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With the recent announcement from Boustead Holdings Bhd that it had file a suit against its former managements for negligence; breach of fiduciary duties under the Companies Act 1965 and is seeking a sum of £6.4 million (RM35.37 million current value)1, this article will provide an insight as to directors’ duties and principle of exercise of business judgement by exploring the Federal Court case of Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd and another appeal  2 MLJ 177 (“Petra”).
[B] DIRECTORS DUTIES TO EXERCISE BUSINESS JUDGMENT UNDER THE COMPANIES ACT 1965
Under section 132 of the Companies Act 19652:
(1)“A director of a company shall at all times exercise his powers for a proper purpose and in good faith in the best interest of the company;
(1A)A director of a company shall exercise reasonable care, skill and diligence with –
(a) the knowledge, skill and experience which may reasonably be expected of a director having the same responsibilities; and
(b) any additional knowledge, skill and experience, which the director in fact has.”
In deciding whether a director has exercised a reasonable care, skill and diligence in making a business decision for the company, the director is in fact required to exercise a business judgment on the commercial affairs of the company.
What is a Business Judgement?
Under section 132(6) of Companies Act 19653:
“business judgment” means “any decision on whether or not to take action in respect of a matter relevant to the business of the company.”
How Directors Shall Exercise Their Business Judgement?
In most times the exercise by directors of business judgment on company affairs will result in the company making profits or suffering losses or other financial consequences.
The important question is what is the legal barometer to decide if the directors had or had not breached their duties to the company having exercised their business judgment over a commercial decision?
The barometer is provided for in the Companies Act, pursuant to which the statutory duties and requirements imposed on directors when exercising business judgment for company are as follows:
Under section 132(1B) of the Companies Act 19654 :
“A director who makes a business judgment is deemed to meet the requirements of the duty under subsection (1A) and the equivalent duties under the common law and in equity if the director –
(a) makes the business judgment in good faith for a proper purpose;
(b) does not have a material personal interest in the subject matter of the business judgment;
(c) is informed about the subject matter of the business judgment to the extent the director reasonably believes to be appropriate under the circumstances; and
(d) reasonably believes that the business judgment is in the best interests of the company.”
The Federal Court defined the above as “the statutory business judgment rule” which provided a presumption that a director acted with due care and skill if the requisite conditions provided in section 132 (1B) of the Companies Act 1965 are fulfilled.5
The Federal Court has also provided its observations on principles applicable to interpretation of some of the important provisions of section 132 (1B) of the Companies Act 1965 which will be discussed in the following parts of this article.
[C] IMPORTANT PRINCIPLES ON EXERCISE OF BUSINESS JUDGEMENT
Principle 1: Court’s Reluctance to Make Business and Management Decisions
The Federal Court reiterated an established principle where, in the absence of fraud, breach of fiduciary duty and conspiracy, there is a general reluctance among courts to replace its own decision with the business and management decisions of the directors as the court should recognise that risk-taking is an unavoidable element for profits in commercial realities.6
In summary, the Federal Court held that the courts should not:
(a) undertake the exercise of assessing the merits of a commercial or business judgment made by directors; and
(b) interfere with companies business decisions as long as the directors acted bona fide.7
Principle 2: Subjective Test
The Federal Court held that the test on whether a director has acted in the best interest of the company combines both subjective and objective tests.8
The subjective test involves an assessment of the state of mind of the director, namely whether the director (not the court) considers the exercise of discretion in the particular business transaction or decision is in the best interest of the company.9
The Federal Court further mentioned two English court judgments illustrating the nature of the subjective test, in which:10
(a) Lord Greene MR in re Smith & Fawcett, Limited stated that directors must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interest of the company;11 and
(b) Jonathan Parker J in Regentcrest Plc (in liq) v Cohen said on the question whether the director honestly believed that his act or omission was in the interests of the company, the issue is as to the director’s state of mind. It was further held where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.12
Principle 3: Objective Test
On the other hand, the objective test provides that the director’s assessment of the company’s best interest is subject to an objective review or examination by the courts13, with the following question to be considered, namely:
“whether an intelligent and honest man in the position of a director of the company concerned could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company.”14
The Federal Court took note that the Court of Appeal (in another case) had applied this principle and confirmed it as the correct objective test applicable to directors’ duties assessment.15
[D] FEDERAL COURT DECISION
Following the application of both tests, the Federal Court held that:
(a) the directors did not breach their duties in approving and undertaking the relevant commercial transaction, which the Federal Court accepted was indeed a business judgment made by the directors for a proper purpose, and in good faith in the best interest of the PPB;16
(b) there was clearly no evidence that as directors of the PPB, the directors had acted in breach of their duties to the PPB;17 and
(c) an honest and intelligent man in the position of the directors would reasonably have concluded that the 2nd and 3rd divestments were in the best interests of the PPB.18
In addition, this article will also explore several precautionary practices, based on our above observation of the Federal Court’s judgement in which directors could adopt to safeguard their interest in the event of unwanted litigation.
(i) Contemporaneous Documents – Minutes of Board Meetings
The High Court had supported the notion of recording the minutes of meeting in its judgement and stated the minutes form a valuable and objective study of the proceedings of the PPB at the material time. Matters as encompassed in contemporaneous and in form of the minutes of meeting are therefore directly relevant and assist the court to ascertain the rationale or purpose underlying the decision to sell the subject PEB shares vide the second and third divestments.19 Company directors are therefore encouraged to take steps to ensure that proper minutes of the board of resolutions are made and retained.
(ii) Tape Recording
Secondly, the practise of audio recordings during board meetings, albeit not a common approach, was also commended by the High Court trial judge for its importance as it revealed the decision in the third divestment was reached by the board of directors after due and long deliberations. In this regard, the High Court and Federal Court were able to conclude and undermine the credibility of the PPB’s witness, who was also one of the company’s directors, who sought to later deny the approval of the third divestment in trial.20 As such, it would be advisable for directors to adopt such approach, especially in meetings which involve highly contentious matters.
(iii) Internal and External Advice
The High Court and Federal Court, in arriving its judgements, also took into consideration of the internal and external advices sought and received by the directors, in the form of presentation and briefing by the senior management of the company, legal opinion and professional advices, prior to the meetings to consider whether to approve and implement divestments in shares.21
Prepared By: Lee Kin Hing, Ong Sern Tai & Gabriel Yee Full Yek