Waikato Law Review
I am both honoured and delighted to have been invited to deliver the inaugural Stace Hammond Grace Lecture in commercial law here at the Waikato University School of Law. My delight is for two reasons. First, it is gratifying to find that the partners of Stace Hammond Grace, many of whom are well known to me personally as a result of my time in practice in Hamilton, have decided to endow this annual lectureship. The Law School must be well satisfied that it is receiving such encouragement from one of the major Hamilton legal firms. Secondly, as the Chancellor of this University when the proposal for a Waikato Law School was first mooted and one who had a somewhat limited role at the initial stages, I have watched with interest the development of the School to the stage where its first graduates have now received their degrees. This interest, no doubt, will continue both because of my past involvement in the University and the Law School and also for so long as I may be Chairman of the Council of Legal Education.
The topic is timely. Interest in the powers and duties of directors tends to wax or wane according to the climate of the time. One suspects that, during the excesses of the 1980s leading to the share market crash of October 1987, many persons who were directors of major companies, not only those described as “entrepreneurial”, gave little thought to the powers and duties that flowed from that office. Post crash, many of them found, I suspect rather to their surprise, that they were directly in the firing line. In a large number of cases disgruntled shareholders and creditors thought that the losses they had suffered should be reimbursed by directors whom they considered had failed to exercise their duties in the manner the law required. In fewer, but more dramatic instances, the breach of those duties attracted the sanctions of the criminal law. All of this has greatly increased interest in just what were the duties and potential liabilities of directors.
The passing of the Companies Act 1993 (the 1993 Act) with its detailed provisions spelling out the powers and duties of directors has resulted in further interest in the topic - an interest that no doubt will heighten further when the 1993 Act comes into force on 1 July 1994.
The 1993 Act, flowing as it does largely but certainly not entirely from the report of the Law Commission published in June 1989, will result in dramatic changes generally to the law relating to companies and particularly to the powers and duties of directors. Indeed, an eminent international authority on company law, Professor L S Sealy, described the Report as
perhaps the most radical reappraisal of this branch of law that has been put forward anywhere in the Commonwealth (including the UK) since limited liability was introduced in 1855.
In his commentary on his paper, Professor Sealy referred to the contrasting “enabling” and “regulatory” approaches. He was an advocate of the former. It was his view that the best focus for a companies code is to see it as oiling the wheels of commerce, to make the wheels of business even better. Experience, he said, showed that tough company laws do not pay off. The detailed powers and duties contained in Part VIII of the 1993 Act appear to be an amalgam of regulatory and enabling provisions.
I intend to make a brief reference to the history of the reform, to comment on the approach to directors' duty that has finally emerged in the 1993 Act, to examine the statutory duties and make some comments on them, to consider the extent to which other provisions in the Act bear on these duties, and to point out the civil and criminal liabilities that may flow from a breach of those duties.
Finally, I make the customary judicial disclaimer. Any views I express tonight on principle or detail are not likely to have the slightest persuasive force if cited to me in Court. The benefit of careful, well researched submissions by competent counsel may well result in my reaching an opposite conclusion.
A look backwards can often be of considerable help in determining the intent or purpose of any particular statutory reform. What follows is only a brief glance at the events that preceded the passing of the Act.
The Companies Act 1955 was an almost exact copy of the United Kingdom Act of 1948 but, as the Law Commission noted in its report, with the United Kingdom company law now increasingly influenced by European law, it no longer provides an obvious model for New Zealand.
Major reforms proposed by the Commission included the simplification of the Act, a restatement in it of the major rules of company law at present found in case law, a substantial overhaul of the notion of share capital, a reassessment of the distribution of power within the company and the position of and remedies available to minority shareholders, and the streamlining of the registration system. These reforms were incompatible with the structure of the 1955 Act. For that reason, the Commission concluded that selective amendment of the 1955 Act was not sufficient and that the Act should be replaced.
The Law Commission Report Number 9 was published in June 1989. Included in it was a draft Companies Act. It was not until fifteen months later, in September 1990, that a Companies Bill was introduced into Parliament. In a number of respects, including some relating to directors' duties, it was markedly different from the draft Bill. To a person looking at law reform from the outside, it is not easy to understand why a reform proposed by the Law Commission after publication of various discussion papers and extensive consultation with persons interested in the reform proposed, should then be re-examined and frequently, as in this case, substantially altered by the Law Reform Division of the Justice Department. One could be excused for thinking that the Commission, made up of senior, highly qualified persons with a substantial research assistance, independent of the executive, might be better qualified to judge the shape black letter law reform should take than persons staffing a division in a government department. One of the disadvantages of this method of law reform is that the changes introduced by the Law Reform Division are not accompanied by any report explaining the reasons for them. It is now well recognised that reports of the Law Commission or a Law Reform Committee can be a valuable aid in ascertaining the statutory purpose of any particular provision. That aid is not available where the changes have been made by the Law Reform Division. An example is the introduction into the Bill of what is now section 133, the “proper purpose” provision, to which I later refer.
For the same reason care must be exercised in using the Law Commission Report Number 9 as an aid in interpretation. If a reform it has proposed has been changed by the Law Reform Division, commentary on that reform may not be of assistance.
Another consequence of this rather piece-meal approach was the extraordinarily long study of the Bill by the Justice and Law Reform Select Committee. It was not until over two years later, in December 1992, that the Bill was reported back to the House. It was, as I suppose was to be expected, something of a compromise between the approaches adopted by the Law Commission and by the Law Reform Division. The result, therefore, is an Act which in some areas, including that relating to directors' duties, lacks a consistency of approach.
The Law Commission pointed out that, although the proposals contained in the report might seem revolutionary, they generally had working models in Canada and the United States. They went on to say:
But the crucial elements of the company as we have always known it are confirmed in the reforms proposed. Dead wood has been pruned away but the essential elements of the company remain. They have been distilled from the existing legislation and the case law and restated in the draft statute to make them more accessible and useful.
In the area of directors' duties, the Commission observed that the duties were not set out in the 1955 Act. They had to be gleaned from a large volume of complex case law. The proposal in the discussion paper that it was time to distil the general principles from the cases and express them in the statute to make them more accessible received overwhelming support in the responses to the paper.
In the absence of any report accompanying the alterations it proposed, the approach of the Law Reform Division is not so easy to ascertain. But the impression one gains looking at those changes is that the Law Reform Division’s approach was, contrary to the opinion of Professor Sealy, more regulatory than enabling. For example, clause 115 of the Bill placed a higher standard of care on a director in a profession or occupation or who possessed special skills or knowledge, a provision that was dropped in the 1993 Act. Similarly, the reckless trading provision set out in clause 113 was very large in scope.
The question may arise whether the enacted directors’ duties constitute a complete code or whether the previous common law decisions may remain relevant. It is clear from the Law Commission's second report that the Commission did not intend them to be a code. The Commission said that it had refrained from a recommendation that its proposal on director's duties be described as a code, but was confident that the courts would recognise a statutory set of director's duties as the text of first resort in considering issues in that area. Further, it considered that where some of the main problems of modern company law had been directly addressed, such as minority shareholder remedies and restrictions on share issues, some of the current common law rules developed to avoid apparent injustices could be safely set aside.
The 1993 Act is not the only place to look when considering the obligations of a director. Section 27 provides inter alia that if a company has a constitution each director has the rights, powers, duties and obligations set out in the Act except to the extent that they are negated or modified in accordance with the Act by the constitution of the company. There are a number of sections relating to directors' duties that expressly provide for the constitution to modify the statutory provisions.
A helpful commentary on the overall approach to directors' duties as contained in the Act is in a paper presented by Alan Galbraith, QC, at a recent conference. Mr Galbraith emphasised the concept of directors' diligence:
The core concept underlying the general duty seems to me to be that of diligence. Diligence requires a director to be alert and active. Being alert includes an obligation to enquire and understand. Being active includes an obligation to make a judgment and to act on that judgment. A directorship is not a sinecure. Anybody misguided enough to adopt the position of a sleeping or titular director is simply underwriting the actions of the other directors of the company.
Any consideration of the enacted directors’ duties should commence with the long title to the 1993 Act, to which I suspect reference will frequently be made in submissions directed to the purpose or object of any particular provision. The long title reads:
An Act to reform the law relating to companies, and, in particular, -
(a) To reaffirm the value of the company as a means of achieving economic and social benefits through the aggregation of capital for productive purposes, the spreading of economic risk, and the taking of business risks; and
(b) To provide basic and adaptable requirements for the incorporation, organisation, and operation of companies; and
(c) To define the relationships between companies and their directors, shareholders, and creditors; and
(d) To encourage efficient and responsible management of companies by allowing directors a wide discretion in matters of business judgment while at the same time providing protection for shareholders and creditors against the abuse of management power; and
(e) To provide straightforward and fair procedures for realising and distributing the assets of insolvent companies.
Efficiency and responsibility are both goals of the Act but the words I have emphasised also recognise that the taking of business risks is legitimate and that, in matters of business judgment, the directors have a wide discretion. These general statements of purpose are likely to be of some significance when considering whether or not any particular act transgresses any of the express provisions in Part VIII of the Act.
For the purpose of the sections enacting directors' duties, “director” has an expanded meaning. It includes a person in accordance with whose directions or instructions a person occupying a position of director may be required or is accustomed to act. So where another person (whether an individual or a company) that, for example, holds a substantial share holding in the company, appoints a director on the basis that that director will follow the directions or instructions of the individual or company appointing him or her, the individual or company is, for these purposes, also a director. This has particular importance to the provisions relating to disclosure of interest but it has also to be borne in mind when considering directors' duties generally.
I now propose to refer to some but not all of the enacted directors’ duties.
Section 131 of the Act states:
131. Duty of directors to act in good faith and in best interests of the company - (1) Subject to this section, a director of a company, when exercising powers or performing duties, must act in good faith and in what the director believes to be the best interests of the company.
That a director must act honestly, has, of course, always been the case. An obligation to act in good faith may require a little more, but that too has long been a recognised duty. The second part of the subsection may arouse more interest in two respects. First, the test is clearly intended to be subjective. Interestingly, this was not the Law Commission's recommendation. Its draft Bill required the director to act in a manner “that he or she believes on reasonable grounds” to be in the best interests of the company. The phrase “on reasonable grounds” was excluded in the Bill that came from the Law Reform Division. It is not clear why that change was made. I agree with Henry J's observation where he expressed reservations as to whether the subjective qualities of the particular director are appropriate factors to apply in determining the yardstick in today's business world. In practice I imagine that it is likely that the courts will interpret the phrase in the manner the Law Commission intended, namely, that there must be reasonable grounds for the director’s belief. However, in the interests of avoiding doubt, it would have been preferable had the Law Commission's draft been adopted.
Secondly, there is the reference to “the best interests of the company” - not, it is to be noted, the shareholders or the creditors. Again this is a restatement of a longstanding common law rule. Linley MR said that, if directors act honestly for the benefit of the company they represent, they discharge both their equitable as well as their legal duty to the company.
The subsection also affirms the reluctance of the courts to review an exercise of business judgment taken in a boardroom. Any person such as a shareholder or creditor seeking to challenge in court such a boardroom decision, on the grounds that it was in the circumstances unwise or inappropriate, faces an uphill task. As long ago as 1812 Lord Eldon LC observed that:
This Court is not to be required on every Occasion to take the Management of every Playhouse and Brewhouse in the Kingdom.
Professor Sealy observed, after citing Lord Eldon:
The Courts do not have the time and the Judges do not have either the training or the inclination to review every decision of policy and every exercise of business judgment taken in a boardroom.
To a similar effect are the dicta of Lord Wilberforce:
there is no appeal on merits from management decisions to Courts of Law: nor will Courts of Law assume to act as a kind of supervisory board over decisions within the power of management honestly arrived at.
Section 133 of the Act states:
133. Powers to be exercised for proper purpose - A director must exercise a power for a proper purpose.
Of all the enacted directors’ duties, this is likely to be the most troublesome. The problem with the provision is its great uncertainty. It appears to be directly contrary to the purpose of the enacted directors’ duties, that is, to make it easier for directors to know just what their responsibilities are. A director looking at this provision will be left completely in the dark. Even if he or she consults a lawyer to find out what it means, I doubt that much light will be cast.
The Law Commission recognised this difficulty. In its second report, it referred to the common law concept of “proper purposes” which, it said, involved great uncertainty in the absence of identifiable limits to the powers of companies and directors. The use of the concept to prevent disruption of existing constitutional balances - as in the Privy Council decision in Howard Smith Ltd v Ampol Petroleum Ltd  - would be overtaken by the Commission's draft provision dealing with class rights and minority remedies.
No doubt for these reasons, the Commission did not include a “proper purpose” section in its draft Bill. The section was inserted by the Law Reform Division and thus was in the Bill as introduced to Parliament. It therefore appeared without any report, comment or explanation on what the provision was intended to achieve. Any attempt to decide the meaning of the section requires a consideration of the case law.
The authorities on whether directors have been acting for a proper purpose are mostly but not only concerned with the directors exercising their power to issue further capital. What has been at issue is whether that power has been exercised for a proper purpose. Thus, in Punt v Symons & Co Ltd, the directors had issued shares with the object of creating a sufficient majority to enable them to pass a special resolution depriving other shareholders of special rights conferred on them by the company's articles. Byrne J said:
The power of the kind exercised by the directors in this case is one which must be exercised for the benefit of the company: primarily it is given them for the purpose of enabling them to raise capital when required for the purposes of the company. There may be occasions when the directors may fairly and properly issue shares in the case of a company constituted like the present for other reasons.
But when I find a limited issue of shares to persons who obviously meant and intended to secure the necessary statutory majority in a particular interest, I do not think that is a fair and bona fide exercise of the power.
In Piercy v S Mills and Co Ltd, the directors had issued shares with the object of creating a sufficient majority to enable them to resist the election of three additional directors whose appointment would have put the two existing directors in a minority on the board. Peterson J said that directors are not entitled to use their powers of issuing shares merely for the purpose of maintaining their control or the control of themselves and their friends over the affairs of the company or merely for the purpose of defeating the wishes of the existing majority of shareholders.
In Hogg v Cramphorn Ltd, the directors of a company faced with a takeover proposal established a trust and allocated to the trustees sufficient shares to defeat the takeover. Buckley J held that the power to issue shares was a fiduciary power and, if exercised for an improper motive, the issue was liable to be set aside. Further, he held that the issue of the additional shares could not be justified by the view that the directors genuinely believed that it would benefit the company if they could command a majority of the votes in general meeting. He thus seemed to differ from Byrne J in Punt, where the latter said that the power must be exercised for the benefit of the company.
These authorities were considered by Berger J of the British Colombia Supreme Court in Teck Corp Ltd v Millar. This too was a takeover case. The directors of the target company issued shares to another company with a view to defeating the takeover. Teck Corporation, the offerer company, brought proceedings to prevent the directors issuing shares which altered fundamentally the corporation share structure. The proceedings failed. Berger J declined to follow the judgment in Hogg v Cramphorn, and said:
The Court's jurisdiction to intervene is founded on the theory that if the directors' purpose is not to serve the interests of the company but to serve their own interest or that of their friends or of a particular group of shareholders, they can be said to have abused their power. The impropriety lies in the directors' purpose. If their purpose is not to serve the company's interest, then it is an improper purpose. Impropriety depends upon proof that the directors were actuated by a collateral purpose; it does not depend upon the nature of any shareholders' rights and may be affected by the exercise of the directors' powers.
The judgment in Teck Corp Ltd v Millar was followed by Montgomery J in Re Olympia and York Enterprises Ltd v Hiram Walker Resources Ltd. He held that the issue of shares could not be challenged if the directors act in good faith and on what they believe on reasonable and probable grounds to be the best interests of the company. Provided they so act, it matters not that they also benefit as a result.
For this country, the leading authority is the decision of the Judicial Committee of the Privy Council on appeal from the Supreme Court of New South Wales in Howard Smith Ltd v Ampol Petroleum Ltd and others  - yet another case involving issue of shares. Ampol was making a takeover bid. The target corporation's management was resisting this bid in favour of another. The directors purported to issue sufficient shares to put the bidding company into a minority position. The relevant article empowered the directors to allot shares “to such persons on such terms and conditions and either at a premium or otherwise, as the directors may think fit”.
The trial judge had held that the directors had improperly exercised their powers. The Judicial Committee dismissed the appeal against that decision. Lord Wilberforce delivered the judgment. It merits some analysis. He commenced by stating the arguments advanced on each side. On the one side it was argued that, for validity, what is required is bona fide exercise of the power in the interest of the company: that once it is found that the directors were not motivated by self interest - that is, by a desire to retain their control of the company or their positions on the board - the matter is concluded in their favour and the court will not enquire into the validity of their reasons for making the issue. On the other side, the main argument was that the purpose for which the power is conferred is to enable capital to be raised for the company and that once it is found that the issue was not made for that purpose, invalidity follows. Lord Wilberforce said that neither of these extreme positions could be maintained.
His Lordship went on to observe that, where the self interest of the directors is involved, they will not be permitted to assert that their action was bona fide thought to be, or was, in the interests of the company. The absence of any element of self interest is not enough to make an issue valid. He cited, as what he described as the clearest of several well-known statements of the law, the dicta of Viscount Finlay in Hindle v John Cotton Ltd:
Where the question is one of abuse of powers, the state of mind of those who acted, and the motive on which they acted, are all important, and you may go into the question of what their intention was, collecting from the surrounding circumstances all the materials which genuinely throw light upon that question of the state of mind of the directors so as to show whether they were honestly acting in the discharge of their powers in the interests of the company or were acting from some bye-motive, possibly of personal advance, or for any other reason.
The words I have emphasised in this passage tend to suggest that Lord Finlay was adopting the test that Lord Wilberforce had rejected, namely, that the exercise of the power would be valid if the directors acted bona fide in the interests of the company.
Lord Wilberforce stated what the Judicial Committee considered to be the correct approach in this passage:
In their Lordships' opinion it is necessary to start with a consideration of the power whose exercise is in question, in this case a power to issue shares. Having ascertained, on a fair view, the nature of this power, and having defined as can best be done in the light of modern conditions the, or some, limits within which it may be exercised, it is then necessary for the court, if a particular exercise of it is challenged, to examine the substantial purpose for which it was exercised, and to reach a conclusion whether that purpose was proper or not. In doing so it will necessarily give credit to the bona fide opinion of the directors, if such is found to exist, and will respect their judgment as to matters of management; having done this, the ultimate conclusion has to be as to the side of a fairly broad line on which the case falls.
Later in the judgment, Lord Wilberforce referred to Berger J's judgment in Teck Corporation, observing that it was in line with English and Australian authorities. Yet, as I have pointed out, Berger J's approach, that an exercise of the power is proper if it is bona fide in the interests of the company, was an approach that Lord Wilberforce had earlier rejected.
With all the very considerable respect which must be accorded to Lord Wilberforce's opinion, the test that he set out in the passage I have cited above does not seem to me to be particularly helpful. To say that, to decide whether a power has been exercised for a proper purpose, the court is required to reach a conclusion whether that purpose was proper, obviously begs the question. Later in the judgment, he said:
it must be unconstitutional for directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority, or creating a new majority which did not previously exist. To do so is to interfere with that element of the company's constitution which is separate from and set against their powers. If there is added, moreover, to this immediate purpose, an ulterior purpose to enable an offer for shares to proceed which the existing majority was in a position to block, the departure from the legitimate use of the fiduciary power becomes not less, but all the greater.
One would not argue with that opinion. But it is not necessarily inconsistent with the approach that the directors must exercise their power bona fide in the interests of the company. To do what he has described would not be exercising the power for the interests of the company, but for some other, therefore improper, purpose.
Howard Smith has been considered in New Zealand by Prichard J in Baigent and Others v D McL Wallace Ltd and Others. The plaintiffs, as minority shareholders, sought to prevent a company selling a substantial asset in a joint venture company. It was not therefore a share issue company. Prichard J cited the passage from Howard Smith that I have set out and went on to say:
In the case of powers such as the power to allot shares and the power to refuse to register share transfers the “broad line” is comparatively narrow: the purpose for which such powers are intended are well defined and they are restricted in scope: the use of such powers to affect the voting structure of the company for purposes unrelated to the object of the powers is readily identified as an abuse of power.
I am not so sure that the powers are well defined. Certainly some purposes are clearly not proper, generally because they are purposes relating to the directors' own interests rather than the interests of the company. But what if the directors refuse to approve a share transfer because they believe, bona fide and for good reason, that the transferee will harm the company?
How then is section 133 to be applied? What is the relationship between the section and section 131? Can directors, facing an allegation of exercise of a power for an improper purpose, meet that allegation by asserting that they acted in good faith and in what the director believed to be the best interests of the company, as is the law in Canada? If he or she can, section 133 would appear to be redundant. If he or she cannot, what test is to be applied in considering whether or not a director's purpose is proper? I accept that there may be circumstances where the directors may consider the action they are taking is in the best interests of the company, yet they may be using their powers for a purpose other than that for which they were conferred. In some cases that conclusion may be obvious, but in others it will be far from clear.
Questions such as these will have to be answered by the courts. That is not a satisfactory result of a reform intended to clarify the responsibilities of directors. In my view the section should not have been included in the Act. Issues of the kind that arose in the share issue cases, to which I have referred, should be determined by applying section 131, although it would be preferable if the test in that section were objective, as the Commission had proposed. The issue of additional shares, for example, would not be able to be challenged if the directors could establish that they were acting in good faith and in what they believed on reasonable grounds to be the best interests of the company. If, despite that belief, some shareholders considered that by, for instance, the directors issuing shares, the affairs of the company were being conducted in a manner that is unfairly prejudicial to them, they can apply to the court for relief.
Sections 135 and 136 of the Act state:
135. Reckless trading - A director of a company must not -
(a) Agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or
(b) Cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors.
136. Duty in relation to obligations - A director of a company must not agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.
These sections are broadly akin to section 320 of the 1955 Act although that section applies only where a company is being wound up. In its present form the section is the product of the unsatisfactory course that was adopted for this reform. The Commission’s version proposed that directors be liable for “an unreasonable risk of causing the company to fail to satisfy the solvency test”. Thus reasonable risks could be taken. That was deleted by the Justice Department, and a “reckless” test substituted. That in turn was axed by the Justice and Law Reform Select Committee, from which the section in its present form emerged. It is not surprising that such a piecemeal method of law reform has produced a rather uncertain result.
These sections are strongly criticised by Dr Roderick S Deane in a recent paper. He points out that there are two elements to business decisions. The risk of loss is one. Equally important is the size of the prospective gain. The higher the risks the higher the rewards often are. The balancing of risks and rewards is part of every investment decision for creditors as well as directors. These two new sections, he submits, show no reflection of the need for that balance.
I do not consider his concern to be well founded. If a risk of loss is reasonably balanced by a prospect of gain, the risk could not be characterised as substantial. In assessing the degree of risk the courts are likely to take an attitude which is commercially realistic. The two words of emphasis in the phrase “a substantial risk of serious loss” support the view that a court is unlikely to consider a director in breach of that duty if the risk of loss created is commensurate with the likelihood of profit. This is one of the contexts where there will be reference to the statutory objective set out in the long title, expressly recognising, as appropriate in the management of a company, the taking of business risks by allowing directors a wide discretion in matters of business judgment.
But Dr Deane's criticisms do have this validity. If, as I consider to be the case, a judgment on whether there has been created a substantial risk of serious loss can properly have regard to the size of a prospective gain, that is, if it is legitimate to balance the risk with the return, it would have been preferable for the section to say so. As it is, the boundaries of the duties under the section will have to be determined by the court. That is contrary to the purpose of the reform. The directors’ duties spelt out in the Act should be clear and unambiguous. This section is not.
A similar approach is likely to section 136. Certainly the section requires a director to believe that the company will be able to perform the obligation, not that it may be able to. But the obligation is not absolute. All that the section requires is that, at the time the obligation is incurred, the director believes on reasonable grounds that the company will be able to perform. If there are shown to be reasonable grounds for the belief, particularly if professional advice has been obtained, liability will not follow. To put it in the alternative, if a director does not believe on reasonable grounds that the company will be able to perform its obligations when required, it is appropriate that the director should be liable for any resulting loss.
Section 137 of the Act states:
137. Director's duty of care - A director of a company, when exercising powers or performing duties as a director, must exercise the care, diligence, and skill that a reasonable director would exercise in the same circumstances taking into account, but without limitation, -
(a) The nature of the company; and
(b) The nature of the decision; and
(c) The position of the director and the nature of the responsibilities undertaken by him or her.
Apart from detail, there is nothing new in this description of a director's duty of care. It seems likely that the section was drafted to accord with the approach of Henry J in Fletcher v National Mutual Nominees Ltd, where he said that the standard of care to be exercised by directors “is to be assessed by also having regard to the circumstances pertaining and to the responsibilities which the directors have undertaken”. Nor is it unusual for this duty to be expressed in statutory form. In Australia, the Corporations Act 1989 provides that “an officer of a corporation shall at all times exercise a reasonable degree of care and diligence in the exercise of his or her powers and the discharge of his or her duties”. This provision has now been amended by requiring a director to exercise the degree of care and diligence “that a reasonable person in a like position in a corporation would exercise in the corporation's circumstances”.
Dr Deane is critical of this provision also. He considers that
it makes perilous the position of the specialist who may have a lot to contribute, but in a narrow area, or the wise old head whose contribution is just wisdom, or skill in assessment of people, without other paper qualifications.
I think not. Certainly the test is the objective test of a reasonable director. That is to be judged in the same circumstances. And further, the section, in my view helpfully, expressly states that there should be taken into account the nature of the company, the nature of the decision, the position of the director and the nature of the responsibilities undertaken by him or her. Thus the section has regard to the position and the responsibilities undertaken by the specialist and also to the position of the “wise old head”. So these are all factors to which the Court will have regard in judging whether a director had failed to exercise the expected care, diligence and skill. After all, there is no reason why a specialist director, and the “wise old head”, should not keep themselves generally informed of the company's affairs and be able to exercise an informed, independent judgment. If they are not able to do so, they should not be directors.
This approach is reinforced by the change that occurred in the Select Committee hearings. The Law Reform Division had inserted into the Bill a considerably higher standard of care by requiring that a director in a profession or occupation or possessing special skills or knowledge must exercise the care, diligence and skill that a reasonable director “in that profession or occupation or possessing those special skills or knowledge, would exercise in the same circumstances”. This requirement has been deleted. In its place there are the particular matters to be taken into account to which I have already referred.
Section 130 deals with delegation of powers. It authorises the board to delegate certain of its powers to a committee of directors, a director or an employee of the company. A board that so delegates will be responsible for the exercise of the power unless the board:
(a) Believed on reasonable grounds at all times before the exercise of the power that the delegate would exercise the power in conformity with the duties imposed on directors of the company by this Act and the company's constitution; and
(b) Has monitored, by means of reasonable methods properly used, the exercise of the power by the delegate.
Similarly, section 138 authorises a director to rely on reports, statements and financial data and other information prepared or supplied and on professional or expert advice, given by persons of the kind set out in the section. Subsection 2 provides that subsection (1) applies to a director only if the director:
(a) Acts in good faith; and
(b) Makes proper inquiry where the need for inquiry is indicated by the circumstances; and
(c) Has no knowledge that such reliance is unwarranted.
While these provisions probably reflect what a conscientious director would regard as appropriate, they are a far cry from the earlier far more relaxed attitude the courts had to the obligations of directors to be actively involved in the management of their company. A vivid example of this attitude is In re Cardiff Savings Bank, the Marquis of Bute's case. The Marquis had been appointed the president of the board when he was six months old. In the following thirty-eight years he attended one board meeting when he was aged twenty-one. Stirling J concluded that the Marquis was not liable for the consequences of certain frauds and defalcations. The judge considered that to hold the Marquis guilty of neglect or omission in respect of a duty in the absence of any knowledge or notice that it was not duly performed, would be to fix him with liability for the neglect or omission of others rather than his own. Those indeed were the days of gentlemen directors. Thus, in Re City Equitable Fire Insurance Co and others, Romer J held that
a director was not bound to give continuous attention to the affairs of his company. His duties are of an intermittent nature to be performed at periodical board meetings.
No longer, as Kirby P recently put it:
The time has passed when directors and other officers can simply surrender their duties to the public and those with whom the corporation deals by washing their hands with impunity, leaving it to one director or a cadre of directors or to a general manager to discharge their responsibilities for them.
Even the more recent pronouncement of Rogers J of the New South Wales Supreme Court in AWA Ltd v Daniels may need to be reconsidered in the light of these sections. He said:
A director is justified in trusting officers of the corporation to perform all duties that, having regard to the exigencies of business, the intelligent devolution of labour, and the articles of association, may properly be left to such officers. ... A director is entitled to rely without verification on the judgment, information and advice of the officers so entrusted. ... Reliance would only be unreasonable where the director was aware of circumstances of such a character so plain, so manifest, and so simple of appreciation, that no person with any degree of prudence acting on his behalf would have relied on the particular judgment, information and advice of the officers.
Sections 130 and 138 set a higher standard. By way of illustration, a board is only excused from responsibility for the exercise of the power by the delegate if it has monitored, by means of reasonable methods properly used, the exercise of the power of the delegate. And the belief that the delegate would exercise the powers properly must be based on reasonable grounds. Similarly, a director relying on reports must make proper enquiry where indicated by the circumstances. The director will not be excused unless the director can show that he or she acted in good faith, made proper enquiry, and did not know the reliance was unwarranted.
I see no difficulty with these provisions. If a director suspects that an employer may not be completely reliable, there is nothing unreasonable in requiring the director to monitor the performance of the employer or to treat any advice or information received with care and caution. The overall consequence is that no longer will directors be able, in respect of actions or decisions that are or should be those of the board, to evade responsibility simply because those actions or decisions were left to others.
I shall refer to some but not all of other provisions in the Act which also bear on the duties and obligations of directors.
The sections referring to transactions involving self interest deal with disclosure of interest and disclosure of share dealings. These provisions are one of the major reforms. Their purpose is to replace the application to company directors of the rule of equity which makes voidable any transaction in which a fiduciary is directly or indirectly interested irrespective of the merits of the transaction. The section makes such a transaction voidable only where the transaction is not fair to the company. The 1993 Act, therefore, recognises the mischief resulting from directors being involved in company business where they stand to gain personally, but now places a greater emphasis on the extent of the directors' interest and whether the company has received fair value from the transaction.
The meaning of “interested” is defined by reference to “a material financial benefit”. No doubt there will be debate on the meaning of “material” but this is a word of a kind that the courts commonly have no difficulty in applying to any particular set of circumstance.
Every company is now required to keep an interests register. A director interested in a transaction must cause the fact that he or she is interested to be entered in the interests register and, if the company has more than one director, disclose the interest to the board. Failure to comply does not affect the validity of a transaction but renders the director liable to a penalty. This is one of the areas where the expanded definition of director, to which I have already referred, may become significant. Take, by way of illustration, a director appointed by Brierleys to the board of a company in which Brierleys has an interest, on the understanding that the director will act in accordance with instructions from Brierley. Any transaction between the company and any other company in which Brierley has an interest is likely to give rise to a requirement to disclose that interest.
However, provided the interest is disclosed, the effect is not as significant as it may at first sight appear to be. Subject to the constitution of the company, a director who is interested in a transaction can participate in a meeting of directors at which the transaction arises and vote on it as if the director were not interested. Even more significantly, to be avoided, a transaction in which a director is interested must be avoided by the company within three months after disclosure to all the shareholders. But the transaction cannot be avoided if the company receives fair value. It is presumed to receive fair value if the transaction is entered into by the company in the ordinary course of its business and on usual terms and conditions.
These provisions, therefore, are clearly intended to strike a balance. On the one hand there are stringent requirements for disclosure. On the other, a transaction will be avoided only if a company has not received fair value and then only within a limited time. This is in clear contrast with the application of the rules of equity that could result in the avoidance of transactions where the company had suffered no prejudice. By concentrating on the mischief which equity sought to prevent, that is, the abuse of power, but side-stepping equity's often draconian consequences where there is no such abuse, the sections alleviate what was often an unfair principle. Bona fide third parties are protected.
The onus of proof differs. As between the company and a director, the onus of proof is upon the director to show that the transaction was fair. As between the company and a third party, the company has the onus of establishing that it did not receive fair value. The Commission decided not to attempt to define “knowledge” for the purposes of these provisions. It considered that actual knowledge would set the standard too low. It preferred to leave the matter to be dealt with by the courts on principles of general application, referring expressly to Baden v Société-General Pour Favouriser le Développement du Commerce et de l'Industrie en France S A.
However there have been some expressions of disapproval of the classification of types of knowledge in Baden. For example, in Equiticorp Industries Ltd v Hawkins, Wylie J’s detailed examination of the recent authorities demonstrates the difficulty of discerning what type of knowledge should be imputed in different circumstances, and the problems that can arise from the Baden classification. Blanchard J has recently observed that he finds the Baden specifications unhelpful and unrememberable. If, as it said, the Commission regards actual knowledge as setting the standard too low, what is the standard to be applied in deciding whether a director should be held to have knowledge of matters that could make him or her liable? If some type of knowledge other than actual knowledge is to result in liability, it would have been preferable for the Act to have defined the nature of that knowledge. Leaving this definition to the courts will result in undesirable uncertainty.
Section 149 sets out the basis upon which directors may acquire or dispose of shares where the director has information material to an assessment of the value of shares obtained in his or her capacity as a director. This section overrides the decision in Percival v Wright, where it was held that directors of a company are not trustees for individual shareholders and may purchase their shares without disclosing pending negotiations for the sale of the company's undertaking. Section 149 recognises that directors do owe duties to shareholders in circumstances in which they deal in shares on the basis of confidential, price sensitive information. Again, the test applied in assessing liability, if any, is fair value. As the Commission succinctly put it, the director who is in possession of material price sensitive information has two options: to abstain from trading or to ensure that the person with whom he or she is dealing receives fair value. This section is intended to provide for the type of situation that arose in Coleman v Myers.
A new and significant provision is section 129, prohibiting a company from entering into a major transaction unless the transaction is approved or contingent on approval by special resolution. “Major transaction” is defined. In essence it means the acquisition of assets equivalent in value to the value of or the greater part of the assets of the company for acquisition or the disposition of the whole or greater part of the assets of the company. The prohibition does not apply to a receiver.
“The greater part of the assets” presumably means more than half of the value of the assets, they including property of any kind whether tangible or intangible. The section does not say so but I assume that the “assets of the company” are intended to be the gross assets, otherwise the section would have referred to assets less liabilities, as in the solvency test.
This provision results in a major, but in my view entirely justifiable, restriction on the powers of directors. It is based on the view that some dealings have such far-reaching effects that they should be referred to shareholders. Shareholders should not find that, without warning, massive transactions have transformed the company in which they invested.
The Act adopts a deliberate policy of requiring directors to sign a certificate in a large number of instances where they are likely to be making decisions of significance. There are some twenty-one statutory provisions requiring such certificates to be signed covering, by way of illustration only, consideration for issue of shares, satisfaction of the solvency test on authorising distributions, financial assistance for share purchases, directors' remuneration, amalgamations and the like.
As Mr J Hodder, a former Law Commissioner, has pointed out, the purpose of such certificates is essentially two-fold: to concentrate the minds of the directors on the decision or action in question (perhaps erring on the side of caution); and to provide something of a “paper trail” if breaches of directors' obligations are alleged and pursued by shareholders or a liquidator. Certainly these certificates are likely to loom large in any litigation involving the matters in respect of which the certificates are required. The Commission regarded these certificates as one of the means of overcoming difficulties of proof of director wrongdoing. Directors will need to realise that, before signing certificates, they will have to satisfy themselves that what is in the certificates is appropriate.
During the transition period, that is from 1 July 1994 until 30 June 1997, two systems of company law will be provided for in New Zealand: under the 1955 Act (as amended for the transition period) and under the 1993 Act. No company may be formed or registered under the 1955 Act after 1 July 1994.
During the transition period existing companies can choose between continuing under the 1955 Act (as amended by the Companies Amendment Act 1993) or applying for re-registration under the Companies Re-Registration Act 1993 which results in their being governed by the 1993 Act.
The detailed provisions relating to the transition period and in particular those set out in the Companies Amendment Act 1993 are beyond the scope of this lecture but for those provisions relating to directors' duties.
In case directors under an existing company think that they may be able to avoid some of the duties placed on them by the 1993 Act by not re-registering, they should be aware that that tactic will not succeed. The 1993 Amendment inserts into the 1955 Act almost all the provisions in the 1993 Act relating to directors and in particular to directors' duties and transactions involving self interest. Amongst the exceptions is the need to keep an interests register - that will not apply to 1955 companies. Apart from these exceptions, the duties and obligations to which I have referred will apply to companies that continue under the 1955 Act in exactly the same way as they do to companies incorporated under the 1993 Act or re-registered under the Re-Registration Act.
No consideration of directors' duties can be complete without some reference to the liabilities that flow from a breach of those duties. The 1993 Act contains significant changes designed to improve the remedies available to shareholders. I do not propose to analyse these remedies in detail but will draw attention to five aspects where significant changes have been made.
First, the court now has express statutory authority to make an order restraining a company or a director that proposes to engage in conduct which would contravene the constitution or the Act. The application may be made by the company, a director or shareholder or “an entitled person”.
Secondly, there are now express provisions governing derivative actions. The court can authorise a shareholder or a director to bring proceedings in the name of and on behalf of the company where the court is satisfied that the company does not intend to bring or defend the proceedings or it is in the interests of the company that proceedings should not be left to the directors or the determination of the shareholders as a whole. Section 165 is intended to do away with the rule in Foss v Harbottle. The court must order that the cost of a derivative action shall be borne by the company unless it considers that it would be unjust or inequitable to do so.
Thirdly, there are express provisions for personal actions by shareholders against directors for breach of a duty owed to him or her as a shareholder. The section specifies which of the duties set out in the Act are duties owed to shareholders and which are duties owed to the company and not to shareholders.
Fourthly, there are the provisions relating to oppressive conduct. These are similar to section 209 of the 1955 Act. But section 175 sets out eleven sections in the Act, failure to comply with which is conduct unfairly prejudicial for the purpose of section 175. So is the signing by directors of a certificate without reasonable grounds existing for an opinion set out in it. The Commission regards this as an extremely important section in the scheme of the Act. It adds that, since the provisions infringed are for the most part procedural, the court is likely to require a shareholder to show loss or damage before granting substantive relief.
Looked at broadly, these provisions should lessen, although they certainly would not remove, some of the difficulties which disgruntled shareholders have experienced in the past in seeking remedies for what they considered to be breaches by directors of the duties owed to them.
Offences and penalties are set out in Part XXI. I do not propose to detail them. The Act adopts a sliding scale of monetary penalties, that is, $5000, $50 000 or $200 000 depending on the section contravened; and, in respect of directors, there are two levels of penalties, namely $5000 and $10 000.
Section 376 enacts an “all reasonable and proper steps” defence available to a director charged in relation to a duty imposed by the company or the board.
Finally, I refer to section 383 which empowers a court to disqualify a director for a period not exceeding ten years where the director has been convicted of certain specified offences. The section is a substantial re-enactment of section 189 of the 1955 Act. This power to disqualify has been exercised in the past only sparingly. One of the reasons, no doubt, is because there needs to be an express application for an order by the registrar, the official assignee, the liquidator, a shareholder or a creditor. I am not aware of any application having been made in respect of the directors who were found guilty in the Equiticorp trial.
I would like to see, as an alternative to this provision, an amendment to the Criminal Justice Act 1985 giving jurisdiction to the court, when sentencing a director convicted of fraud in relation to a company, to order a disqualification as a director as part of the sentence. I doubt the effectiveness of long prison sentences for white collar crime - the community's interests may well be better served by a shorter sentence coupled with a disqualification.
In the Law Commission's second report, the Commission said it was satisfied of the need to try to achieve a balance between ensuring accountability and making the position of director so onerous that people with appropriate skills are dissuaded from retaining or taking up directorships.
The opinion of Dr Deane to the contrary notwithstanding, it is my view that a reasonable balance has been struck. I would be surprised if a person of appropriate knowledge, skill and experience, offered a directorship, would decline because of the directors' duties as now set out in the Act. Indeed, the contrary may be the case. Whereas previously there was no comprehensive source to which a director could turn to ascertain just what were the responsibilities of the office, now they are clearly set out in a way that is mostly, although not entirely, comprehensible. One does not have to be a lawyer to understand, at least in general terms, what those obligations now are, although, in the cases to which I have referred, it is unfortunate that a greater degree of precision has not been achieved. The duties are not so different from the obligations at common law - the difference now is that, in the form of a statutory set of directors' duties, they are much more accessible.
Nor do I consider that compliance with these enacted duties will stifle initiative and enterprise. The emphasis in the long title and elsewhere in the Act on the taking of risks and allowing directors a wide discretion in matters of business judgment, clearly signals an intention not to discourage the enterprising and innovative director - an intention to which the courts will have full regard.
[*] LLB (Auckland), QC, judge of the High Court of New Zealand, former Chancellor of the University of Waikato.
 NZLC, Company Law Reform and Restatement R9 (1989).
 Sealy, L S “Directors' Duties - Striking the Right Balance Between Accountability and Freedom of Action” (paper presented to the Ninth Commonwealth Law Conference, April 1990).
 Sealy, “Company Law: Directors and the Company they Keep”  New Zealand Law Journal 434.
 Supra note 1, at 29.
 Ibid, 27 and 28.
 See Burrows, J F Statute Law in New Zealand (1992) 134-135.
 Supra note 1, at 33.
 Ibid, 186.
 Supra note 3.
 NZLC, Company Law: Transition and Revision R16 (1990) xxii.
 See, eg, s 126 (meaning of “director”), s 130 (delegation of powers), s 131(2) (duty of directors), and s 144 (voting by interested directors).
 Galbraith, A “The 1993 Act . Balancing the rights of shareholders, directors, executive officers and creditors” (paper presented to the Company Law Conference, 1994).
 Ibid, 130.
 S 126(1)(b).
 This is similar to but is an expansion of the definition of director in s 2 of the 1955 Act.
 See, eg, In Re City Equitable Fire Insurance Company Ltd  1 Ch 407, 427.
 Fletcher v National Mutual Life Nominees Limited  3 NZLR 641, 661.
 Cf s 135, which refers expressly to “loss to the company’s creditors”.
 Lagunas Nitrate Co v Lagunas Syndicate  2 Ch 329, 435.
 Carlen v Drury (1812) 1 Ves and B 149, 158.
 In his paper to the Commonwealth Law Conference (supra note 2).
 Howard Smith Ltd v Ampol Petroleum Ltd  UKPC 3;  AC 821, 832.
 Supra note 10, xxiii.
  UKPC 3;  AC 821.
  2 Ch 506.
 At 515.
  1 Ch 77.
 At 84.
  1 Ch 254.
 At 267-8.
 (1972) 33 DLR (3d) 288.
 At 312.
 (1986) 59 OR (2d) 257.
 For a helpful comment on the position in Canada, see Welling, B L Corporate Law in Canada (2nd ed 1991) 336 et seq.
  UKPC 3;  AC 821.
 At 834.
 (1919) 15 Sc LR 625, 630-631.
 At 835.
 At 837.
 (1984) 2 NZCLC 99,122.
 At 99,129.
 See, eg, the report of E Milner Holland QC into the Savoy and Berkeley Hotels (HM Stationary office (1954)).
 S 174.
 Deane, R S “‘Besieged by Duties’. Will the new Companies Act work for Directors?” (paper presented to the New Zealand Law Society and the New Zealand Society of Accountants' Company Law Conference, 1994).
 See, eg, In Re City Equitable Fire Insurance Co Ltd  Ch 407, 428, recently affirmed by the Privy Council in Kuwait Asia Bank ER v National Mutual Life Nominees Ltd  3 NZLR 513, 533.
  3 NZLR 641, 661.
 S 232(4).
 See the Corporate Law Reform Act 1992, s 11.
 Supra note 44.
  2 Ch 100.
 At 110.
  1 Ch 407.
 At 429.
 Metal Manufacturers Pty Ltd v Lewis (1988) 13 NSWLR 315, 318-319.
 (1992) 10 ACLC 933.
 At 1015.
 S 130.
 S 138 (2).
 Ss 139 to 149 inclusive.
 S 139 (1).
 S 189(1)(c). But this obligation does not apply to a company, registered under the 1955 Act, that has not re-registered under the 1993 Act.
 S 140.
 S 144.
 See Regal (Hastings) Ltd v Gulliver  UKHL 1;  1 All ER 378.
 See Hely-Hutchinson v Brayhead Ltd  1 QB 549,  3 All ER 98.
 S 141(5).
 Supra note 1, at 532.
  4 All ER 161 applied in Westpac Banking Corporation v Savin  2 NZLR 41, 52.
  3 NZLR 700, 718 et seq.
 In Nimmo v Westpac Banking Corporation  3 NZLR 218, 228.
  2 Ch 421.
 Supra note 1, at 537.
 Ibid, 542.
  NZHC 5;  2 NZLR 225.
 S 4.
 Supra note 1, at 499.
 Hodder, J R, “Company Law I - Getting Started” (New Zealand Law Society Seminar, 1994) 56.
 Supra note 1, at 574.
 S 32.
 S 164.
 Ss 165, 166 and 167.
  EngR 478; (1843) 2 Hare 461.
 S 166.
 S 169.
 Ss 174 and 175.
 Supra note 1, at 573.
 Supra note 10, at xxii.