DEFENCES OF DIRECTORS OF A COMPANY

Directors today are exposed to increased liability and penalties. This increased exposure to
personal liability has caused anxiety and concern, and has resulted in several proposals for wider
protection against and relief from personal liability for company directors.1

1. Business judgment rule.

The legislature has empowered the board of directors to directly or indirectly ‘manage the
business of the corporation’. Thus there is no general scope for the courts to interfere with their
business judgments: they have ‘managerial freedom’. Or, as it has been put in the well-known
case of Smith v Van Gorkom;

‘In carrying out their managerial roles, directors are charged with an unyielding fiduciary duty to
the corporation and its shareholders ... The rule itself ‘is a presumption that in making a business
decision, the directors of a corporation acted on an informed basis, in good faith and in the
honest belief that the action taken was in the best interests of the company’. Thus, the party
attacking a board decision as uninformed must rebut the presumption that its business judgment
was an informed one.2 The predominant aim with the rule was identified as protecting directors
against personal liability when they have taken innovative business decisions or displayed
‘entrepreneurial flair’.3 They should be protected against mere errors of judgment.

The business judgement rule requires a director to have:

• made a decision in good faith and for a proper purpose;

• no personal interest in the subject matter of the decision;

• informed themselves with regard to the subject matter of the decision to the extent they
reasonably believed to be appropriate; and

1
M Legg and D Jordon, ‘the Australian Business Judgment Rule after ASIC V Rich: Balancing Director Authority
and Accountability’ (2014) 34 ALR 403 at 403–26.
2
Smith v Van Gorkom (1985) 488 A 2d 858.
3
A Greenhow, ‘the Statutory Business Judgment Rule: Putting the Wind into Directors’ Sails’ (1999) 11 Bond LR
33 at 34.
• rationally believed the decision was in the best interests of the company.

In 1989, the Companies and Securities Law Review Committee recommended the introduction
of a statutory business judgment rule based on two notions: that ‘informed business judgments
should be encouraged in order to stimulate innovation and risk-taking’ and ‘to limit judicial
intrusiveness in private sector decision making’.4

In order to overcome the presumption afforded by the business-judgment rule to corporate

directors, a plaintiff must plead fraud, breach of trust, conflict of interest, oppression, corruption,
improper motive, bad faith, overreaching, complete abdication of corporate responsibility, or a
failure to investigate that was “clearly unreasonable under the circumstances known to them at
the time.” Frances T. v. Vill. Green Owners Assn., to plead one of these exceptions to the
business judgment rule’s presumption that a decision by a corporation’s directors was based on
sound business judgment, a plaintiff must allege sufficient facts to establish the exception;
“conclusory allegations of improper motives and conflict[s] of interest” are insufficient.

Complexity and uncertainty regarding the business judgment rule

First, its protection is strictly limited to directors’ duty of care and diligence. 5 The ‘stepping
stone approach’ was considered in Australian Securities and Investments Commission v
Cassimatis. In this case, ASIC used the fact that the company (Storm Financial) contravened a
provision of the Corporations Act, as ‘stepping stone’ to allege that the directors (Mr. and Mrs.
Cassimatis) were automatically in breach of their duty of care and diligence under s 180 of the
Corporations Act. Edelman J raised ‘serious doubt as to whether this assumption is correct’ and
accepted the submission of the directors (Mr. and Mrs. Cassimatis) ‘that s180 “cannot be used to
create liability in directors merely because their companies have contravened other provisions of
the [Corporations Act]”’ and affirmed the decision in Mariner. In Mariner, Beach J held that ‘the
duty owed under s 180 does not impose a wide-ranging obligation on directors to ensure that the

4
Senate Standing Committee on Legal and Constitutional Affairs, Company Directors’ Duties: Report on the Social
and Fiduciary Duties and Obligations of Company Directors, Cooney Report, Parliament of Australia, Canberra,
1989

5
J J du Plessis, ‘Company Law Developments in South Africa: Modernization and Some Salient Features of the
Companies Act 71 of 2008’ (2012) 27 Aust Jnl of Corp Law 46 at 68.
affairs of a company are conducted in accordance with law. It is not to be used as a back-door
means for visiting accessorial liability on directors’.

The second reason why we submit that the scope and application of the statutory business
judgment rule is complex and uncertain, is because a ‘business judgment’ is narrowly defined as
only applying to ‘the business operations of the corporation.

2. Honest and reasonable defence.

The purpose of the Honest and Reasonable Director Defence is to create an environment that is
conducive to strong yet responsible corporate performance and which supports directors who act
honestly. The defence would not alter the primary duties and obligations imposed on directors by
the law. This defence applies to alleged breaches of the directors’ duties and to any other
contravention. The Honest and Reasonable Director Defence is an overarching defence that may
be used as an alternative or in addition to, any other specific defenses which may be available.
The Honest and Reasonable Director Defence will only apply when a director conducts him or
herself honestly. Directors who act dishonestly or with an intention to defraud or deceive others
will not receive the benefit of the Defence.

a. A broad based defence

The Honest and Reasonable Director Defence is intended to have broad application. By being a
defence, the Honest & Reasonable Director Defence also makes clear that the provision is
intended to be a safety net for honest and committed directors rather than a redefinition of the
standards of governance applicable to directors in Australia. In this way, the Defence does not
undermine or interfere with the specific regimes set up under the Acts to regulate particular
subject matter.
The Honest & Reasonable Director Defence is designed to provide an effective and straight
forward way to support directors that act with an appropriate level of care and integrity, while at
the same time preserving the implicit messages as to the standard of conduct expected of
directors as enunciated by the specific provisions and defenses in both Acts.
 b. Acts and omissions
The Honest and Reasonable Director Defence will apply in circumstances where a director acts
or does not act, as such, it will be available in proceedings that relate to allegations arising from
positive acts as well as omissions. The Honest & Reasonable Director Defence would therefore
be available to directors in proceedings where there is an allegation that the director has omitted
to do something, has not turned their mind to an issue or has failed to act in a particular way.
c. Honesty
The directors must prove that they acted “honestly” in order to rely on the Honest & Reasonable
Director Defence, the Defence will not be operative to absolve those who are involved in serious
Wrongdoing. The onus would also be on the director to demonstrate that he or she is entitled to
the protection afforded by the defence. It is intended that the standard of proof to be attained by
A director to establish the Defence will be the balance of probabilities.

In the Commonwealth Bank of Australia v Friedrich the Supreme Court of Victoria defined
“honestly” as meaning acting “without moral turpitude. There is a marked distinction between
having an intention to deceive and making an error of judgment. In this regard the difference is
adeptly articulated by Palmer J in Hall v Poolman where His Honor emphasized that:
“There is a great deal of difference between acting in discharge of an office without prudence,
skill or judgment and acting dishonestly. Imprudence is not dishonesty unless it is so reckless as
to lead to the conclusion that the person could not have been making any genuine attempt at all
to act in accordance with his or her duty.”
It is intended that “honestly” in the Honest and Reasonable Director Defence should be
interpreted in accordance with the common meaning of the term. As such, we would expect that
“honestly” requires consideration of the defendant’s intention and state of mind at the time of the
relevant conduct.
Honesty was also considered by Gazell J in ASIC v MacDonald (No 12) (2009) 73 ACSR 638.
For conduct to be honest Gazell J stated it needed to be: “without moral turpitude in the sense
that it is without deceit or conscious impropriety, without intent to gain improper benefit or
advantage and without carelessness or imprudence at a level that negates the performance of the
duty in question.”
d. For a proper purpose
The Honest and Reasonable Director defence will only apply when a director acts or does not
act, for a proper purpose. Assessing whether a director’s conduct or exercise of powers is for a
proper purpose will be an objective test to be determined according to the circumstances of each
case.
Generally, a power will be exercised for a proper purpose if the director’s conduct is for the
benefit of the company. There may be circumstances, however, where conduct which the
directors believe to be in the best interests of the company is still improper. For example, an
allotment of shares to defeat a minority shareholding or the issue of shares to prevent a takeover
may be deemed to be an improper exercise of power even if the directors were of the view that
the exercise of the power was in the best interests of the company. Indicators that a director has
not acted for a proper purpose may include where a director promotes his or her personal
interests ahead of the company in circumstances where the director has a material conflict of
interest.6
In summary, it is intended that if the directors’ conduct is “extraneous to the interests of the
company and not a legitimate purpose for the exercise of the powers of a director” then the
director will not be able to rely on the Honest and Reasonable Director Defence. Similarly, if the
director is acting for a collateral purpose or with some bye motive (Maronis Holdings Ltd and
Another v Nippon Credit Australia Pty Ltd) other than the interests of the company or outside his
or her powers, then a director will not be able to rely on the Defence.

e. The degree of care and diligence the director rationally believes to be reasonable
In addition to the other elements set out above, to rely on the Honest & Reasonable Director
Defence, a director will be required to show that they conducted themselves with the degree of
care and diligence that the director rationally believed to be reasonable in all the circumstances.
Directors must therefore continue to exercise their powers and discharge their duties with the
degree of care and diligence that a reasonable person would exercise if they were:
 a director or officer of the corporation in the corporation’s circumstances and
 Occupied the office held by, and had the same responsibilities within the corporation as,
the director or officer.

6
HIH Insurance Ltd and HIH Casualty and General Insurance Ltd; ASIC v Adler (2002) 41 ACSR 72
 i. The degree of care and diligence that was reasonable in all the circumstances
The Defence requires a director to prove that they believed the degree of care and diligence they
exercised was reasonable. This element of the defence is intended to be a subjective test. The
director must genuinely believe that their conduct met a standard of care and diligence that was
reasonable having regard to the surrounding circumstances
ii. The belief must be rational
It is important to emphasize that for the Defence to apply the director’s belief as to the degree of
care and diligence reasonable in all the circumstances must be a rational one. While the
director’s assessment as to the reasonableness of the care and diligence applied in a particular
circumstance will be a subjective test, whether that assessment by the director is rational will be
an objective test. If all of the other elements of the Defence are met and a director has a rational
belief that the degree of care and diligence exercised is reasonable in all the circumstances, then
a Court will not be able to hold the director personally liable for that contravention. Irrational
assessments made by a director as to the degree of care and diligence exercised in a particular
circumstance will not be protected.

f. In his or her capacity as a director

The Honest & Reasonable Director Defence is limited in its operation so that it applies only
when a director is acting in his or her capacity as a director. If a contravention is committed by a
director outside the performance of his or her role as a director, such as where a director is acting
in their personal capacity, conducting their own affairs or acting as a shareholder, the defence
will not apply.
Having appreciated comparative jurisprudence in respect of Director Defenses from Australia it
is worthwhile noting that Kenya’s Company Act also contains some defenses especially in
respect of issuing of prospectus as highlighted below

A person sued under S.45 can rebut the presumption of liability by proving that:
i. Having consented to become a director he withdrew his consent before the issue of the
prospectus and that it was issued without his authority or consent; or
 ii. ii. the prospectus was issued without his knowledge or consent, and that on becoming
aware of its issue he forthwith gave reasonable public notice that it was issued without his
knowledge or authority; or
iii. iii. After the issue of the prospectus and before allotment there under he, on becoming
aware of the untrue statement, withdrew his consent to the prospectus and gave
reasonable public notice that he had done so and why; or
iv. iv. As regards every untrue statement not purporting to be made on the authority of an
expert or of a public official document or statement, he had reasonable ground to believe
that the statement was true; or
v. v. The statement was made by an expert and the expert consented to the inclusion of his
statement in the prospectus and that he believed the expert to be competent to make the
statement; or
vi. vi. The statement was taken from a public official document or was made by an official, and
was a correct and fair representation of the document or statement.
RATIFICATION
Ratification is a term generally understood to mean acceptance accession or acquiescence.
Sometimes Directors make errors that the company shareholders feel that they can live with and
hence consider not to seek redress for the error. In such an instance then the shareholders vote to
ratify the actions of the Director thus absolving him or her from any liabilities.
It should generally be appreciated however that ratification has its own limitation since it can not be
used to absolve from liability a Directors action which is manifestly illegal or ultra vires the
company’s constitutive objects
RELIEF FROM LIABILITY
Under Section 402 (1), the court has power in an action against an officer for breach of duty to grant
relief where, although the officer is in breach, it appears that he has acted honestly and reasonably and,
having regard to all the circumstances of the case, including those connected with his appointment, he
ought fairly to be excused for the negligence, default, breach of duty or breach of trust.

COMPENSATION FOR REMOVAL

Subsection (6) provides that nothing in Section 185 shall be taken as depriving a removed director of
compensation or damages payable to him in respect of the termination of his appointment as director
or of any appointment terminating with that as director. This provision which restates the common law
rule, would enable a managing director to sue the company for damages for wrongful dismissal if the
effect of his removal as director was to prematurely terminate his appointment as managing director,
and was inconsistent with the contract. The director might also, if he is a member of the company, be
entitled to an order for the winding up of the company by the court on the “just and equitable” ground:
Ebrahimi v Westbourne Galleries Ltd.

COMPENSATION FOR LOSS OF OFFICE

Section 192 makes it unlawful for a company to make a director any payment by way of compensation
for loss of office or as consideration for or in connection with his retirement, unless particulars of the
proposed payment, including the amount, are disclosed to the members of the company and the
proposal is approved by the company in general meeting. If the payment is not disclosed and approved,
the director to whom it is paid shall be deemed to have received it in trust for the company. The
directors who paid the money are liable to repay the money to the company: Re: Duomatic.

CONCLUSION

The case of Salomon V Salomon was no doubt land mark in asserting the separate existence of a
company. Yet whereas a company is vested with all the legal attributes of a natural person , truth is ,a
company does not have a thinking mind or hands to carry mails thus heavily relies on Directors to do the
work for it. And whereas shareholders are protected from the adverse effects of their venture, Directors
usually have to fend themselves from claims by shareholders whose sole interest is profit making and
mostly view Directors as their agents. The above defenses, though not exclusive, I dare say, form an
essential bulk of the defenses and reliefs available to Directors if things go south.

Emmanuel Rai Tsuma