Case Update: Federal Court Decides on Extent of Directors’ Duties – Key Lessons for Directors

The Federal Court issued its grounds of judgment in the Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Berhad case. This is a significant decision explaining the scope of directors’ duties. It gives guidance on when a director acts in the best interest of the company and the discretion afforded to a director when the director makes a business judgment.

This case update will set out the brief background facts of the case and the legal principles that were decided by the Federal Court.  I also set out the key takeaways and points that directors should take note of.

Background Facts

The Plaintiff, Petra Perdana Berhad (Petra Perdana), was a public-listed investment holding company. In turn, Petra Perdana owned approximately 64% of the shares of the public-listed entity, Petra Energy Berhad (PEB).

The three Defendants were previously directors of Petra Perdana. The first Defendant was the Executive Chairman and CEO, while the second and third Defendants were non-executive directors.

The starting point of the dispute was a particular shareholders’ resolution of Petra Perdana. The shareholders had passed an ordinary resolution imposing certain restrictions on the directors for Petra Perdana to sell the PEB shares. Some of the restrictions were that any sale was for cash and with a maximum 10% discount. This general mandate imposed by the shareholders were renewed annually by the shareholders in general meetings.

Petra Perdana experienced cashflow problems. The Petra Perdana directors decided to sell a significant number of the PEB shares that the company owned. This was in order to quickly raise funds to alleviate the cashflow problems. The sale was carried out through two divestments of the PEB shares. The sale of these shares did not require any statutory approval of the shareholders as it was not a substantial portion of the company’s assets. However, this sale did not comply with the restrictions set out in the shareholders’ mandate.

Eventually, there was a shareholder dispute at Petra Perdana. This led to the Defendants being removed as directors of the company. With new management in place, Petra Perdana filed a suit against the now-removed directors.

At the end of the High Court trial, the Court dismissed Petra Perdana’s suit. The Court essentially found that the directors had not breached their duty to act in the best interest of the company.

The Court of Appeal reversed the findings of the High Court. In particular, the Court of Appeal focused on the mandate provided by the shareholders. It was decided that when the directors are to act in the best interest of the company, the shareholders’ resolution was the barometer to assess what is in the best interest of the company. In failing to comply with the restrictions in the shareholders’ resolution, the directors had failed to act in the best interest of the company.

Federal Court Findings on Directors’ Powers and Duties

There were certain key issues decided by the Federal Court.

(1) Shareholders’ Resolution Cannot Override the Management Powers of the Board

The first key issue related to the nature of the relationship between the shareholders in general meeting and the board of directors. The issue was whether the shareholders’ mandate could override or restrict the management powers of the directors to sell the PEB shares.

The Federal Court restored the conventional position that shareholders in general meeting cannot control the powers of management conferred by the articles of association on a board of directors. Shareholders can only do so by altering the articles to take away the powers of the board. Alternatively, if the opportunity arises, the shareholders can refuse to re-elect the directors whose actions they disapprove.

This legal position is further reinforced by section 131B of the Companies Act 1965 (now section 211 of the Companies Act 2016). Section 131B was inserted to emphasise that the “business and affairs of a company must be managed by, or under the direction of, the board of directors.” (emphasis added)

(2) The Test for Directors Acting in the “Best Interest of the Company”

The second key issue was on the test for breach of duty of a director to act in the best interest of the company. The Federal Court held that the test is a combination of both a subjective and objective test. The first element being the subjective test is to assess the state of mind of the director. Whether the director, and not the court, considered the exercise of discretion is in the best interest of the company. Nonetheless, the second element is the objective test. The court will assess whether an intelligent and honest man in the position of the director could have reasonably believed that the transactions were for the benefit of the company.

(3) Directors Exercising Their Business Judgment

The third key issue related to the statutory business judgment rule. This was contained in section 132(1B) of the Companies Act 1965 (and now section 214 of the Companies Act 2016). The business judgment rule provides additional protection for a director. This rule will presume that a director acted with due care and skill if certain pre-conditions are fulfilled.

It was held that the court would not second guess the merits of a commercial or business judgment made by directors. The court would not interfere with business decisions as long as the directors acted bona fide.

Other Takeaways: Possible Lessons for Directors

Aside from the clarification on the law, the Petra Perdana case also highlighted some useful practical examples. These examples flesh out how directors can adopt practices to demonstrate that they are complying with their duties. I draw on the instances highlighted at the High Court trial and at the Federal Court.

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(1) The Minutes of the Board Meeting: Strength of Contemporaneous Documents

The Federal Court noted the “compelling evidence” of all the contemporaneous documents, in particular, the board meeting minutes. These minutes showed how all members of the board had collectively and unanimously decided on the sale of the PEB shares.

As the High Court trial judge pointed out, when assessing the directors’ purpose or rationale in making a decision, the court will consider the full chronology of events.

The court found the most useful available and objective evidence would be the board meeting minutes during that period. The minutes provide an accurate and contemporaneous record of the state of mind of the directors, the rationale for their decisions and their acts and omissions. It also offers an insight into the running and management of the plaintiff including the part played by senior management personnel.

Hence, in my view, it is good practice for board meeting minutes to capture in greater detail what was discussed by the directors and the rationale for the decision. This is in contrast with merely having skeletal minutes noting that a decision was made.

(2) Tape Recording of a Contentious Meeting

In this dispute, there was one particular crucial board meeting. This was a board meeting where the directors agreed to make the second significant divestment of the PEB shares. At the insistence of one of the directors, audio recordings had been made of the board meetings.

The High Court trial judge listened to the more than 2-hour long audio recording of this particular board meeting. The judge found it very crucial and useful to have this audio recording. This is especially where the recording contradicted the evidence subsequently put forward by one of the other directors.

Having audio recordings and retaining such recordings are usually not common company practice. But from my experience, where there is the possibility of disputes among the directors, or the among shareholders, such audio recordings of important board meetings or shareholders’ meetings can be crucial. This is especially where there are disputes on the accuracy of subsequent minutes of that meeting.

(3) Company Management’s Advice to the Directors

The High Court trial judge also noted the consistent role played by the company’s senior management in briefing and providing information to the directors. In particular, the company’s de facto financial controller was present at many of the board meetings and audit committee meetings. The financial controller presented the information on the tight cashflow of the company.

The High Court trial judge accepted the evidence of one of the directors that he relied entirely on the data and information provided by the company’s management. He had no reason to doubt the accuracy of the information provided to the board. He would have verified matters personally only if he doubted the information presented by the management.

(4) External Advice to the Directors

The High Court and the Federal Court gave weight to the fact that the directors had made an independent assessment of the professional external advice they had obtained. The directors had obtained the following: a legal opinion, professional advice from Affin Investment Bank  on the methods to raise funds to alleviate the company’s financial difficulties, and professional advice from TA Securities Holdings Bhd.

The directors were advised by these professional advisers and were entitled to rely on their advice.

(5) Executive Directors vs Non-Executive Directors

This was a specific issue that the Federal Court declined to answer. This was in light of its decision made in the other issues of law. The issue was whether executive directors and non-executive directors should be treated differently when assessing the extent of their duties.

This issue arose due to a particular finding that the High Court made. The High Court assessed the role played by the two non-executive directors. The High Court found that these two non-executive directors were entitled to rely on financial data and financial information provided by the company’s management. Their knowledge would be less complete or coherent than the executive director. The non-executive directors cannot be expected to have a full working knowledge of the day-to-day operations and finances of the company.

We will have to wait for future Malaysian cases to further clarify whether executive directors and non-executive directors will be measured against a different yardstick.

(6) Companies Act 2016: Shareholders’ Power of Management Review

The Petra Perdana decision was decided under the Companies Act 1965. The division of powers between the shareholders and directors will now be further examined under the Companies Act 2016.

Section 195(2) of the Companies Act 2016 allows shareholders in a general meeting to make non-binding recommendations to the directors on management matters. Section 195(3)(b) goes further to state that if the shareholders pass a special resolution and it is in the best interest of the company, such a recommendation would be binding on the directors. This decision has provided guidance on how to assess “the best interest of the company” and it will be interesting to see how section 195 will be applied in the future.

 

3 thoughts on “Case Update: Federal Court Decides on Extent of Directors’ Duties – Key Lessons for Directors

  1. GK Ganesan January 5, 2018 / 12:25 pm

    Good work Lee Shih. Enjoyed that!

  2. Loh Yeow Boo January 6, 2018 / 11:48 am

    Very informative.

  3. Caroline Darlington January 16, 2018 / 12:44 pm

    Very informative and clear explanation. well done!

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