Better to be Safe than Sorry – Director’s Duty to Make Disclosure of Interest

Let’s say X is a director of Company Y and Company Z concurrently.

Can X cause Company Y to enter into a contract with Company Z? Will it cause conflict of interests? How should X deal with a situation like this?

The short answer is: X has to disclose to the boards of directors of both Company Y and Company Z regarding his interests in the contract.

The Law

In Malaysia, Section 221 (1) of the Companies Act 2016 (“CA 2016”) provides that every director of a company who is in any way, whether directly or indirectly, interested in a contract or proposed contract with the company shall, declare the nature of his interest at a meeting of the board of directors as soon as is practicable after the relevant facts have come to the director’s knowledge

The objective of Section 221 was highlighted in the recent decision of the Court of Appeal on 11th February 2020 in the case of Delta-Pelita Sebakong Sdn Bhd v. Wong Hou Lianq & Ors And Other Appeals [2020] MLRAU 41. In the wise words of Her Ladyship Rhodzariah Bujang JCA:

It is obvious that the said section is rooted in the need to ensure transparency in the dealings by the management of the company and the moral integrity of those helming the administration of the company. 

Notwithstanding that, at the same time, there is one thing to note; not all types of interests must be disclosed. 

Section 221 (2) of CA 2016 stipulates that the duty to disclosure under Section 221 (1) shall not apply in the case where the interest of the director being a member or creditor of a corporation interested in a contract or proposed contract with the first-mentioned company if the interest of the director may be regarded as not being a material interest.

In short, only those interests which are material and those transactions which are significant to the company that needed to be disclosed. And that failure to disclose will amount to none other than a breach of fiduciary duty by the director. 

Test for Director’s Duty of Disclosure

At common law, the “reasonable man” test is used – the interest required to be disclosed are those which a reasonable man taking into account relevant facts and circumstances will come to a conclusion that there is a real sensible possibility of conflict. 

Justice Warren (England & Wales Chancery Division) in the interesting case of Wilkinson v West Coast Capital [2005] All ER (D) 346 (Dec) held that there is no real sensible possibility of conflict if a director of a company selling fashion clothing decides to take a stake in a farm machinery company. 

With that being said, whether or not interest is material or not, is a question of facts. Among others, one has to examine the following:

1. How the company’s business is organised;
2. The subject matter involved;
3. The nexus between the subject matter and the company;
4. The role played by the director; and 
5. The contractual terms governing the parties. 

An example would be – A and B were directors of C, a hotel industry consultancy company. At the same time, B entered into a brokerage agreement with D, a vendor. A and B then advised E, a buyer to buy a property from D. After the sale, E discovered that B received a commission fee of €10million from D. E then claimed that B failed to make proper disclosure of the brokerage agreement and hence the said commission was a secret profit. 

The above story is the actual facts of the case of FHR European Ventures LLP v Mankarious [2011] EWHC 2999 (Ch).

Guess what?

The Judge in the above case held that considering that the commission fee was much more than what is customary, it was insufficient for B to merely inform the board of the receipt of such a commission; it is also imperative for B to disclose the amount of the commission received.

The question now boils down to the extent of which a director must disclose his interest. 

Case law tells us that a director must provide full and frank disclosure with regard to interests that concerns the company. Whether or not such disclosure is sufficient or effective is a question of fact, taking into consideration the circumstances of each case. There is no exact formula to such disclosure. A director’s “full and frank” disclosure may vary based on a variety of factors, including the degree of interests, the amount of monies or value involved in a given transaction, the source or scale of profits in a transaction and etc.

To Disclose or Not to Disclose

At this point, directors are at a crossroad on whether or not the disclosure of interest is warranted and the extent of disclosure, if any.

Fret not. The law does provide for some guidance. The Court of Appeal in Delta-Pelita Sebakong Sdn Bhd v. Wong Hou Lianq & Ors And Other Appeals [2020] MLRAU 41 cited the Annotated Statutes of Malaysia on the Companies Act and held that:

“…disclosure of potentially conflicting information is part of the commercial morality expected of company directors, and the general rule should be, when in doubt, disclose.”

I repeat. WHEN IN DOUBT, DISCLOSE!

The Effects of Disclosure

Let’s say that a director has disclosed his interest in a contract to the board of directors. Does this also mean that the director has effectively discharged the fiduciary duty owed to the company?

An effective disclosure only displaces the repercussions of the no-conflict rule. In other words, by effectively disclosing his interest, the director has avoided facing the consequences of a conflict of interest. This does not absolve the director from his duty to act in good faith in the best interest of the company and its purposes.

As aptly pointed out by Richard Malanjum J (as his Lordship was then) in the Tawau High Court case of Magnifine Sdn Bhd v. Yap Mun Him [2005] 2 MLRH 277:

“As a fiduciary the defendant was obliged to make a full and frank disclosure of not only the fact that he was being paid but also as to the amount. Indeed even with a full and frank disclosure the no-conflict rule and no-profit rule would not have excused or exempted him from his fiduciary duty to act bona fide in the interest of the plaintiff and for proper purposes.“

Conclusion

Based on the above, it is clear that directors have the duty to disclose his their interest (whether directly or indirectly) in a contract or proposed contract with the company at a meeting of the board of directors, as soon as practicable after the relevant facts have come to his knowledge. Failing which, the director shall be held liable for a breach of fiduciary duty.

However, the law provides that only material and significant interests need to be disclosed, and the determination of what constitutes “material and significant” interests remains a question of fact for the courts to decide.

Regardless, whenever in doubt, full and frank disclosure is still the safest bet. As saying goes, it is always better to be safe than sorry.