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[2013] SPECJU 2
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Muswaka, L --- "Shielding Directors against Liability Imputations: The Business Judgment Rule and Good Corporate Governance" [2013] SPECJU 2
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Shielding Directors against Liability Imputations: The Business Judgment Rule and Good Corporate Governance
Linda Muswaka*
Lecturer, Lecturer, Faculty of Law, School of Postgraduate Studies and Research, North West University
1. INTRODUCTION
There is always a link between good governance and compliance with law. Good governance is not something that exists separately from the law and it is entirely inappropriate to unhinge governance from the law.1
The business judgment rule,2 has found its anchor in the new Companies Act 71 of 2008.3 The rule is found in section 76(4) of the Act and relates to the director’s duty4 to act in the best interests of the company5 and with care, skill and diligence.6 In terms of the rule, a director will be protected from allegations of breach of the duty to act in the best interests of the company and with care, skill and diligence in relation to a matter where that director has (i) taken reasonably diligent steps to become informed about the matter, (ii) either had no conflict of interest in relation to the matter or complied with the rules on conflict of interests and (iii) had a rational basis for believing, and did believe, that his decision was in the best interest of the company.7 The business judgment rule therefore becomes a protective measure for directors against liability imputations.8It protects honest directors from liability where a decision turns out to have been an unsound one,9 and at the same time prevents the stifling of innovation and venturesome business activity.10 The rule is a ‘standard of non-review of the merits of a business decision corporate officials have made.’11
In this article the writer examines the statutory business judgment rule12. The reasons are twofold: Firstly, the increased interest in director accountability and the quest for economic efficiency makes the business judgment rule a topic of international interest and of most practical relevance. Secondly, South African courts will no doubt be called upon in future to interpret the requirements of the business judgment rule as it has been framed in the Act. In this regard, this article seeks to give meaning to the requirements. It also further seeks to advance the thesis that in determining compliance with the business judgment rule, not only compliance with legislation but also compliance with governance codes and good governance criteria is relevant.
2. THE BUSINESS JUDGMENT RULE
The business judgment rule has been incorporated into the South African company law as part of the statement on the duty to act in the best interest of the company13 and the duty to act with care, skill and diligence.14 Business decisions therefore exist alongside these duties which are entirely separate and distinct, although complementary concept. A separate analysis of whether or not a director has complied with these duties is always necessary. These duties apply whether or not a business judgment has been made. For instance, if the directors fail to monitor the affairs of the company, there could be liability under the duty of care, skill and diligence and the business judgment rule would have no application.
The enactment of the business judgment rule is therefore, not a fortress for directors, as dishonest directors and directors who act irrationally will still face the sanction of the court for breach of the duty to act in the best interest of the company15 and the duty to act with care, skill and diligence.16 In terms of section 77(2)(a), a director may be held liable in accordance with the
principles of the common law relating to breach of a fiduciary duty,17 for any loss or damages suffered by the company as a result of a breach of, inter alia, the duty to act in the best interest of the company. Similarly, in terms of section 77(2)(b), a director may be held liable in accordance with the principles of the common law relating to delict for any loss or damages suffered by the company as a result of a breach of the duty to act with care, skill and diligence.18
The business judgment rule is intended to further the objective of the Act, succinctly described by Davis et al19 as follows:
Read as a whole, the 2008 Act promotes the objective that there should not be an over-regulation of company business. The Act grants directors the legal authority to run companies as they deem fit, provided that they act within the legislative framework. In other words, the Act tries to ensure that it is the board of directors, duly appointed, who run the business rather than regulators and judges, who are never best placed to balance the interests of shareholders, the firm and the larger society within the context of running a business.
It is noteworthy that a number of South African authors have discussed the business judgment rule. In particular, authors such as Bouwman,20 Botha and Jooste,21 Havenga22, Jones23, McLennan24, Kennedy-Good and Coetzee,25 provide interesting insight on the business judgment rule. These authors, among others, contributed to the debate on the business judgment rule prior to its adoption in the Act. The issue then was whether or not the business judgment rule should be introduced into South African law. In general, these authors argued against the introduction of the business judgment rule.26 It is therefore important to note that while a number of prior studies in South Africa have discussed the business judgment rule, the focus has been on the issue whether or not the rule should be adopted. Now that the rule is entrenched in the Act, this article, moving beyond prior literature, considers how the business judgment rule intersects with existing corporate governance principles and seeks to give meaning to its requirements.
2.1 The Requirements of the Business Judgment Rule
Section 76(4) of the Act provides:
In respect of any particular matter arising in the exercise of the powers or the performance of the functions of director, a particular director of a company-
(a) will have satisfied the obligations of subsection (3)(b) and (c)27 if-
(i) the director has taken reasonably diligent steps to become informed about the matter;
(ii) either-
(aa) the director had no material personal financial interest in the subject matter of the decision, and had no reasonable basis to know that any related person had a financial interest in the matter; or
(bb) the director complied with the requirements of section 75 with respect to any interest contemplated in subparagraph (aa); and
(iii) the director made a decision, or supported the decision of a committee or the board, with regard to that matter, and the director had a rational basis for believing, and did believe, that the decision was in the best interests of the company […]
The first requirement of the business judgment rule is that the director must have taken reasonably diligent steps to become informed about the matter.28 Guidance is not given in the Act as to what would constitute taking ‘reasonably diligent steps to become informed about the matter.’ It is submitted that if the question whether or not a director has taken reasonably diligent steps to become informed about the matter is considered in the context of the Lex Acquilia, it can be addressed by asking what public policy would demand in each individual case. The question whether or not a director has taken reasonably diligent steps to become informed about the matter should therefore be in line with the general principles of the South African law of delict,29 be answered by applying the wrongfulness test30. This should be determined with reference to the legal convictions of the community, the boni mores31. The legal convictions of the community is an objective test based on the criterion of reasonableness.32 The basic question is whether, according to the legal convictions of the community and in the light of all the circumstances of the case, the defendant infringed the interests of the plaintiff in a reasonable or unreasonable manner.33 It is important to note, as stated by Neethling et al,34 that in applying the boni mores criterion in the law of delict, we are not concerned with what the community regards as socially, morally, ethically or religiously right or wrong, but whether or not the community regards a particular act or form of conduct as delictually wrongful.35 Nevertheless, conduct which was initially regarded as morally (but not legally) reprehensible may in the course of time also be censured by the law of delict.36
In answering the question whether a director acted wrongfully (in other words, did not take reasonably diligent steps to become informed about the matter), various factors should be considered. These will include whether the director holds a full-time position or not, his access to relevant information, particular experience and the skills that he undertook to bring to the company, functions delegated by or assigned to him, as well as the nature of the company. In the light of this reasoning, it will therefore not be an overstatement to submit that in terms of the boni mores more will be expected from a director who, for example, undertook to bring expert knowledge to the company than from one with no or less expertise. Thus, there is a subjective orientation to what constitutes ‘taking reasonably diligent steps to become informed.’ The extent of the steps required to be taken in order to satisfy the requirement depends on the circumstances of the particular decision, made by the particular director or board, in the company’s circumstances. The test, however, remains an objective one in the sense that due regard must be given to what would be expected from a person in that situation in terms of the convictions of the community.
The second requirement is that the director must not have a material personal financial interest in the subject matter of the decision and no reasonable basis to know that any related person had a personal financial interest in the matter.37 The word ‘material’ suggests that if a personal financial interest is present, then it must relate to more than an immaterial or insignificant financial interest. For example, where the board was to decide on whether or not to buy a piece of land priced at above market value from a fellow director, this may amount to a material personal financial interest which would deny that director the protection of the business judgment rule. Furthermore, it is submitted that if a director exerted significant influence over the other directors, to the extent that they were simply ‘rubber-stamping’ the decision, this requirement would not be satisfied and those directors cannot rely on the business judgment rule as well.
In terms of the third requirement, the director must have rationally believed that the decision was in the best interests of the company.38 Guidance is again not given in the Act as to what would constitute a rational belief. In order to nurse a ‘rational belief’ directors must be independent with respect to the action that is at issue. A director is independent when he or she is in a position to base his or her decision on the merits of the issue rather than being governed by extraneous considerations or influences. In Australian law,39 section 180(2) of the Corporations Act40 states that a director or officer’s belief that the judgment is in the best interest of the corporation is a rational one unless the belief is one that no reasonable person in his position would hold.
It is submitted that an objective test, as in the Australian context, must be applied in order to determine whether or not the director’s belief that a decision was in the best interests of the company was a ‘rational belief’. In this context, if the directors are informed and their decision is one which a reasonable person in their position would hold, then the decision is said to have a rational basis. However, if the decision is one which a reasonable person in their position would not at all hold, then this requirement is not satisfied. For example, a decision by the directors to accept a ridiculously low price for the sale of company assets will not be reasonable as it will not be in the best interests of the company and may therefore lead to an inference that there is lack of good faith. In this case, the business judgment rule would not apply. Compliance with all the elements is required for the rule to apply.
3 THE CONCEPT OF CORPORATE GOVERNANCE
There is no universal definition for ‘corporate governance.’ Bottomley observes that ‘corporate governance' is a slippery term, used both in discussions about the role of companies in society and also in discussions about the organization of affairs within companies.41 Generally, ‘corporate governance’ is understood to mean the way in which companies are directed and controlled. 42 When issues of corporate governance are considered, the emphasis is usually on the role played by directors in running their companies and the interests to be considered in corporate decision-making. Indeed, the theory is that better managed companies will yield benefits for all, hence the focus on the role of directors in, inter alia, managing companies. This is the main reason why corporate governance is undeniably pivotal in the modern world.
According to the definition of the Organization for Economic Co-operation and Development (OECD):43
Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set and the means of attaining those objectives and monitoring performance are determined.44
The OECD however, acknowledges that there is no single model of good corporate governance.45 The OECD Principles are non-binding and are not prescriptive.46 Their rationale is to operate as a basic reference point.47 The OECD Principles were created in order to support member and non-member states48 in the evaluation and improvement of the legal, institutional and regulatory structures for corporate governance in their countries.
3.1 Corporate Governance in South Africa
In 1992, the Institute of Directors in Southern Africa49 formed the King Committee to review corporate governance and make recommendations to the corporate world, in order to improve the standard of corporate governance. In 1994, the King Committee issued a Report50 and a Code of Corporate Practices and Conduct. Since it was the duty of the King Committee to review corporate governance on an ongoing basis, it issued, on 26 March 2002, the second Report on Corporate Governance in South Africa51. In view of the (then) anticipated new Companies Act52 a new King Report became necessary. King II was therefore, replaced by the revised King Report on Corporate Governance for South Africa 200953 which was launched on 1 September 2009 and came into effect on 1 March 2010.54
King III, like King I and King II, promotes good corporate governance in South Africa alongside compliance with the law. King III applies to all incorporated entities and domicile in South Africa, regardless of the manner and form of their incorporation or establishment and whether in the public, private or non-profit sectors.55 King III operates on an “apply or explain” basis.56 This is a refinement of the “comply or explain” basis that King I and King II operated on.57
King III recognises the responsibility of those persons that perform the management functions of the company. This is inter alia evident from the set of principles in the report relating to the role of the board of directors.58 The King III recommendations are not prescriptions. They are guidelines designed to produce an outcome of efficiency. King III does not adopt a “one size fits all” approach to corporate governance. Instead, it formulates guidelines of best practice for optimising corporate performance and accountability in the interests of shareholders and the broader economy. The general approach is one of flexibility. If a company considers that a recommendation is inappropriate to its particular circumstances, it is free not to adopt it.59
4 KING III AND THE COMPANIES ACT
While
King III is not law, and failure to comply therewith will not result in direct liability for directors, it is submitted that in determining compliance with the business judgment rule, not only compliance with legislation but also compliance with governance codes and good governance criteria is relevant. Corporate governance practices will raise perceptions of what can be regarded as conduct justifying exoneration form liability. Courts should therefore, when determining whether a particular director meets the requirements of the business judgment rule, consider whether such a director has also complied with the corporate governance principles.60A matter of concern that arises with regard to the above submission is on what basis the courts should use the corporate governance codes as a tool to assist in the interpretation of the Act. It is noted that section 5 of the Act, which deals with the rules regarding the general interpretation of the Act, does not expressly provide for the use of corporate governance codes such as King III when interpreting the Act. It is however, argued that section 5 of the Act must be interpreted within a broader context. In this light, it is submitted that section 5(1), read together with section 7,62anc" HREF="#sdendnote62sym" SDFIXED>61 in particular section 7(b)(iii), provides ground for justification of reliance on the corporate governance codes by the courts. Section 5(1) provides that the Act must be interpreted and applied in a manner that gives effect to the purposes set out in section 7. Section 7(b)(iii) provides as one of the purposes of the Act, ‘to promote the development of the South African economy by encouraging transparency and high standards of corporate governance as appropriate, given the significant role of enterprises within the social and economic life of the nation.’ It is argued in light of section 5(1), read together with section 7(b)(iii), that the starting point for the courts should definitely be King III.
Reliance by the courts on King III is undeniably pivotal if the Act is to be interpreted in a manner that promotes the development of the economy by encouraging transparency and high standards of corporate governance. Indeed, corporate governance in South Africa has changed from being a ‘soft’ mainly ethical issue, to a ‘hard’ issue, recognised as pivotal to the success and revitalisation of the country’s capital markets, and ultimately the prospects of corporate economy. The corporate governance codes serve a crucial role in promoting good corporate governance in South Africa alongside compliance with the law, as highlighted in King III:
In addition to compliance with legislation, the criteria of good governance, governance codes and guidelines will be relevant to determine what is regarded as an appropriate standard of conduct for directors. The more established certain governance practices become, the more likely a court would regard conduct that conforms with these practices as meeting the required standard of care. Corporate governance practices, codes and guidelines therefore lift the bar of what are regarded as appropriate standards of conduct. Consequently, any failure to meet a recognised standard of governance, albeit not legislated, may render a board or individual director liable at law.62
Thus, ‘there is always a link between good governance and compliance with the law.’63 Good governance is therefore, not something that exists separately from the law and it is entirely inappropriate to unhinge governance from the law.64 In this regard, it would therefore not be an overstatement that the Act and King III should work in tandem to promote the development of the South African economy by inter alia encouraging high standards of corporate governance. In the ensuing discussion, with reference to the directors’ moral duties stated in King III, the link between good governance and compliance with the business judgment rule is highlighted.
4.1 GOOD CORPORATE GOVERNANCE AND THE BUSINESS JUDGMENT RULE King III Principle 1.1, paragraph 1565 states that as a steward of the company, each director should also discharge inter alia the following moral duties;66
i. Conscience: A director should act with intellectual honesty and independence of mind in the best interests of the company and all its stakeholders, in accordance with the inclusive stakeholder approach to corporate governance. Conflict of interest should be avoided.67
It is submitted that this principle is fundamental to the business judgment rule. The business judgment rule absolves from liability directors who, in good faith,68 adopt a course of action which they honestly and reasonably believe will benefit the company. The business judgment rule, will not protect from liability a director who fails to ‘act with intellectual honesty and
independence of mind in the best interests of the company and without any conflict of interest’ as required by King III.
A director complies with the moral duty to inter alia act with intellectual honesty and independence of mind in the best interests69 of the company where he effectively participates in the affairs of the company. Effective participation entails amongst other things debating ideas where necessary before resolving to adopt a particular course of action. The need for active debate is central to the development of a healthy boardroom culture and effective running of the affairs of the company. Directors must have the capacity and willingness to challenge each other’s assumptions and beliefs. This is dependent on their personal fortitude and external trust to allow for opposing viewpoints and challenging questions. Companies must have discerning boards that treat no subject as undiscussable. Thus, robust and effective teams need to be constructed at governance level. The role of the chairperson and the independent directors is central in guaranteeing that this robustness occurs by ensuring that individual opinions are heard and valued:
ii. Competence: A director should have the knowledge and skills required for governing a company effectively.
This competence should be continually developed.70
The business judgment rule will not protect a director who fails to comply with this principle by for example, making a decision that is not in the best interest of the company simply because he lacked the ability to perform the job he undertook. If a director brings specific skills or experience to the company, he must apply them. Furthermore, directors must qualify themselves on a continuous basis with sufficient understanding of the company’s business and seek expert advice where necessary. If the directors need and get expert advice in order to make a decision, records must show that expert advice was taken. Where an expert’s opinion is obtained and forms the basis of a bad decision made by the directors, which is in good faith, reliance on it may, depending on the circumstances and merit, absolve them from personal liability. It should, however, be borne in mind that responsibility may never be delegated. It still lies with the board and hence no member of the board may blindly rely on the information and advice given by other officers of the company or professional persons:71
iii. Commitment: A director should be diligent in performing his duties and devote sufficient time to company affairs. Ensuring company performance and compliance requires unwavering dedication and appropriate effort.72
A director displays commitment where he for example regularly attends all meetings and acquires a broad knowledge of the business of the company so that he can meaningfully contribute to its direction. In this light, what was said of the non-executive director in the case of Fisheries Development Corp of SA Ltd v Jorgensen,73 may no longer suffice without qualification. In that case it was stated that the non-executive director is not bound to give continuous attention to the affairs of the company or to attend all meetings though he ought to whenever he is reasonably able to do so.74 However, recent cases have shown that more is now expected of the non-executive director.75
The modern non-executive director is now required not only to attend meetings regularly but also to acquaint himself with the issues underlying the agenda and to acquire a broad knowledge of the business of the company. Active participation in the management of the affairs of the company is now the call of all directors. A director cannot turn a blind eye to what is going on about him in the conduct of the business of the company and have it said that he is exercising
business judgment. One must therefore, contrast a director who acts erroneously on the one hand and on the other with one who does not act at all.76 While a director who acts erroneously may find protection in terms of the business judgment rule, one who does not act77 at all lacks commitment and may be found liable for negligence:78
iv. Courage: A director should have the courage to take the risks associated with directing and controlling a successful, sustainable enterprise, and also the courage to act with integrity in all board decisions and activities.79
It will be reiterated that the business judgment rule protects directors from liability to the company or its shareholders for losses resulting from poor-decision making made in good faith.80 By so doing, the business judgment rule gives directors the courage to take “the risks associated with directing and controlling a sustainable enterprise” as required by moral duty stated above, without fear of the risks inherent in hindsight reviews of their unsuccessful decisions.
The fact that the business judgment rule exonerates honest directors from liability should encourage directors to act with integrity in board decisions and activities. A director acts with integrity where he for example, does not accept board papers at face value and makes a proper analysis of the information before him first. The onus lies with the director to familiarise himself or herself with the business and finance of the company and to ask appropriate questions. Where directors fail to make enquiries regarding the information given to them with the result that an uninformed decision is arrived at, such directors should not be excused from liability.
From this discussion, it then becomes clear that a director who complies with King III moral duties81 would most likely be exonerated by the business judgment rule should the decision made turn out to have been a wrong one. It is in this regard that it is submitted that the courts, when applying the business judgment rule, should also consider compliance with good corporate governance practice.
5. CONCLUSION
Section 76(4) of the Companies Act introduces the business judgment rule into South African company law. In light of this development, the courts will no doubt be called upon in future to interpret the requirements of the business judgment rule as framed in the Act. It is in this regard that an effort has therefore been made in this article to give meaning to the requirements dictated by the Act. It has also been illustrated that the business judgment rule has the effect of protecting directors against liability imputations. Furthermore, the relationship between the business judgment rule and good corporate governance has been highlighted. It has been recommended that the courts, when determining whether or not a director meets the requirements of the business judgment rule, should also consider compliance with good corporate governance practice.82 While section 5 does not expressly provide for the use of corporate governance reports and codes of practice, it has been argued that section 5(1),83 read together with section 7(b)(iii),84 provides for justification of such reference and reliance. The Act and King III should therefore, work in tandem to promote the development of the South African economy by inter alia encouraging high standards of corporate governance.
* LLB; LLM (University of Fort Hare).
1The King Report on Corporate Governance for South Africa 2009 7. The argument presented in this paper strongly finds support in this quote as will be highlighted as the discussion unfolds.
2The business judgment rule was developed in the United States of America (USA) alongside the duty of care and relates to one aspect of this duty, namely that of decision-making. In the USA, the business judgment rule as a common law principle can be traced as far back as 1829 – see Percy v Milledon 8 Mart (NSW) 68 78 (La 1829).
3 Hereinafter, the Act. The Act was assented to by the President on 9 April 2009. It became effective on the 1st of May 2011, the date gazetted in the Government Gazette No 34239.
4 The Act introduces provisions relating to the standards of conduct of directors in the form of a partially codified regime of directors’ duties, which includes a fiduciary duty and a duty of reasonable care – see section 76 (3). The provisions governing directors’ duties are supplemented by other provisions addressing (i) conflict of interest – see section 75; (ii) directors’ liability – see section 77; and (iii) indemnities and insurance – see section 78. It is noteworthy that the common-law principles regarding directors’ duties remain, but only to the extent that they have not been narrowed by the Act.
5 Section 76(3)(b).
6 Section 76(3)(c). The standard of care, skill and diligence expected is one that ‘may reasonably be expected of a person (i) carrying out the same functions as those carried out by that director and (ii) having the general knowledge, skill and experience of that director.’
7 Section 76(4).
8 The rationale being to promote innovation by providing the right balance between the competing interests of commercial risk taking by directors and, on the other hand, their accountability.
9 Havenga M “The Business Judgment Rule – Should We Follow the Australian Example? 2000 SA Merc LJ 28.
10 American Law Institute Principles of Corporate Governance and Structure: Restatement and Recommendations (1982), quoted by Lipton P & Herzberg A Understanding Company Law 6th ed 1995 393. On the historical development of the rule see Gordon CJ “Corporate Mismanagement as Malpractice: A Critical Re-analysis of Corporate Managers’ Duties of Care and Loyalty” 1984 Houston LR 105 118.
11 Branson D.M. “The Rule That Isn’t a Rule – The Business Judgment Rule,” 2002 Val. U.L.Rev. 631; Ian D “Delivering the Judgment on Statutory Business Judgment Rule In Australia” 1995 Australia Journal of Corporate Law 422; Larelle L “The Business Judment Rule In Australia: A Re- Appraisal Since the AWA Case” 1997 Company and Securities LJ 174; see also Harold Co v Seawell 472 F 2d 1081 (10th Cir 1972); Financial Industrial Fund Inc v McDonnell Douglas Corp [1973] USCA10 60; 474 F 2d 514 (10th Cir 1973); Wolf v Fried 473 Pa 26 373 A. 2d 734 (1977); Shlensky v Wrigley 95 Ill App 2d 173 237 NE 2d 776 (1968), in which the court correctly declined to interfere with the business judgment of a board of directors of Chicago Club, a Delaware corporation, against night home games; Olson Brothers v Engelehart 42 Del Ch 348 211 A. 2d 610 (CH 1965); John Hancock Capital Growth Management Inc v Aris Corporation NO 9920 (Del Ch 1990); Credit Men’s Adjustment Burea Inc v Weiss 305 NY 1 110 NE 2d 397 (1953); Glossberg v Boyd 35 Del Ch 293 116 A 2d 711 (Ch 1955), where a director was held not liable for good faith payment of out-of-state taxes subsequently invalidated as unconstitutional; Conviser v Simpson 122 F Supp 205 (D.Md 1954); Hornstein v Paramount Pictures Inc 292 NY 468 55 NE 2d 740 (1944) ; Lewis “The Business Judgment Rule and Corporate Directors’ Liability for Mismanagement” (1970) 22 Baylor L. Rev 157; Arsht SS “The Business Judgment Rule Revisited” (1979) 8 Hofstra LR 93.
12 Very closely related to the business judgment rule is the director’s duty of care, skill and diligence. It was considered seriously to also include a discussion of the duty of care, skill and diligence. That will, however, have to wait for another day as the literature on the duty of care and skill in South Africa is vast.
13 Section 76(3)(b). This duty exists by virtue of the special relationship that exists between the director and the company, namely the fiduciary relationship. The basis on which a director is held liable by his company for a breach of his fiduciary relationship is the general principle that a person standing in a fiduciary relationship to another commits a breach of trust if he acts for his own benefit or to the prejudice of that other. The cause of action is neither delictual nor contractual but one that is based on breach of trust (Robinson v Randfontein Estates Gold Mining Co Ltd 1921 AD 168). See Benade ML et al Entrepreneurial Law – Incorporating the New Companies Act Manual 4th ed 2009 131.
14 Section 76(3)(c). A director who does not observe his duties of care and skill towards his company is liable to it in delict for damages. If in addition there had been a contract between the director and his company, as is usually the case with full-time directors, he could be guilty of breach of contract as well.
17 For a discussion of breach of a fiduciary duty see Havenga M “Breach of Directors’ Fiduciary Duties: Liability on What Basis?” 1996 SA Merc LJ 366; Havenga M “Directors’ Fiduciary Duties under Our Future Company- Law Regime” 1997 SA Merc LJ 310; Havenga M “Directors’ Secret Profit– Accounting To the Company” 1991 SA Merc LJ 95; Havenga M “Directors in Competition with Their Companies” 2004 SA Merc LJ 275; Cilliers et al Corporate Law (2000) 152; Farrar, Furey and Hannigan Company Law (1991) 396-402; Gower Modern Company Law (1992) 585-589; McLennan JS “Directors’ Fiduciary Duties and the Companies Act” 1983 SALJ 417; McLennan JS “Directors’ Fiduciary Duties and Misapplication of Company Funds” 1982 SALJ 394; Botha DH “Holding and Subsidiary Companies: Fiduciary Duties of Directors” 1984 De Jure 167.
18 See for example McLennan JS “Duties of Care and Skill of Company Directors and Their Liability for Negligence” 1996 SA Merc LJ 94; Sievers S “Farewell To The Sleeping Director – The Modern Judicial And Legislative Approach To Directors’ Duties of Care, Skill And Diligence” 1993 ABLR 111.
19 Davis et al Companies and other Business Structures in South Africa (2011) 16.
20 Bouwman N, “An Appraisal of the Modification of the Director’s Duty of Care and Skill” 2009 Merc LJ 509.
21 Botha D & Jooste R, “A Critique of the Recommendations in the King Report regarding a Director’s Duty of Care and Skill” 1997 114 SALJ 65.
22 Havenga M “The Business Judgment Rule – Should We Follow the Australian Example? 2000 12 SA Merc LJ 28.
23 Jones E, “Directors’ Duties: Negligence and the Business Judgment Rule” 2007 19 SA Merc LJ 326.
24 McLennan JS “Duties of Care and Skill of Company Directors and Their Liability for Negligence” 1996 SA Merc LJ 94.
25 Kennedy-Good S & Coetzee L, “The Business Judgment Rule (Part I)” 2006 Obiter 62; Kennedy-Good S & Coetzee L, “The Business Judgment Rule (Part II)” 2006 Obiter 277.
26 See for example Bouwman N, “An Appraisal of the Modification of the Directors’ Duty of Care and Skill” 2009 SA Merc LJ 509 529-531; Jones E, “Directors’ Duties: Negligence and the Business Judgment Rule” 2007 SA Merc LJ 326 332-333; Kennedy-Good S & Coetzee L, “The Business Judgment Rule (Part II)” 2006 Obiter 277-291.
27 Subsection 3(b) provides that a director must act in the best interest of the company while subsection 3(c) provides that a director must exercise reasonable care, skill and diligence.
28 Section 76(4)(i).
29 The researcher will not engage into a comprehensive discussion of delictual principles as these fall outside the scope of this article. However, the elements of delict for Aquilian liability are as follows; (i) conduct, (ii) wrongfulness, (iii) fault, (iv) causation and (v) damages.
30 Various criteria are used to determine wrongfulness. One of them is the infringement of a subjective right. The court accepted the doctrine of subjective rights inter alia in Universteit van Pretoria v Tommie MeyerFilms (Edms) Bpk 1977 4 SA 376 (T) 387. The fundamental premise of this doctrine is that wrongfulness consists of the infringement of a subjective right – see Neethling et al Law of Delict 4th ed (2001) 50. A company director must in terms of this criterion, infringe a subjective right of the company to comply with the delictual requirements of wrongfulness in accordance with this doctrine. As has been stated, the infringement of a subjective right is only one criterion to determine wrongfulness. There are circumstances in which it is more appropriate to determine wrongfulness by enquiring whether a legal duty has been breached – see Neethling 55. Instances of liability for an omission or the causing of pure economic loss are recognised as such circumstances.
31 Neethling 37-38.
32 See Neethling 31 51.
33 In Coronation Brick (Pty) Ltd v Strachan Construction Co (Pty) Ltd 1982 4 SA 371 (D) 380, the court expressed it as follows: “In any given situation the question is asked whether the defendant’s conduct was reasonable according to the legal convictions of the community.” In Compass Motor Industries (Pty) Ltd v Callguard (Pty) Ltd 1990 2 SA 520 (W) 528-529 Van Zyl J pointed out that the boni mores concept has points of contact in our common law where it is also linked to the concept of good faith.
34 Neethling 31 42.
35 Naturally, however, legal convictions are influenced by ethical, moral and religious convictions.“Wrongfulness is tested according to society’s legal, as opposed to its moral convictions but at the same time morality plays a role in shaping society’s legal convictions. If it is accepted, as I think it should, that law is but a translation of society’s fundamental values into policies and prescripts for regulating its members’ conduct, then the court when it determines the limits of such a basic legal concept as wrongfulness, has to have regard to the prevailing values of society” - see Clarke v Hurst 1992 4 SA 630 (D) 652.
36 See Minister van Polisie v Ewels 1975 3 SA 590 (A).
37 Section 76(4)(ii)(aa).
38 Section 76(4)(iii).
39 The researcher will not enter into a discussion of the Australian law as a comparative analysis falls out of the scope of this paper.
40 Corporations Act 2001 (Cwlth).
41 Bottomley S, “From Contractualism to Constitutionalism: A Framework for Corporate Governance,” 1997 Sydney L. Rev. 277.
42 See, among others, Report of the Committee on the Financial Aspects of Corporate Governance (Cadbury Report) (1992). The King Committee used this formulation as their working definition – see King I chapter 1 para 2 1.
43 Hereafter the OECD.
44 Preamble to the ‘OECD Principles of Corporate Governance,’ 2004. Accessed on 26 July 2011, available at http://www.oecd.org/daf/corporateaffairs/corporategovernance. The ‘OECD Principles of Corporate Governance,’ 2004 is a revised version of the ‘OECD Principles of Corporate Governance,’ 1999 which was the brainchild of the OECD Council that met at Ministerial level during April 1998 in order to request that the OECD, together with national governments, relevant international organizations and the private sector; create a set of corporate governance standards and guidelines.
45 Preamble to the ‘OECD Principles of Corporate Governance,’ 2004. Accessed on 26 July 2011. Available at http://www.oecd.org/daf/corporateaffairs/corporategovernance.
46 Ibid.
47 Preamble to the ‘OECD Principles of Corporate Governance,’ 2004. Accessed on 26 July 2011. Available at http://www.oecd.org/daf/corporateaffairs/corporategovernance.
48 It is worth noting that South Africa is one of the many non-member economies with which the OECD has working relations in addition to its member states. On 16 May 2007, the OECD Council at Ministerial level adopted a Resolution on Enlargement and Enhanced Engagement to strengthen the co-operation with South Africa, as well as with Brazil, China, India and Indonesia through a programme of enhanced engagement. The OECD Council Resolution on Enlargement and Enhanced Engagement, accessed on 14 May 2012 is available at http://www.oecd.org/brazil/oecdcouncilresolutiononenlargementandenhancedengagement.htm.
49 Hereinafter, IoDSA.
50 The King Report on Corporate Governance 1994. Hereinafter, King I.
51 The King Report on Corporate Governance for South Africa 2002. Hereinafter King II.
53 Hereinafter, King III.
54 Both the Companies Act 71 of 2008 and changes in international governance trends necessitated the publication of King III. King III is not law, and failure to comply therewith will not result in direct liability for directors
55 King III 17. This may have the effect that entities and stakeholders will require a deeper understanding of governance in order to decide how governance principles and practices should be adopted and implemented in their particular entity – ‘the one size does not fit all’ consequence.
56 King III 7. King III has opted for the more flexible ‘apply or explain’ approach to its principles and recommended practices.
57 The King Committee found the word “apply” more appropriate than “comply” for the following reasons: “The ‘comply or explain’ approach could denote a mindless response to the King Code and its recommendations whereas the ‘apply or explain’ regime shows an appreciation for the fact that it is often not a case of whether to comply or not, but rather to consider how the principles and recommendations can be applied” – King III 7.
58 For example, King III Chapter 1 ‘Ethical Leadership and Corporate Citizenship’ and Chapter 2 ‘Board and Directors.’
59 Companies are encouraged to use the guidelines provided in King III as a focus for re-examining their corporate governance practices and to determine whether and to what extent the company may benefit from a change in approach, having regard to the company’s particular circumstances.
60 While corporate governance principles in King III relating to directors are legion, focus will be limited to Principle 1.1 para 15 dealing with the directors’ moral duties.
61 Section 7 sets out an impressive list of legislative purposes.
62 King III 8.
63 King III 7.
64 King III 7.
65 King III Chapter 1.
66 King III Chapter 1, Principle 1.1 para 15 21-22. Para 15.2 states, “Inclusivity of stakeholders is essential to achieving sustainability and the legitimate interests and expectations of stakeholders must be taken into account in decision-making and strategy.” This principle is not discussed as it does not further the argument made.
67 Para 15.1 21.
68 The requirement of good faith is omitted from the statutory criteria. However, it is felt that it nonetheless applies as directors must always act in good faith when conducting the affairs of the company.
69 Chapter 1 Principle 1.1, Para 15.2 22.
70 Para 15.3 22.
71 In Fisheries Development Corporation of SA Ltd v Jorgensen: Fisheries Development Corp of SA Ltd v AWJ Investments (Pty) Ltd 1980 4 SA 156 (W) 165 166B-D. Hereinafter Fisheries Development Corporation of SA Ltd v Jorgensen.
72 Para 15.4 22.
73 Fisheries Development Corporation of SA Ltd v Jorgensen 165H.
74 Ibid.
75 Examples of such cases include Howard v Herrigel And Another NNO [1991] ZASCA 7; 1991 2 SA 660 (AD); Cronje NO v Stone en’n Ander 1985 3 SA 597 (T); Ex Parte Lebowa Development Corporation Ltd 1989 3 SA 71 (T) 106I-J; Fourie v Braude And Others 1996 SA 610 (T); TJ Jonck BK h/a Bothaville Vleismark v Du Plessis NO 1998 1 SA 971 (C); Gordon NO And Rennie NO v Standard Merchant Bank Ltd And Others 1984 2 515 (C); Terblanche NO And Others v Damji And Another 2003 5 SA 489 (C); Nel And Others NNO v McArthur And Others 2003 4 SA 142 (TPD); Triptomania Twee (Pty) Ltd And Others v Connolly And Another 2003 3 SA 558 (C).
76 Where a director fails to act, liability follows only if the omission was in fact wrongful. This will be the case only if in the particular circumstances a legal duty rested on the defendant to act positively and he failed to comply with that duty. A director has a duty to act positively by participating in the collective management of the affairs of the company. This duty exists by virtue of the special relationship that exists between the director and the company, namely the fiduciary relationship.
77 Failure to act refers to situations where the law expects a director to take action and he fails to do so. In these instances, the director will be in breach of the duty of care and skill where he harms the company by remaining passive and fails to perform his duties of participating in the management of the company. See for example Howard v Herrigel 75.
78 However, it needs to be noted that a person does not act wrongfully for purposes of the law of delict in all instances where he fails to act positively to prevent harm to another. Thus, the point of departure is that a person is generally not liable where his omission gives rise to an actual infringement of the interests of another. Liability follows only if the omission was in fact wrongful.
79 Para 15.5 22.
80 Havenga 2000 SA Merc LJ 27.
81 King III, Chapter 1, Principle 1.1 para 15 21.
82 Focus has however been on King III Chapter 1 Principle 1.1 para 15 21-22.
83 Section 5(1) provides that the Act must be interpreted and applied in a manner that gives effect to the purposes set out in section 7.
84 Section 7(b)(iii) provides as one of the purposes of the Act, ‘to promote the development of the South African economy by encouraging transparency and high standards of corporate governance as appropriate, given the significant role of enterprises within the social and economic life of the nation.