Introduction

Not only has the Companies Act 71 of 2008 (the “Act”) changed our entire corporate landscape, but it has also transformed the roles and duties of directors and the associated liability they may face.

Generally, directors are responsible for running a company’s day-to-day business.The Act also includes ex officio directors and prescribed officers. The status and duties of ex officio directors were already illustrated in Strut Ahead Natal (Pty) Limited v Burns 2007 3 All SA 190 (D), where the court found that the defendant was not registered at the Companies and Intellectual Property Commission (CIPC) as a director but was, in fact, responsible for running the company as a director would have. The defendant in this case was declared personally liable by the court, in terms of section 424(1) of the Companies Act of 1976 (the ”old Act”), for knowingly carrying on company’s business recklessly. This judgement was based on the fact that he was the only person with knowledge of the company’s financial affairs.

This means the Act has broadened the definition of a director. Furthermore, it does not draw any distinction between executive and non-executive directors (employees and non-employees who serve as directors).

When ensuring accountability and transparency under section 7 of the Act within companies, directors’ duties now codified by the Act play a pivotal role. Broadly speaking directors’ fiduciary duties have not changed except for being codified in the Act. The duty of care and skill, on the other hand, has evolved somewhat. Therefore, it is the focus of this article.

Duty of care and skill - the nature of the business judgment rule

It is useful to consider the laws specifically of the USA and Canada, which the Act empowers our courts to do in its section 5(2). Furthermore, the so-called business judgement rule (section 76(4)), originally imported from the USA into Canada and then into SA, states that directors may be exonerated for liabilities in general provided they acted with due care, skill and diligence.

According to Stoop HH 2012 129(3) SALJ 547, this American creature determines that a court will not interfere with the business judgement of directors where fraud, bad faith or lack of care is absent. However, the interpretation and specific application of this has not been tested by our courts. So, for some guidance on its potential interpretation and implementation in South Africa, we refer to the most notable foreign ruling (USA - Delaware) in terms of the business judgement rule: the Disney case (In re Walt Disney Derivative Litigation, Case No. 411, 2005 (Del. June 8, 2006).

Here, a group of shareholders brought an action against the directors of the Walt Disney Company broadly on the grounds of breach of fiduciary duty and taking due care. The facts of this case were that the board of directors hired − then dismissed − a chief operating officer just 14 months later on a particularly large termination package, estimated at $140 million. The court ruled that the board had been properly authorised and the chief operating officer’s appointment and terms were valid. Importantly, the board was ruled to have exercised sound business judgement despite the losses incurred. As a result, the shareholders’ action failed.

The court stated that: “As for the plaintiff’s contention that the directors failed to exercise ‘substantive due care’, we should note that such a concept is foreign to the business judgment rule. Courts do not measure or qualify directors’ judgements. We do not even decide if they are reasonable in this context. Due care in the decision-making context is process due care only. Irrationality is the outer limit of the business judgment rule. Irrationality may be the functional equivalent of the waste taste or it may tend to show that the decision is not made in good faith, which is a key ingredient of the business judgment rule.”

In Canada, however, the business judgment rule is not a standalone rule as a description of how directors’ duties of care and skill are measured, although it is imported from the US. This is according to Nordick et al, as well as recent jurisprudence in the cases of Brant Investments Ltd v Keep Rite Inc 1991 3 OR 3rd 289 CA, which was furthermore applied in several further Ontario rulings. The Supreme Court of Canada further endorsed this approach in the 2004 ruling in Peoples Department Stores Inc (trustees of) v Wise 2004 3 SCR 461.

Here, the court stated: “Directors and officers will not be held to be in breach of a duty of care…if they act prudently and on a reasonably informed basis. The decisions they make must be reasonable decisions in light of all the circumstances about which directors or officers knew or ought to have known. In determining whether directors acted in a manner that breaches the duty of care, it is worth repeating that perfection is not demanded. Courts are ill-suited and should be reluctant to second guess the application of business expertise to considerations that are involved in corporate decision-making, but they are capable, on the facts of any case, of determining whether an appropriate degree of prudence and diligence was brought to bear in reaching what is claimed to be a reasonable business decision at the time it was made (para 6.7).”

Could this mean that our courts should now avoid interfering in corporate decision making and only focus on the manner in which a decision was reached?

Further to this, D Rosenberg Bepress Legal services 2006 1067: 14 -18 (http://law.bepress.com/cgi/viewcontent.cgi?article=5078&context=expresso: accessed 13 October 2012) states that in terms of Delaware law, there is a requirement that the directors act honestly and in good faith. Rosenberg further notes that this is only the starting point of interpreting the business judgment rule. He further comments that the reasonable director standard (the test we have previously used in SA) is too strict. The pivotal question Rosenberg raises in his paper is: How can a court determine that a decision is reasonable or falls within the required parameters or was reached by the exercise of skill and care if the decision itself is not examined? It is very difficult to distinguish between the standards for “reasonable” and “rational” when it comes to corporate directors. It could even be impossible in the light of this comment: “A rational director is one who makes decisions he believes to be reasonable.” (Rosenberg BLR 2006 – 20). 

Rosenberg further states at 22 and 23, that there must be a point at which a court will look at a decision that appears to be free from any hint of disloyalty and simply review it because of its utter, galactic stupidity. Additionally, when he also investigated the Disney case, one of the judges commented that the decision does not hinge on the breach of a duty of loyalty but rather on fulfilling the duties of care and good faith. Accordingly, directors will be free from liability if they unknowingly or unintentionally acted against the best interests of the company. This is very close to section 77(9) of our Act. On the other hand, Rosenberg continues, where a director will knowingly and intentionally act against the best interests of the company, they would have acted disloyally and, therefore, in bad faith.

Finally, Rosenberg quotes a decision in Caremark Intern. Inc. Deriv. Lit., 698 A.2d 959, 967 (Del. Ch. 1996): “To employ a different rule that permitted an object of evaluation of the decision would expose directors to substantive second-guessing by your input judges or juries, which would, in the long run, be injurious to investor interests. Thus, the business judgement rule is process orientated and informed by a deep respect for all good faith board decisions.”

Generally speaking, we are somewhat in a state of limbo in South Africa. On one hand, directors will apparently be held to a higher standard of conduct and responsibility and will be measured by both a subjective and objective test. On the other hand, they will be allowed a certain leeway under the fairly broad business judgement stipulations. Internationally, our courts are generally considered not to interfere with corporate decision making. But the terms under which this part of the new legislation will be applied in South Africa, and the extent to which it will be applied, will remain uncertain until clarified by the courts.

Conclusion

In my view, the courts should not interfere with the corporate decision making process when they do not have the commercial or business acumen to do so. Where the courts do so, it is important that they consider the parameters enshrined in foreign law and the specific company’s MOI insofar as it applies. The duty of good faith should be pivotal in corporate decision – making.

Until we have precedent to understand the exact interpretation of the business judgment rule in the South African context, companies should choose directors wisely and attorneys should attempt to regulate their clients’ positions and its parameters carefully through the company’s MOI. Companies should not only align their MOI with the provisions of the Act, but they should also codify directors’ qualifications.

Written by Nicolene Schoeman-Louw, Schoeman Attorneys

*** PLEASE NOTE THAT THIS FULL RESEARCH PAPER WAS PUBLISHED IN THE JULY 2013 EDITION OF WITHOUT PREJUDICE - http://www.gleason.co.za/fusion/articles.php?article_id=1679 OR http://www.schoemanlaw.co.za/publication-in-without-prejudice-journal-how-the-companies-act-impacts-on-directors/