Landmark Federal Court case on Power of Directors vs Shareholders
The Federal Court (FC) ruled that it is the Board of Directors who make the business decisions of the company and not the shareholders, provided they act within the powers delegated to them by the law. The courts will not examine the merits of commercial decisions or business judgement of company directors as long as they have acted bona fide. The FC also reiterated the test to determine the duty of directors to act in the best interest of the company and the test to determine whether there was a breach of duty of directors.
The company, Petra Perdana Bhd (PPB) sued three former directors of the company – Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra (also the Executive Chairman and Chief Executive Officer), Wong Fook Heng ( Non Executive Independent Director) and Tiong Yong Kong (Non-Executive Independent Director) for breach of duty to act in the best interest of the company, acting dishonestly and conspiring to cause the company loss and damage (the 3 Impugned Directors). The claim arose from a business decision made by the Board of Directors to sell off the controlling shares in Petra Energy Bhd (PEB), a subsidiary of PPB.
PPB, inter alia, claimed that the decision of the directors to sell the shares of PEB breached prior resolutions passed by the shareholders at several prior Annual General Meetings (AGM) of PPB where the Board of Directors were given the mandate to sell off up to 10% of the shareholding of PPB in PEB subject to certain price restrctions (the Shareholders’ Mandate). This Shareholders’ Mandate was initially passed in PPB’s AGM in 2007 and then repeated at every AGM until 2009. In late 2009, the Board of Directors had decided to sell off PPB’s entire shareholding in PEB (which amounted to approximately 55% of PEB’s shareholding) in several tranches, termed “Divestments”.
This, the company, PPB, claimed was in breach of the Shareholders’ Mandate as the Board of Directors had decided to sell PPB’s entire shareholding (as opposed to 10%) in PEB and there was at least 1 tranche, the 2nd Divestment, where the price restrictions imposed in the Shareholders’ Mandate was not met.
In February 2010, at an Extraordinary General Meeting (EGM) called by some shareholders, who were opposed to sale of the PEB shares, the majority of shareholders voted to remove the 3 Impugned Directors and Tengku Petra’s wife from the board of directors of the company premised on mainly the allegation that the Board of Directors had breached the Shareholders’ Mandate and that they had acted in breach of their fiduciary duties to PPB. New directors aligned to the shareholders who had called for the EGM were then appointed to the Board of Directors of PPB in place of the 4 removed directors.
In , newly constituted Board of Directors of PPB then initiated civil proceedings against only the 3 Impugned Directors, although the decision was that of 5 members of the board of directors, for breach of fiduciary duties and conspiracy to cause damage and loss to PPB.
The 3 Impugned Directors claimed they sold off the shares in order to alleviate serious cash flow problems faced by PPB. Their decisions to sell the PEB shares were made in meetings of the Board of Directors, after studying financial reports and proposals submitted by the finance manager and taking expert advice from professionals.
In the High Court, judgment was in favour of the 3 Impugned Directors. On appeal to the Court of Appeal, the decision of the High Court was reversed. And now on appeal to the FC, the appeal was allowed and the High Court judgment was restored in favour of the 3 Impugned Directors.
The FC Decision
Powers of Directors vs Shareholders
The Federal Court held that shareholders in General Meeting may not usurp the powers of management conferred by the articles of associations (AA) on the Board of Directors of a company. Shareholders may only assert their powers over the Board of Directors by altering the AA to take away the powers of the directors whose actions they disapprove or remove the directors concerned. (See John Shaw & Sons (Salford) Limited v. Peter Shaw and John Shaw  2 KB 113, C.A.; Scott and Scott  1 All ER 582).
The FC also relied on S.131B, Companies Act, 1965, which was inserted into the Companies Act 1965 in August 2007 which expressly provides that the board of directors “must manage the business and affairs of the company.
The FC restated the English common law position which is codified in the Companies Act, 1965, that shareholders cannot interfere with business decisions of a company made by the board of directors. This effectively meant that even if shareholders pass resolutions at General Meetings of a company that have an effect on “business decisions” of a company, the Board of Directors are not curtailed or restricted by those resolutions. The Board of Directors possess the ultimate powers to make “business decisions” of the company subject to the duties of directors to act “in the best interest” of the company.
Test for Directors’ Duty to Act in the Best Interest of the Company
In determining whether there was a breach of duty to act in the best interest of the company, the test to be applied is the subjective test i.e. whether the directors exercised their powers honestly and not for any collateral purpose, in what they consider to be the best interest of the company. (Re Smith & Fawcett Ltd  1 Ch 304). In this regard, the court will not second guess what is in the best interest of the company as it is solely a business decision that the directors take based on their own assessment and evaluation of the business risks of the company.
Test for Breach of Director’s Duty
In determining whether there was a breach of duty by the directors, the FC held that both subjective and objective tests had to be used. The subjective test was the state of mind of the director i.e. whether the director acted bona fide. The objective test called the Charterbridge principle (as enunciated in the famous English Charterbridge case) is whether an honest and intelligent man in the position of the director could, taking all matters into consideration, have reasonably believed that the transaction was for the benefit of the company. (See Charterbridge Corp Ltd. v. Lloyd’s Bank Ltd. Ch 62; adopted by our Court of Appeal in Pioneer Haven Sdn Bhd v. Ho Hup Construction  3 MLJ 616 .
Applying the tests to the facts of the present case, the FC ruled that the divestment of the shares in PEB were in the best interest of the company, for proper purpose and in good faith and there was no evidence that the directors acted in breach of their duties.
The FC also held that the statutory business judgement rule is provided under S.132(1B), Companies Act, 1965 and supported by the common law, that the courts do not undertake the exercise of assessing the merits of a commercial decision or business judgement made by directors as long as the directors acted bona fide. (See Howard Smith Ltd. v. Ampol Petroleum Ltd and Others  AC 821).
This case restates the law and clears the air pertaining to the debate over the constant struggle between the powers of management of directors over the powers of shareholders to control directors’ powers. The decision cannot be read to give carte blanche powers to directors to do as they please. It restates the law that shareholders cannot curtail or control the board of directors when it comes to “business decisions” of a company. The directors are always subject to provisions in the Companies Act, (now 2016) that provide that directors must always act in “the best interest” of the company. This case has also determined the tests that the directors have to comply with in determining what is “the best interest” of a company.
Alex De Silva and Gajendran Balachandran from BPD acted for Wong Fook Heng and Tiong Yong Kong. For further information, please contact email@example.com