Directors’ Duties: The Proper Test for the Improper Purpose

If you are a fan of the Marvel Cinematic Universe movies, you would know the movie, ‘Captain America: Civil War’. 

In ‘Captain America: Civil War’, Thaddeus Ross, the US Secretary of State, informed the Avengers that the United Nations was preparing to pass the ‘Sokovia Accords’, which would establish a UN panel to oversee and control the Avengers. The Avengers were divided, with one faction (headed by Tony Stark) supported the oversight, and the other, opposed it.

Why? 

Humans (aside from aliens of course – the existence of which is still arguable) may be the species with the highest intellectual capacity in the universe.

Nevertheless, it is, understandably, inevitable that we fear other humans having more powers than us. Most of the time, this fear is deeply rooted in the things that are not visible to our eyes – particularly the motives behind the exercise of such powers. Hence the need for some assurance that other humans who have more powers than us can be held accountable for the exercise of the same.

Directors, in this sense, are like superheroes – they too have powers! And, instead of gene mutation or a rock from the space, these powers are conferred by the constitution of the company and/or the relevant laws (statutory or otherwise).

However, the issue is not when the directors act outside of their powers. It is when the directors seemingly act within their powers, but for a different purpose. 

“With great power, there must also come great responsibility.”

Peter Parker, Spiderman

Indeed, directors have the duties to “…exercise his powers… for a proper purpose and in good faith in the best interest of the company…” [see Section 213 of the Companies Act 2016].

So, how can the court pick up pieces of the puzzle and put them together to complete the whole picture (or at least, one on the balance of probabilities)?

The answer is the ‘proper purpose test’. 

The ‘proper purpose test’

The ‘proper purpose test’, according to the Federal Court in Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd and another appeal [2018] 2 MLJ 177 (“Tengku Dato’ Ibrahim case”) involves both subjective and objective elements, as follows:-

“[166] In our judgment, the correct test combines both subjective and objective tests. The test is subjective in the sense that the breach of the duty is determined on an assessment of the state of mind of the director; the issue is whether the director (not the court) considers that the exercise of discretion is in the best interest of the company… 

[167] The test is objective in the sense that the director’s assessment of the company’s best interest is subject to an objective review or examination by the courts.

… 

The subjective element lies in the court’s consideration as to whether a director had exercised his discretion bona fide in what he considered (and not what the court considers) is in the interests of the company…

The objective element in the test relates to the court’s supervision over… 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.” 

What is considered as the best interest of the company is wide, and may even extend to the interests of the shareholders [see the decision of the Court of Appeal of Australia in Darvall v North Sydney Brick and Tile Co (1989) 16 NSWLR 260].

Even a smidgen of ulterior purpose could spoil the milk. 

In Pioneer Haven Sdn Bhd v Ho Hup Construction Co Bhd & Ano and other appeals [2012] 3 MLJ 616, the Court of Appeal held:-

“Even though the motives for exercising a fiduciary power are substantially altruistic, if those altruistic motives were actuated by an ulterior or impermissible purpose or were carried out in an improper manner, they will be set aside. This is so in order to ensure the integrity of the actions of the fiduciary and to require that the fiduciary’s decisions are made bona fide and for proper and relevant purposes.”

Examples of how the Court applied the ‘proper purpose test’

In applying the ‘proper purpose test’, the Court, amongst others, will look into:- 

• the circumstances leading up to and/or surrounding the exercise of the power of the directors; and 
• the effects of and/or reasons put forth by the directors in the exercise of such power, 
• to ascertain the purpose of the exercise of such power, as can be seen below.

The Pioneer Haven case

In the Pioneer Haven case, the Court of Appeal, in determining whether the directors of Ho Hup Construction Co Bhd (“HHCC”), the company in question, had exercised their powers for a proper purpose and/or in good faith, looked at the circumstances leading to and the effect of the entry into the JDA, as, inter alia, follows:- 

(a) shortly before the directors of HHCC entered into the joint development agreement (“JDA”), HHCC was facing the risk of being delisted. As such, the entering into the JDA would:- 

• prevent the delisting HHCC; and 
• solve the financial problems faced by HHCC.

To further compound the view of the directors on the JDA, the sentiment of the said directors was also shared by the financial officer of HHCA.

(b) In addition to the above, there was no tangible evidence of the JDA being “…a bad deal…” for, amongst others, HHCA. 

The MARA case

In the case of Majlis Amanah Rakyat (MARA) v Dato’ Abd Rahim Bin Abd & Ors [2019] 7 MLJ 381 (“MARA case“) case, the first to the fourth defendants (being the directors of Med-Bumikar Mara Sdn Bhd (“MBMS”), the company in question) purported to appoint, by way of a directors’ circular direction, the fifth and sixth defendants as additional directors of MBMS. 

Wong Chee Lin JC (as Her Ladyship then was), in taking into account the events leading up to the appointment of the fifth and sixth defendants as additional directors of MBMS, held, amongst others, that the said directors did not exercise their powers, in such appointment, for a proper purpose and/or in good faith as:- 

The appointment of the fifth and sixth defendants by the directors of MBMS (approximately a month after MARA issued a notice to requisition an extraordinary general meeting (“EGM”) to, inter alia, appoint additional directors of their own to the board of MBMS), was made to scupper MARA from proceeding with the said EGM; 

The first to fourth defendants had also not shown:- 

• why there was a need to appoint two additional directors at that material time; and 
• why the appointment could not have been tabled at a physical meeting of the directors of MBMS.  

The Tsang Wai Lun case

In the case of Tsang Wai Lun Wayland & Anor v Chu King Fai & Ors [2009] HKCU 1195 (“Tsang Wai Lun case“), the directors of Grand Field, the company in question, appointed their own additional directors purportedly on the basis that such appointment could strengthen the expertise of Grand Field. However, the Hong Kong Court of First Instance found that the power of the directors in issuing shares was not exercised for a proper purpose and/or in good faith as, inter alia:-

• the sole or predominant motive of the directors in issuing such shares was to prevent the majority shareholder of Grand Field from nominating himself and his brothers as directors, and thereby, entrench control of the management of Grand Field by the said directors by diluting the shares of the said majority shareholder in Grand Field; and
• there was also no reason for additional shares to be issued (since amongst others, the company does not require more capital at that particular time). 

The Pan Asia case

In Lim Koei Ing v Pan Asia Shipyard & Engineering Co Pte Ltd [1995] 1 SLR 499 (“Pan Asia case”), the High Court of Singapore looked at the effect of the appointment of the four new directors to the board of the defendants, and found that the directors did not exercise their powers for a proper purpose and in good faith in such appointment as, inter alia:- 

• such appointment would result in the failure in the board of the defendants to fairly reflect the interests of the shareholders in the defendant; and 
• that there was no credible explanation as to why the services of these new directors were required by the defendants at the particular point of time.

Conclusion

The ‘proper purpose test’ is a holistic approach in determining whether the exercise of a particular power by the directors in question is used for a proper purpose and in good faith, and no particular factors override another as it would depend on the factual matrix of each case. This is evident as courts have considered:-

• the absence of any element of the self-interest of the directors in exercising their powers [see the decision of the Privy Council in Smith (Howard) Ltd v Ampol Petroleum Ltd [1974] AC 821]; and 
• the statements by directors concerning their subjective intentions or beliefs [see the decision of the Supreme Court of Australia in Advance Bank Australia Ltd v FAI Insurances Ltd (1987) 12 ACLR 118],

as not conclusive evidence of the minds and motive of the said directors.