27 May 2004

Directors' stand alone duty to disclose misconduct

by Dean Jordan, Fiona Boyce

An English case has held that a director can be obliged to disclose his or her own misconduct to the company which is a victim of it. If followed in Australia, this could lead to an additional ground of action for companies to employ against wayward directors.

"What has to be considered is whether…[a] director of a company is ever, and if so in what circumstances, obliged to disclose his own misconduct to the company which is a victim of it."

The above quote comes from an English decision involving an action by a company against one of its executive directors who was negotiating with a third party supplier to rob the company of its business, Item Software v Fassihi [2002] EWHC 3116.

In November 1998, the company was in the process of negotiating more favourable terms with the supplier. Prompted by the director in question, the company took a hard line in its negotiations which were ultimately unsuccessful, resulting in the supply contract being terminated. At the same time, another company, associated with the executive director, commenced negotiations with the supplier and later entered into a separate distribution agreement with the supplier one month after the company's contract was terminated.

The company sued the executive director for, inter alia, breaches of his duties as a director, in particular the duty to act in good faith and in the best interests of the company. The specific claims included:

  • sabotaging the company contract with the supplier by inducing the Managing Director of the company to negotiate unwisely
  • inducing these unwise negotiations so as to seek to obtain the contract for himself (ie. for the associated company)
  • persuading staff to leave the company and join the associated company; and
  • using confidential information of the company to divert customers to the associated company.

The court held that breaches of these duties by the executive director did not in themselves result in the company's loss, as even without the breaches, the negotiations would not have taken a different course. Nevertheless, the court held that had the company been aware of the executive director's misconduct, the negotiating style adopted by it would have been changed, and thus its losses did result from the executive director's breach of duty to disclose his misconduct. Importantly, the court answered the question "can a director be obliged to disclose his or her own misconduct to the company which is a victim of it?" in the affirmative.

The circumstances that the court took into account in reaching this view included that the director was contractually obliged to disclose important information known to him when negotiating on behalf of the company, that there had been fraudulent concealment by the director and that he was making a profit by appropriating the company's contract.

If the decision is followed by the Australian courts, it will mean that, depending always upon the circumstances of each case, companies may have a separate ground of action to recover damages for the losses they suffer at the hands of wayward directors, in addition to the grounds of action set out in the Corporations Act.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.