarks were also made by Norse L.J. in Brady v Brady24. Sealy25 believes it may even be possible to trace this line of thinking to Mason, J in Walker v Wimborne26 when he said:
It should be emphasised that the directors of a company must take account of the interest of its shareholders and its creditors. Any failure by the director to take into account the interests of creditors will have adverse consequences for the company as well as for them.
Then there is the dictum of Lord Templeman in Winkworth v Edward Baron Development Co. Ltd.27:
A company owes a duty to its creditors, present and future. The company is not bound to pay off every debt as soon as it is incurred and the company is not obliged to avoid all ventures which involve an element of risk, but the company owes a duty to its creditors to keep its property inviolate and available as well as its management, is confined to its directors. A duty is owed by the directors to the company and to the creditors of the company to ensure that…its property is not dissipated or exploited.
In New Zealand, Cooke J has suggested that the directors’ concern for the interest of creditors, although initially envisaged “as a matter of business ethics”, may be translated into a legal obligation in accordance with “the new persuasive concepts of duty to a neighbour and the linking of power with obligation.”28
Gower’s29 comment on the dictum in West Mercia30 is that directors’ duties may be seen as owed to those with ultimate financial interest in the company – the shareholders – when the company is in operation; and to the creditors, once the company’s capital has been lost.
In the Cayman Islands case of Prospect Properties Ltd v McNeil & Bodden31, it was stated that “in discharging his fiduciary duty to act in the best interest of the company, a director must, in appropriate circumstances, take into account the interest of the creditors of the company.” Here the directors were found in breach of this fiduciary duty when they arranged and orchestrated a meeting, at which certain resolutions were passed pertaining to the company, which were “of no benefit and advantage to the company but were only for the purpose of furthering their [the directors’] interests.”32
Darren Skinner33 points out that Commonwealth Caribbean statutory and case law derives jurisprudence relating to the company director from the legislation and decisions of England. “The attempt to harmonise the company law of the Commonwealth Caribbean, drawing from sources all over the common law world, shows a refreshing reluctance to slavishly follow English precedents. Nevertheless, existing law on the legal character of directors remains largely reflective of the English position.”34
Creditors in the United Kingdom, however, may find some relief through the Insolvency Act 1986. Section 336 of the Act – viewed by some as unconscionable – makes provisions for a trustee in bankruptcy to obtain vacant possession of the bankrupt’s home with a view to its sale in the interest of creditors. The other provisions provide for payment to creditors – preferential, secured and unsecured - in the event of insolvency.35
Sealy36 points out that the “wrongful trading” provisions of the UK’s Insolvency Act 198637 allows for statutory developments “which are properly integrated with insolvency law as a whole.” This also extends to legislations of the region, which make no mention of directors’ duties to creditors in those sections on ‘Duty of Directors and Officers’.38 As it stands, directors duties to creditors only arise on the insolvency of a company, when, following payments to the government (taxes and duties), it is creditors who are then paid, prior to the shareholders. But this is a general rule of company law; there is no Insolvency Act – such as that in the United Kingdom – which guarantees this. In more recent times it has been recognised that creditors’ interests require protection before insolvency.
It follows therefore, that the position in the Caribbean regarding the
accountability of directors to creditors has been recognised and successfully
applied through the common law in the Cayman Islands which implies that
Barbados may follow suit. But as far as statute goes, creditors are offered
some ‘protection’39, but there is no reference made to ‘duties’ and
obligations owed to creditors by directors. Thus, statute remains woefully
inadequate in recognising the fiduciary duty owed by directors to creditors
in Barbados in this era of the corporate form.
Directors’ Duties to other Directors
Corporate legislation in the Commonwealth Caribbean, that of Barbados being no exception, makes no provision for directors’ accountability to each other. It is also a point seemingly overlooked or avoided by legal luminaries, as little, if anything has been written on the subject. This may suggest that directors owe no duties to each other.
Not so! In 1980, Galligan, J in the Ontario Supreme Court (High Court of Justice) declared that a director, “in addition to the harm which he caused the corporation...was subjecting Beamish [another director] to special and separate risk of harm from that of the corporation."40
The judge pointed out that there were circumstances in which there could be a cause of action by one director against the other:
“In my opinion, if a director of a corporation acts in contravention of his duties to the corporation under s144 of the Business Corporations Act, and when doing so, he knows or ought to know that his conduct not only is against the best interest of the corporation, but will also subject another director to a risk of special harm or damage quite apart from the damage to be suffered by the corporation, then in my opinion, he owes a duty to that other director as well as to the corporation, not to subject him to special harm or damage.”41
In this case B and S were equal partners and directors in a corporation and were both required to sign any conveyance of the business. The enterprise failed and they agreed to sell to a third party and also agreed on how the proceeds of the sale would be distributed. B had signed a personal guarantee to the company’s bank. S however, had given no personal guarantee on that transaction. Had the purchase and sale of the company been concluded, the proceeds would have paid all the company’s debts. There would not, however, be sufficient funds to pay S the sum agreed to by both directors, but the sale would have been in the best interest of the company. S therefore refused to sign the conveyance for the company and so prevented closing. This was in his own best interest but was a breach of his statutory duty to act in the best interest of the corporation under s144 of the Business Corporation Act of Ontario, Canada. Damage was thereby caused to the company by the breach of S’s duty to the corporation.42
This case represents but one scenario in which a director’s action
causes harm to another director. There may be numerous instances in which
this could occur. But it established common law recognition of the duty
of one director to another. And, as stated in the case cited43, it was
in breaching his duty to the company that the director breached his duty
to the other director. Thus, if duty to the company is of such paramount
importance, should not duty to other directors be seen as one which impacts
upon or is affiliated to, carrying out that duty?
Directors’ Duties to Employees
By statute, directors are required to have regard, in the performance of their functions, not only to the interests of the shareholders, but also to the interests of the company’s employees in general. In Barbados, the provision states:
In determining what are the best interests of a company, a director must have regard to the interests of the company’s employees in general as well as to the interests of its shareholders.44
This statutory provision merely states that they must include the interests of the company’s employees in their deliberations. It does not require that any particular priority be given to them or indeed that it should ultimately influence their decision. So, like all other duties of directors, this is a duty to the company, and employees cannot enforce it directly. This provision in the legislation, therefore, appears impractical and unclear.
The 1962 decision of Parke v Daily News45 found that the gratuitous redundancy payments to former employees was void as this was ultra vires the company unless found to have been in the best interest of the company “as a going concern.”
The explanatory memorandum of the Caribbean Law Institute’s Companies Bill 199146 states that clause 97 would serve to establish the duties of directors statutorily. And quite apart from exercising those duties in the interests of the company with due diligence and skill, the directors would need to take into regard “the company’s employees in general as well as to the interests of its shareholders.”
The Bill represents no improvement over that which currently exists in
Barbados, which is one of the most recently enacted and comprehensive legislation
on company law in the region. Further, there is no provision on which gives
remedial action to employees. Section 225 of the Barbados Act under “Civil
Remedies” in defining ‘complainant’ includes shareholders,
debenture holders, and directors of the corporate registrar. There is no
mention of ‘employees’ which further stretches the point that
there is no genuine interest in the employee’s ‘stake’ in
the company and negates their even having any! Neither the common law nor
statute therefore recognises employees as ‘stakeholders’ to
whom directors owe fiduciary duties in this era of the corporate form.
Directors’ duties to Shareholders
Directors owe no duty to individual shareholders. They owe their duties only to the company. This from the leading case of Percival v Wright47 in which directors purchased shares from shareholders without disclosing that they were negotiating a take-over bid at a higher price. The directors were not held to be liable for this disclosure since they owed no fiduciary duties to the shareholders. The case has since been much criticised, but the principle stands.
Formerly, the notion of acting in the interests of the company was seen as an obligation to act in shareholders’ interests. After all, shareholders were the company – without them the company would not exist – and no other interest group was recognised as having any stake in the corporate enterprise. Thus Percival v Wright48 forged new ground in company law.
But despite that dictum, directors may have duties to shareholders individually, such as when they undertake to act as the shareholders’ agents. Such was the case in Allen v Hyatt49 in which company directors in negotiating an amalgamation with another company, induced the shareholders to give them options to buy their shares at par by representing that this would assist the negotiations. Viscount Haldane, L.C. in handing down his judgement noted that the directors appeared to have the impression that company directors were entitled to act as though they owed no duty to individual shareholders. But on the facts “the directors must here be taken to have held themselves out to the individual shareholders as acting for them on the same footing as they were acting for the company itself, that was, as agents…”50
But where the directors’ company is the ‘target’ in a take-over bid, duties may be owed to the shareholders. Heron International Ltd v Lord Grade51 laid down that principle. “Where the directors must only decide between rival bidders, the interests of the company must be the interests of the current shareholders…Thus the directors owed a duty to the general body of shareholders who were shareholders [on 13 January 1982] to obtain for the shareholders the opportunity to accept or reject the best bid reasonably actionable.” The directors had therefore not acted unreasonably or in breach of duty in accepting the bid.
The Barbados Companies Act provides that directors should take shareholders into account in determining what is in the best interest of the company.52 But unlike the position with employees (also mentioned in that section of the Act), shareholders may exercise their guaranteed rights to protect their interests or to hold directors accountable to them.
In Elliot Ward v The Rum Refinery of Mount Gay53 Sir Denys Williams C.J noted that section 373 “enables the court on the application of a shareholder, to order the liquidation and dissolution of a company or any of its affiliated companies on the grounds corresponding to those set out in section 228 (1) and also on other grounds, one of which is that the court is satisfied that it is just and equitable that the company be liquidated and dissolved.”
He also criticised the rule in Foss v Harbottle54 which provides that where a wrong is done to a person then the company is the proper person to sue. On that Sir Denys Williams, C.J said “a company can only act through its human agents, the directors, who may well be the wrongdoers.”
Walcott believes this decision “cannot be taken as authority for the proposition that directors owe a pre-existing fiduciary duty to shareholders…It seems therefore, that in a take-over situation, while in the Caribbean there is no fiduciary duty owed to shareholders per se the target management must exercise caution as a ‘potential liability’ may arise out of their words and actions if they give misleading advice, if they abuse their positions, or if a ‘special facts’ situation exists.”55 This was exactly the case in Ward v Mount Gay.56
During the liquidation of the Mount Bentinck Sugar Factory in St. Vincent
and the Grennadines, the shareholders were not dealt with until “the
liquidation process is complete, the accounts put together, and debts are
settled.”57 In fact, it was believed that nothing would be left to
pay shareholders “even a refund of their investments.”
Conclusion
Clearly directors are fiduciaries and should be held accountable for their acts that impact upon the companies they manage. However, as has been discussed, their primary responsibility is to the company, not the ‘stakeholders’ in whatever form or shape they may appear.
While both statutes and the common law have had to acknowledge – in one way or another – the ‘stakeholders’ in the company, it is only the shareholders’ and creditors’ rights that have been accorded any serious considerations by way of statute and common law58. For while directors do not generally owe duties to individual shareholders, their duty is to act in the interest of the company as a whole, including its present shareholders as a group and, where appropriate, taking into account the interests of future shareholders as well.
It is a general rule of company law that if a wrong is done to a company (for example, a breach by a director of his duties), the proper plaintiff is the company itself, not its shareholders.59 Another rule is that the courts will not generally interfere with the internal management of a company that is acting within its powers. In carrying out their duties, directors should always consider the position of the minority shareholders and the fact that they might have rights to complain if they are dealt with in a prejudicial manner.
Prentice sums it all up when he states: “There is hardly an area of company law more direly in need of updating than that relating to director’s responsibilities and duties.”60 And it is important to bear in mind that these duties, if and when identified, cannot be easily enforced.
The law has met some of the demands on director’s fiduciary duties
in the Commonwealth through employment laws, insolvency laws and environment
laws.61 Company law’s response has been merely symbolic or permissive,
rather then obligatory.