A company being an artificial person cannot manage its own affairs and that the articles of association of every registered company have provisions regarding the delegation of powers pertaining to the company’s management. Since companies do not have a physical existence, no soul nor a body of its own, it cannot act by itself, but rather through human beings who act as agents, that is, directors.
Table A, Article 80 provides that “the business of the company shall be managed by the directors”.
DIRECTORS“The directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act through agents and it is of course the duty of those agents so to act best to promote the interest of the corporation whose affairs they are conducting”.
Directors are said to be the brain of the company and occupies a pivotal position in the structure of the company, and since the directors are the brains of the company; it is only when the brain functions that the corporation is said to function.
Board of Directors is given the powers to manage and run the company. Cap. 486 together with the articles bestows powers to directors to manage. Members have no right to interfere with such management; infact if members interfere; the directors have a right to bring an action against the members to restrain them.
The directors have an express right to manage the company, but if the management want to interfere with the Board, then they have to convene an extra ordinary general meeting and alter the constitution of the company to allow them interfere.
“If you want to interfere in the management of the company's affairs, convene a general meeting and alter the company’s constitution by passing a resolution obliging the directors to act the way you want”.
Case Law: Automatic Sef Syndicate Ltd vs. Cunningham (1906)
By its articles of association, the general management and control of the company was vested in the directors, subject to regulations as might from time to time be made by extra ordinary resolutions. In particular, the articles of association conferred on the directors the power to sell or otherwise deal with any property of the company on such terms as they may consider fit. The members at a general meeting passed an ordinary resolution forcing the directors to sell certain property of the company on certain terms. The directors refused to the effect that it was directive and therefore declined to sell.
It was held that the company’s constitution conferred upon directors the general powers to manage the company, and in particular to decide when to sell the property of the company and on what terms.
Notwithstanding the fact that powers to manage the company have been given to the directors, the members have a right to intervene and take away such management: -
(a) Where the directors are improperly using the name of the co. in litigation.
(b) If the B.O.D. itself cannot function due to one reason or another the members may intervene.
There were two members who were also directors of the company. A conflict arose which rendered them impossible to even communicate face to face and the only communication was by way of memos. One member went to court petitioning for winding up under the clause “just and equitable”. The court agreed with the application, but it was observed that:-
“If it had been possible to have separate members from these two, the court have ordered that they take up the management until a new team comes in”.
In another instance, (Foster vs. Foster), there was a disagreement and as a result there was a deadlock in voting. The court said that under those circumstances where the directors are unable to exercise powers conferred upon them by the company’s articles, the company/members in a general meeting would take over the management and appoint a new team.
(c) Where the directors have acted ultra vires the powers granted to them or the company itself: - The management can ratify that which the directors did in excess of their powers. For example, if the articles might have conferred upon them some powers but they have exceeded the powers; in that eventuality, the management can take away those powers.
Secondly, the company did not have the kind of powers the directors exercised, and therefore did not give them powers. In this case the members can intervene and remove those directors.
Meaning of a Director
Under Section 2 of the Act, “A director, includes any person occupying the position of director by whatever name called”.
“A director may be identified by the functions the person performs even though he may be named differently, for example, Jaduong, Munene and so on.
A director may therefore be defined as, “a person having control over the direction, conduct, management or superintendence of the affairs of a company”.
What is the position of a person occupying the position of a director but is not duly appointed, is he still a director?
A person, who acts as a director performs the functions of a director although not duly appointed and occupies the position of a director, is a director. This is supported by the phrase “by whatever name called”. This does not limit the meaning. Infact it extends its meaning to include a person who performs the functions as a director though called by another name.
Section 181 also supports the above case in that if a person is not validly appointed as a director, but acts as one and the appointment is later on discovered to be defective, anything that he has done is valid notwithstanding an irregularity in appointment of such a person.
APPOINTMENT OF DIRECTORS
Section 177 provides that every company shall have at lest two directors while every private companies and every other company registered before 1962 shall have at least one director.
Under Table A, Article 75, the actual number of the directors would initially be decided upon by the subscribers of the memorandum (promoters) and until so determined, all of them shall be the first directors.
Table A, Article 94 empowers the company from time to time by ordinary resolution to increase or reduce the number of its directors.
The following are the various stages of appointment of directors:-
(a) The first directors of the company.
(b) Subsequent appointment of directors.
(c) Appointment to fill a vacancy.
(d) Appointment of alternate director.
(e) Appointment of Managing Director.
(a) First Directors
Article 75 provides that the names of the first directors shall be decided in writing by the subscribers of the memorandum of association or a majority of them.
They are usually appointed by promoters of company and normally their names are indicated in the articles of association.
If promoters do not appoint the first director, then the tradition has been to follow the provision in the Articles 75 of Table A, that is, people who subscribe to the memorandum of association will become and be regarded as the first directors, until proper appointment is done. They shall hold office until the directors are appointed at Annual General Meeting.
The articles may also provide that both the number and the names of the first directors shall be determined in writing by the subscribers to memorandum.
(b) Subsequent Directors
The subsequent directors are appointed by the members in general meeting beginning from the first annual general meeting at which all the first directors retire from office and the members are given the first opportunity to elect directors of their own choice. The retiring directors are however eligible for election under Article 91.
At the second annual general meeting, one third of the directors are to retire from office, the ones to retire being the ones who have been longest in office since their last election.
As between persons who became directors on the same day, those to retire shall be agreed upon amongst themselves otherwise it shall be determined by lot. One third of the board shall thereafter retire by rotation annually.
(c) Casual Appointment/vacancy
Articles 95 permits the aboard of directors to fill a vacancy in the board or to get an additional director to join the board for practical reasons provided that the appointment does not cause the number of directors to exceed the limit imposed by the articles. The person appointed this way will hold office until the next annual general meeting. He will then be eligible for re-election, but his appointment will not be taken into account when deciding on the directors who shall retire from office.
(d) Alternate Directors
An alternate director is one appointed by another director to temporarily represent him during his absence or inability in the Board of Directors. This power can be exercised only if it is permitted in the articles of association. The common law rule “delegatus non potest delegare”, states that a director has no authority to appoint an alternate director.
However where the article of association is silent about the appointment of alternate director, a director can still appoint an alternate director.
When a director appoints an alternate director, he may indicate the powers which such an alternate director may exercise on his behalf and those which he may not, for example, he may participate in Board meetings and sign documents but not more than that.
He cannot hold office for a period longer than that permissible to the original director in whose place he has been appointed.
The alternate director may be another director or an outsider. If he is a director, he would have the vote of the absentee in addition to his own vote.
(e) The Managing Director
A Managing Director is part of the subsequent directors. It is governed by company practice because it is always a company’s affair. The Act itself does not contain direct provisions on the appointment of a Managing Director. It is found in the articles of association, not the Act.
A Managing Director who by virtue of agreement with the company, or of a resolution passed by the company in a general meeting, or by virtue of its memorandum or articles, is entrusted with substantial powers of management.
A director so appointed shall not whilst holding that office be subject to retirement by rotation but his appointment shall be automatically terminated if he ceases due to any cause, to be a director.
A Managing Director like any director can be removed at any time from office by a general meeting irrespective of the fact that this duration of his appointment is not yet over. But where his services have been terminated in breach of his terms, he is entitled to claim compensation.
Managing Director receives compensation as may be determine by directors.
RESTRICTION ON APPOINTMENT
There are various restrictions which the Act imposes on appointment of directors and these restrictions must be fulfilled for one to be appointed as director.
(1) Appointment by Articles
Section 182(1) states that a person shall not be capable of being appointed director of a company by the articles unless, before registration of the articles, he has signed and delivered to the registrar for registration a consent in wanting to act as a director and either: -
(a) signed the memorandum for a number of shares not less than his qualification shares, or
(b) taken from the company and paid or agreed to pay for his qualification shares
(c) Signed and delivered to the registrar for the registration, an undertaking in writing to take from the company and pay for his qualification shares.
These provisions do not apply to: -
(a) A company without share capital.
(b) A private company.
(c) A company which was a private company before becoming a public company.
(2) Qualification Shares
Under Section 183 (1), it shall be the duty of every director who is by the articles of the company required to hold a specified share qualification and who is not qualified to obtain his qualification within 2 months after his appointment or within the shorter time as fixed by the articles.
Section 183(3) provides that the director shall vacate office if he fails to obtain his share qualification or ceases to hold the required number of shares
Case: R vs. Camps (1962) Court of Appeal for E.A.
The respondent, in his capacity as a director of a company, had been charged with several offences under the companies Act. Although the directors of the company had under article 96 of the company’s articles of association duly appointed him to be the director and he had acted as such, he never acquired the required share qualification but in a statutory return, subsequent to his appointment, he was shown as a director which was fixed at one fully paid up share in his own right.
Article 87 which agrees with the terms of section 183(1) of the Act provided that the office of the director shall be vacated if a director ceased to hold the number of shares required to qualify him for office or fails to acquire the same within 2 months after his appointment.
The court held that as the respondent had never possessed or acquired his qualifying share, his appointment was invalid and that there were no cases for him to answer.
It was also held that the respondent was never even a de facto director and that in any event a de facto director was not criminally liable as a director under the Company’s Act.
Against that decision, the Attorney General appealed to the High Court and the case was dismissed but on further appeal, the High Court held that: -
(i) The word “director” in the Company’s Act includes a de facto director.
(ii) The respondent was duly and validly appointed a de jure director but he ceased to be a de jure director two months later as he failed to acquire his share qualification within that time.
(iii) If the respondent acted as a director after the expiration of two months from his appointment, he was then a de facto director and he was a director for the purpose of those sections of the Company’s Act which it was alleged he had contravened.
“Appeal allowed, acquittal set aside”.
Therefore if a director does not vacate office but continues to act as a director, he ceases to be a de jure director and becomes a de facto director. Under Section 183(4), a de facto director is incapable of being reappointed director of the company until he has obtained his qualification shares and under Section 183(5), he is liable to a fine not exceeding one hundred shilling for everyday that he acts as a director of the company.
(3) Age Limit
Section 186 provides that no person shall be capable of being appointed a director if at the time of his appointment: -
(a) He has not attained the age of 21.
(b) He has attained the age of 70.
This provision does not apply if the company’s articles provide otherwise or a special notice of the resolution was given to the company.
Section 142 defines “special notice” as a notice given to the company not less than 28 days before the meeting at which the relevant resolutions are to be moved.
(4) Undischarged Bankrupts
Section 188 provides that if a person who has been declared bankrupt or insolvent by a competent court and who has not received his discharge, acts as a director of any company, shall be liable to imprisonment for a term not exceeding 2 years or to a fine not exceeding Sh. 10,000 or both.
(5) Fraudulent Persons
Section 189(1) empowers the court to make an order restraining a person from being appointed, or act as a company’s director for a period not exceeding 5 years if: -
(a) The person is convicted of any offence in connection with the promotion, formation or management of the company, or
(b) in course of winding up, it appears that the person had been guilty of fraudulent trading.
(6) Individual Voting
Section 184(1) provides that the appointment of directors of a company which is not a private company is to be voted on individually, unless a motion for the appointment of the two or more persons as directors by a single resolution was agreed upon by the meeting without any vote against it.
A resolution moved in contravention of this provision is void under Section 184(2) even if no objection is moved. The aim of this provision is to prevent a company’s members being virtually forced to vote for directors who they do not want.
QUALIFICATIONS OF A DIRECTOR
There is no requirement in the Act that a director must hold shares, but more frequently, the articles provides that no person shall act as a director unless he holds certain number of shares or stock.
If the articles of association contain a provision that the qualification of a director shall be holding a specified number of shares, then Section 183 provides that:-
(i) Each director must acquire and retain such qualification shares within two months after his appointment or such a shorter time as may be fixed by Articles.
(ii) The warrant payable to bearer will not count for the purpose of qualification shares.
(iii) If he fails to acquire qualification shares within 2 months he automatically ceases to be a director.
(iv) He cannot be reappointed director unless he has obtained his qualification shares.
(v) If he acts as a director after expiry of 2 months without taking qualification shares, he is liable to a fine up to Sh. 100 for everyday until he stops acting.
Every director is required to retire from office shortly after 70 years and no one should be reappointed after that age-but this does not apply where the appointment is made or approved in Annual General Meeting after a special notice has been given.
It does not apply to private companies unless they are subsidiaries of public company. The act also fixes the minimum age and states that no person is capable of being appointed as a director if at the time of his appointment, he has not reached or attained the age of 21.
Bankruptcy also disqualifies any person from holding office as a director.
Effects of Disqualification
Whether a director holds qualification shares or not, the company will be bound to third parties for the acts of such directors until the effect in appointment or qualification is disclosed.
POSITION OF DIRECTORS
(a) Directors as agents
The directors are elected representatives of shareholders. They are in the eyes of law agents of the company and the general principles of agency regulate in most cases, the relationship between the company and its directors.
The directors are more than agents- they have in certain matters, independent powers. They are not bound to consult shareholders in all maters. Power vested with directors, they and they alone can exercise these powers.
(b) Directors are not personally liable as agents
Where the directors of a company act on its behalf, they are personally liable for contracts which they make provided they act within the scope of their authority and they do not make contracts in their personal names.
It was held that “whenever an agent is liable, directors would be liable, where the principal would be liable; the liability is the liability of the company”.
The directors are personally liable when:-
(i) The contract is in their names
(ii) They use the company name incorrectly e.g. by omitting the words Ltd & Plv. Ltd.
(iii) The contract is signed in such a way that it is not clear whether it is the agent or principal who signed it.
(iv) They exceed the powers given to them by memorandum and articles of association.
(c) Directors as Employees
Although directors are agents of the company, they are not employees or servants of the company for being entitled to privileges and benefits which are granted under the company’s Act to employees but there is nothing to prevent a director from being a servant of the company under a special contract of service, which he may enter into with the company.
Palmer’s statement gives an insight into this matter. He states that, “Directors are not as such employees of the company or employed by the company nor they are servants of the company or members of its staff. A director can, however hold salaried employment or an office in addition to that of his directorship which may for this purpose make him an employee or servant and in such a case, he would enjoy any right given to employees as such but his directorship and his rights through that directorship are quite separate from his rights as employee”.
(d) Directors as Trustees
Directors are treated as trustees of the company’s property and money and of the powers entrusted to them.
Directors are the trustees of the company’s money and property in the sense that they must account for all the company’s money and property to refund to the company any of its money or property which have been impropriety paid, that is, not to pay dividends out of capital. Company property includes confidential information and beneficial contracts meant for the company.
The following points in regard to confidential information are worth noting:-
(i) The information itself must be confidential- nothing public.
(ii) The information must have been communicated to the directors or it has reached them in circumstances obliging them to treat it as confidential.
(iii) The directors must have made an unauthorized use of that information, for example, converting it to their own use.
The court went a length to explain and define the scope of directors’ duties with emphasis on the protection of company’s property:-
(i) A director as a fiduciary is under an obligation not to profit himself personally from the property of the company. More so in a situation where his interest is likely to conflict with those of the company to which he is appointed a director.
(ii) Directors as fiduciaries, if they use the property of the company thereby making profits, must be honest enough to account for this profit to the company.
“Men who assume the complete control of the company’s business must remember that they are bound to protect the property of the company. They are not at liberty to sacrifice the interests which they are bound to protect, and while ostensibly acting for the company, divert in their own favor business which should properly belong to the company they represent”.
Incase director s are guilty of a distinct breach of duty of which they took to secure the contract which was meant for the company, whatever benefit they must have obtained must be regarded as being held by them on behalf of the company.
Directors are however not trustees in the real sense of the word because they are not vested with the ownership of the company’s property. It is only as regards some of their obligations to the company and certain powers that they are regarded as trustees of the company.
The directors are really only quasi trustees because:
(i) They are not vested with the ownership of the company’s property.
(ii) Their functions are not the same as those of trustees.
(iii) Their duties of care are not as onerous as those of trustees.
True position of directors according to Jessel, M.R. in Forest of Dean Coal Mining Company, observed that, “Directors have sometimes been called as trustees or commercial trustees and sometimes they have been called managing partners, it does not matters much what you call them so long as you understand what their real position is, which is that they are really commercial men managing a trading concern for the benefits of themselves and of all the shareholders. They stand in a fiduciary position towards the company in respect of their powers and capital under their control”.
For technical reasons the directors are not regarded as employees of the company of which they are directors. They therefore have no right to be paid their services unless there is a provision for payment in the articles.
Table A, Article 76 provides that “remuneration of the directors shall from time to time be determined by the company in general meeting”.
Provided the resolution has been passed, the remuneration is payable whether profits are earned or not.
The remuneration payable to the directors of a company is determined by the articles of the company or by a resolution passed by the company in general meeting.
The directors have no right to be paid for their services and cannot pay themselves or each other or make presents to themselves out of the company’s assets unless authorized to do so by the instrument in writing, for example, articles or by shareholders at a properly convened meeting.
If directors are not entitled to remuneration and they pay themselves remuneration out of company’s funds, they may be compelled to restore it even though they acted in good faith and honestly believe that the payment was permissible.
Directors may be paid traveling, hotel and other expenses properly incurred by them in attending company’s business. In the absence of such a provision, a salaried director is not entitled to expenses incurred by him as they are usually covered by his remuneration.
The remuneration payable to director is a debt from the company, and a director may sue the company for non-payment.
Incase of absence or inadequacy of profits, it can be paid out of profits with approval of the company.
Powers of Directors
The powers of directors are usually set out in the articles, and quite frequently there is a clause entrusting the management of the company’s affairs in the hands of directors and possess the following powers which enables them to carry out their functions:-
(a) To enter into contracts on behalf of the company.
(b) To engage or dismiss employees.
The directors’ powers may be restricted by the articles, for instance, some certain acts shall not be done by them unless they first obtain the sanction of the company in general meeting.
Where such provisions exist in the articles, failure to obtain the sanction may render the company not bound by the acts and the directors then become personally liable to the third parties.
If a director has an interest in any contract which is being considered by the company he must usually declare his interest when the contract is being discussed.
A director is said to have declared his interest not when he states that he has an interest but when he states what his interests are.
The disclosure should be made at the time the contract in question comes before the Board of Directors for discussion.
Disclosure is only valid if it is made to sufficient number of directors who are themselves not interested in the contract. In a case of three directors, if two are interested and declare to one who is not, it is invalid. This is because the directors who are interested are incapable of voting in the issue and since they are a majority, there is no quorum to which the disclosure is made. Quorum in this case means sufficient number of directors who are not interested in the contract.
Legal effect for directors for non-disclosure of interest
The consequences are two fold:-
(i) Statutory consequences.
(ii) Common Law consequences.
At common law, the contract itself becomes avoidable at the option of the company, that is, the company can decide to continue with the contract or not or repudiate. If the director in question has made secret profits on that contract, he must refund the same to the company.
In statutory consequences under Section 200(4), such directors shall be liable to a fine not exceeding Sh. 2,000.
A company may appoint one or some of its employees to its board of directors. Such appointment is primarily intended to provide employees with a forum where they can express their views on the company’s operations, programmes or policies. Employees who are appointed are usually called “associate directors”.
Although the statutory restrictions on appointment of directors tend to suggest that only a natural person can be appointed as director, in practice it is not so. Holding companies appoint themselves directors of subsidiary companies with a view to securing and maintaining complete control of the subsidiaries. This has been made possible by the fact that there is no provision in the Act which prohibits the practice.
The body corporate would appoint a natural person whom it has formally authorized to attend board meetings on its behalf.
DISQUALIFICATION OF DIRECTORS
Table A, Article 88 provides that the office of director shall be vacated if the director: -
(i) He has ceased to be a director by virtue of Section 183, that is, he has failed to take-up prescribed shares within two months of his appointment or under Section 186 which lays down the minimum and the max age for directors.
(ii) He becomes bankrupt.
(iii) He becomes prohibited from being a director by reason of any order made
under Section 189 (restraining fraudulent persons from managing a company).
(iv) He becomes of unsound mind
(v) He resigns his office by notice in writing to the company.
(vi) He is absent without permission for more than 6 months from meetings of directors held during that period.
Regarding resignation, it was held in Premier Cinema Co. vs. Ennion that a verbal notice of resignation which is given to and is acceptable by the general meeting is effective and cannot be withdrawn. This is because the general meeting would be deemed to have amended the company’s articles by deleting the words “in writing”. But if an oral notice of resignation is given to and accepted by the board of directors, it would be invalid since the directors cannot legally alter the company’s articles of association.
Regarding absence from board meetings, it should be noted that it does not say that the director in question shall vacate office if he “absents himself”. Such would disqualify the director if the absence in question was voluntary. The office would be termed vacated if the director has not been in office even if on medical grounds as per McConnell’s claim.
A person may also cease to be a director for other reasons as follows: -
(ii) Retirement by rotation under articles.
(iii) Dissolution of the company.
VACATION/REMOVAL OF DIRECTOR
A director may leave office either by vacation or by removal.
This is the voluntary quitting by a director. It can happen any time during the directors tenure of office for any reason such as ill health, age, agreement with the Board of Directors, bankruptcy, ceases to hold qualification shares, of unsound mind, is convicted by the court of an offence involving moral turpitude absents himself from meetings, restrained by the court from being a director and so on.
(b) Removal of Directors
Removal means being forced to quit the position of a director. A director can be removed by:-
(i) Operation of law
(ii) Company itself
If a director is in breach of his statutory qualification, the consequence is that the law operates immediately to remove him. Secondly, when the company goes into liquidation, the directors ceases to hold office.
Section 185(1) provides that a company may by ordinary resolution remove a director before expiration of his period of office, not withstanding anything in the articles or in any agreement between him and the company. A company may remove a director by ordinary resolution after giving a notice.
It is vital to note that Section 185 requires that the company observe the rules of natural justice which insists that a man shall not be condemned unheard. The company must send a copy to the director concerned who is entitled to speak in his defence.
A removed director may claim compensation for the loss of office.
Compensation for Removal
Section 185(6) provides that nothing in the section shall be taken as depriving a removed director of compensation or damages payable to him in respect of termination of his appointment as a director.
This provision would enable a managing director to sue the company for damages for wrongful dismissal if the effect of his removal as a director was to prematurely terminate his appointment and was inconsistent with the contract.
COMPENSATION FOR LOSS OF OFFICE
(a) Section 192(1) makes it unlawful for a company to make to a director any payment by way of compensation for loss of office, or consideration for or in connection with his retirement unless the particulars of the proposed payment are disclosed to the members and approved by the company in a general meeting. This is necessary because the directors when negotiating the terms of the proposed settlement would be dealing with one of their own and might as a consequence give inadequate consideration to the interests of the company.
(b) Section 193 provides that it shall not be lawful to transfer any part of the undertaking or property for the purpose of making any payment to a director by way of compensation for loss of office or on retirement unless particulars are disclosed to the members of the company and approved by the company in a general meeting.
(c) If a payment is made to a director as compensation for loss of office or on his retirement, he must take reasonable steps to ensure that the particulars of the proposed payment are included in or sent with any notice of the offer given to the share holders. If this is not done, the director holds the payment on trust for the persons who have sold their shares as a result of the offer.
(d) Section 194 imposes a duty on directors to disclose payments for loss of office, made in connection with transfer of shares in a company. This section provides that such payment should be proposed with a transfer as a result of:-
(i) An offer made to the general body of shareholders.
(ii) An offer made by or on behalf of some other body corporate with a view to the company becoming its subsidiary or a subsidiary of its holding company.
(iii)An offer made by or on behalf of an individual with a view to his obtaining the right to exercise or control of not less than 1/3rd of the voting powers at the general meeting.
Loans to Directors
Section 191(1) renders unlawful any loan made by a company to a director. It is also unlawful for the company to guarantee or secure a loan given to a director by any other person. These restrictions do not apply to:-
(i) A private company, or
(ii) A subsidiary company whose director is its holding company or
(i) Payments made to a director to meet expenses incurred or to be incurred for the purpose of the company, or to enable him to perform his duties, or
(ii) A loan by a money lending company of a bank in ordinary course of business.
Loans to them must be disclosed in the account laid before the general meeting.
DUTIES OF DIRECTORS
The duties of director are usually considered under two broad categories, namely: -
(i) Duties of care, skills and diligence.
(ii) Fiduciary duties.
(1) Duty of Care, Skill and Diligence
Directors should carry out their duties with reasonable care and exercise such degree of skill and diligence as is reasonably expected of persons of their knowledge and status. The directors are not liable for mere errors of judgment.
Case Law: Brazilian Rubber Plantation Estates Ltd (1911)
In this case, the directors of the company decided that the company should invest in some rubber estates in Brazil. They accordingly issued a prospectus inviting members of the public to come forward and subscribe for the shares and debentures of the company, the purpose of invitation being to raise money from the subscription in order to finance the rubber estate project.
In the prospectus they declared to the prospective investors that the project in question for which subscription were being invited was viable or had potential success. Soon after subscription the project turned out to be a failure and the company was wound up.
The subscribers brought an action against the directors for inserting a misleading/false statement in the prospectus upon which they had relied or acted upon to their detriment. In their defense, the directors claimed that they had acted in good faith.
It was held that the directors were not liable because they had made an error of judgment about viability of the project and in making the judgment, they had applied the care and skill that men of experience were expected to apply.
Where a director makes an error of judgment, he will be absolved from any liability so long as the judgment he made or decision he took and considering all surrounding circumstances came from past experiences and knowledge which he had; but if a director fails to exercise due care expected of him in the exercise of his duties, he is guilty of negligence.
Standard of Care
The standard of care, skill and diligence depends upon the nature of the company’s business and the circumstances of the case.
The standard of care depends upon:-
(i) The type and nature of work.
(ii) Division of powers between directors and other officers.
(iii) General usages and customs in that type of business.
(iv) Whether directors work gratuitously or remuneratively.
Case Law: City Equitable Fire Insurance Co. Ltd
The directors of insurance company left the management of the company’s affairs almost entirely in the hands of B, the managing director. Owing to B’s fraud, a large amount of company’s assets disappeared. B and the firm in which he was a partner had taken a huge loan from the company and the cash at the bank or in hand included £7,300 in the hands of the company’s stockbrokers, in which B was a partner. The directors never inquired as to how these items were made up.
It was held that the directors were negligent, though the articles protected them from liability.
Romer therefore observed that “in ascertaining the duties of a director, it is necessary to consider the nature of the company’s business and the manner in which the work of the company carried out amongst the directors and other company officials”.
In Dovey vs. Cory, a director was held not liable for negligence merely because he had failed to verify false information regarding the company’s accounts which he had been given by the company’s manager and managing director.
The court stated, “The business cannot be carried on upon principles of mistrust. Men in responsible positions must be trusted by those above them, as well as by those below them until there is reason to distrust them. We agree that care and prudence do not involve distrust”.
(2) Fiduciary Duties
As fiduciaries, the directors must: -
(a) Exercise their powers honestly and bonafide for the benefit of the company as a whole. But if for example the power to issue further shares is exercised by the directors, not for the benefit of the company but simply and solely for their personal aggrandizement and to the detrimental of the company, the court will interfere and prevent the directors from doing so.
(ii) Not to place themselves in a position in which there is a conflict between their duties to the company and their personal interests. They must not make any secret profit out of their position and if they do, they have to account for it to the company.
Case Law: Cook vs. Deek (1916)
Three directors of a company obtained a contract in their own names, under the circumstances which made it breach of trust by them, and constituted themselves trustees of the contract of the company. By their votes as holders of ¾th of the shares, they induced the company to pass a resolution declaring that it had no interest in the contract.
It was held the directors were liable to account to the company for the profit they made on the contract as in equity, it belonged to the company.
Case Law: Regal Hastings Ltd vs. Guilliver (1942)
R. Co. Ltd owned one cinema and wanted to buy two others with a view to selling the three together. It formed a subsidiary company to buy the two cinemas. It was however unable to provide the necessary finances. As such, its directors themselves subscribed for some of the shares in the subsidiary company. The cinemas were acquired and the shares in R Co. Ltd and the subsidiary sold at a profit.
It was held that the directors must account to R. Co. Ltd for the profit they made because it was through the knowledge and opportunity they gained as directors of R.Co. Ltd, that they were able to obtain the shares.
Case Law: Burland vs. Earle (1902)
Burland, a director of a company, bought a property for £21,564 at a public auction. He subsequently sold it to the company for £60,000. The shareholders brought an action against Burland for restoring the profit made by him out of resale of the property to the company.
It was held that Burland was not liable to pay to the company the profit made by him because there was no evidence whatsoever of any mandate to Burland to purchase on behalf of the company, or that he was in any sense a trustee for the company of the purchased property.
But where a director is under mandate to purchase some property for the company, he is in a sense a trustee for the company of the purchased property. If he purchases the property in his own name and then sells it to the company at a higher price thus making a profit, he is liable to account to the company the profit earned.
(3) Duty of Disclosure
Except with the consent of Board of Directors, a director or his relative or any firm in which he is a member or a director, shall not enter into any contract with the company for the sale, purchase or supply of goods. Even in case of urgent necessity contracts, consent must be obtained. It is the duty of the director to disclose to the Board the nature of his interest in any contract or arrangement entered into
(4) Duty to act honestly
A director must not act in manner trying to make personal gain out of a transaction in the name of the company.
(5) Meetings of the Board
A director is not bound to attend all meetings, but he should obviously attend as many as possible.
(6) Delegation of Authority
A director has duty not to delegate his functions except to the extent authorized by the act or the constitution of the company.
Can a director be liable for the mistakes of his colleagues?
A director absented himself from Board meetings for 20 years and during this period, his colleagues paid dividends out of capital. The shareholders brought an action against this particular director arguing that by absenting himself, he was acting negligently because had he been attending the meetings, he would have discovered that dividends were being paid out of capital.
It was held that this director was not negligent in absenting himself unless there were circumstances warranting non-abstention.
Exceptions to this Rule
Whether a director must attend a Board meeting or not is a question of fact. His compulsory attendance depends on the exigencies of the company’s life. If he is a member of committee of the Board, he must attend or is reasonable expected to attend meetings of that committee to deliberate on issues at hand because by being placed in that committee, his input is considered important.
If a director is so expected to attend but he fails, then such a director is negligent.
Can a director be allowed to delegate?
The directors are bound by the principle “delegates no potest delegata”, that is, a delegate cannot sub-delegate- even then, the exigencies of business allow a director at times to delegate his duties, though he cannot delegate all his duties.
However, at times a director can rely on other officers in the company to perform those duties. He shall not be held negligent in such cases once he is satisfied that the various officers of the company are manning those duties property, and he shall not be held liable for negligence in such cases.
Insider dealing is understood to cover situations where a person buys or sells securities when he is in possession of confidential information which affects the value of those securities. Furthermore the confidential information in question will generally be in his possession because of some connection which he has with the company whose securities are to be dealt in. He may be a director or a professional advisor.
Section 33 of Capital Markets Authority Act (Cap 485 A) prohibits insider dealing. The objective of this prohibition is to promote and facilitate the development of an orderly, fair and efficient capital market in Kenya.
The section imposes criminal penalties and gives statutory right to an aggrieved shareholder to claim compensation if he suffers loss from the transaction, under Section 34(3). If the person guilty under Section 33 profited from the offence, but those harmed cannot practically determine the compensation payable, it shall be made to Investor Compensation Fund established under Section 18(1) of the Act.
Section 33(9) provides that a person is connected with a company if he occupies a position that may reasonable be expected to give him access to “price sensitive information” by virtue of:-
(i) Any professional or business relationship existing between himself and that body corporate, or
(ii) His being an officer or a substantial shareholder in that body corporate, or in a related body corporate.
Section 33(5) prohibits “a connected person” from communicating that information to any other person whom he knows or has reason to believe, will make use of the said information to deal in listed securities.
The object of Section 33(5) is to prevent a connected person from “tipping” another person with the intention that the person “tipped” shall deal or cause another person to deal in the relevant securities.
Section 33(12) provides that any person in contravention of Section 33 shall be guilty of an offence and shall be liable to a fine not exceeding Sh. 500,000 or Sh. 1,500,000 for a body corporate. These fines are to be doubled on any subsequent conviction.
LIABILITY OF DIRECTORS
Directors are not personally liable to outsiders if they act within the scope and powers vested in them. The general rule is that wherever an agent is liable, those directors would be liable, but where liability would attach to the principal only, the liability is the liability of the company.