Between a Rock and a Hard Place
30 April 2017
Kelly Chung discusses the duties of a nominee director under the Companies Act 2016.
The term “nominee director” is not defined in the Malaysian Companies Act 2016 (“CA 2016”). The Corporate Law Reform Committee (“CLRC”) which was established in 2003 pursuant to the Companies Commission of Malaysia Act 2001 to undertake a comprehensive review of the corporate law in Malaysia between 2003 to 2007, accepted the definition by the Australian Companies and Securities Law Review Committee, which states that the term “nominee directors” refers to “persons who, independent of the method of their appointment, but in the performance of their office, act in accordance with some understanding, arrangement or status which gives rise to an obligation … to the appointor.”
The status of nominee directorship may pose difficulties to a nominee director as he may be required to balance the interests of, on the one hand, the company on which he sits on the board, and on the other, of the person who nominated him to the board. This may put a nominee director in a position of potential conflict in dealings between the company and his appointor or other persons or entities in which his appointor has an interest.
DEVELOPMENT OF THE LAW IN MALAYSIA
Statutory regulation of the duty of a nominee director was introduced in Malaysia when the Companies (Amendment) Act 2007 came into force on 15 August 2007. A new section 132(1E) (“S.132(1E)”) was inserted into the Companies Act 1965 (“CA 1965”) which reads as follows –
“A director, who was appointed by virtue of his position as an employee of a company, or who was appointed by or as a representative of a shareholder, employer or debenture holder, shall act in the best interest of the company and in the event of any conflict between his duty to act in the best interest of the company and his duty to his nominator, he shall not subordinate his duty to act in the best interest of the company to his duty to his nominator.”
S.132(1E) of the CA 1965 did not break new ground as it merely codified the duty imposed on nominee directors under the common law, which had hitherto been applied by the Malaysian court in Industrial Concrete Products Bhd v Concrete Engineering Products Bhd  2 MLJ 332.
In this case, an individual, Choo (“Choo”), was appointed as a director of Concrete Engineering Products Bhd (“CEPCO”) by certain individuals whom Choo claimed had acquired controlling interest in CEPCO. Subsequent to his appointment, Choo attempted to dispose of CEPCO’s core business to its main competitor without the consent of CEPCO’s board. According to Choo, this scheme fitted into his appointors’ corporate plan which was to replace CEPCO’s core business with another business.
The trial judge, James Foong, J, referring to the Singapore case of Kumagai Gumi Co Ltd v Zenecon Pte Ltd & Ors  SLR 282, declared that “the primary duty of a director is his allegiance to the company, except, if he, as a nominated director and where there is no conflict of interest, then he may take into account the interest of his principal.”
After considering the facts in detail, the Judge opined that Choo had not acted bona fide in the interest of CEPCO nor promoted or advanced CEPCO’s interests. His Lordship concluded that Choo’s actions as a director throughout this period were solely for the benefit and interest of the group that nominated him to the board of CEPCO. According to the Court, such interest not only conflicted with those of CEPCO but had disastrous consequences on CEPCO as its assets were nearly stripped and its core business was on the verge of being annexed by its main competitor. In light of the foregoing, the learned Judge concluded that Choo had been in breach of his fiduciary duty to CEPCO.
Subsequent to the Industrial Concrete Case, two cases came up for consideration by the Malaysian Courts after the enactment of S.132(1E) of the CA 1965.
The first was Sundai (M) Sdn Bhd v Masato Saito & Ors  9 MLJ 729. The first defendant, Saito (“Saito”) was a director and principal of the plaintiff which carried on business of an education centre for a Japanese education programme in Malaysia. Saito was also the nominee of Sundai Japan, the shareholder of the plaintiff.
Saito conspired with various individuals in a scheme to set up a rival school and carried out various actions, such as using the plaintiff’s confidential information to cause damage to the plaintiff and to further the objectives of the rival school.
The Court held that Saito was bound by S.132(1E) of the CA 1965 and had a duty to act in the best interest of the plaintiff. The Court observed that when there is a conflict between his duty to the plaintiff and his duty to his nominator, Saito should not subordinate his duty to act in the best interest of the plaintiff to his duty to his nominator. Although the Court held that Saito had breached his duty to the plaintiff, this was more a case of breach of a director’s general duty to act in the best interest of the company under section 132(1) of the CA 1965 rather that a case of a conflict between the duty of a director to act in the interest of the company and his duty to his nominator as Sundai Japan was not involved in the establishment of the rival school and was as much a victim of Saito’s actions as the plaintiff.
In Abdul Rahim bin Suleiman & Anor v Faridah bt Md Lazim & Ors  MLJU 598, the first respondent was a shareholder of a company and also the administrator for an estate of which she and her siblings were beneficiaries (“Estate”). The Court of Appeal proceeded on the basis that the first respondent was appointed as a nominee director of the company by the Estate.
The company had intended to bring a claim of approximately RM1.4 million against the Estate. However, a settlement agreement was entered into for approximately one-half of the amount claimed, which the first respondent had voted in favour of. It was found that the settlement was clearly intended to benefit the beneficiaries of the Estate and was not in the best interest of the company. The Court decided that the first respondent could not, on the one hand as the administrator of the Estate, make a proposal for the benefit of the Estate and on the other hand, as a director of the company, accept her own proposal. As such, it was held that the first respondent had acted in contravention of S.132(1E) as she had subordinated her duty to the company to her duty to her nominator.
Subsequent to these cases, the CA 2016 came into operation on 31 January 2017. As section 217(1) of the CA 2016 is identical in terms with the now repealed S.132(1E) of the CA 1965, except for the use of the word “member” in place of “shareholder”, the principles laid down by the Malaysian Courts in Sundai (M) Sdn Bhd and Abdul Rahim bin Suleiman remain applicable.
DEVELOPMENTS IN OTHER JURISDICTIONS
In these days when it is not unusual for a company to have shareholders which are companies or to be formed as a joint-venture between other companies, the strict approach of requiring a nominee director to act in the best interest of the company in the event of a conflict between his duty as a director and his duty to his nominator has been diluted in certain jurisdictions through the introduction of the adjusted fiduciary duty which in certain instances, allows a nominee director to act in the best interests of his nominator.
The adjusted fiduciary duty has been adopted in the New Zealand Companies Act 1993 (“NZCA”). Section 131 of the NZCA provides that a director of a company that is a wholly-owned subsidiary, may if expressly permitted by the constitution of the company, act in a manner which is in the best interests of the holding company even though it is not in the best interest of the subsidiary. Similarly, a director of a joint venture company, may if expressly permitted by the constitution of the company, act in a manner which is in the best interests of a shareholder or the shareholders even though it is not in the best interest of the subsidiary.
The NZCA also permits a director of a company that is a subsidiary (but not a wholly-owned subsidiary) to act in the best interests of the holding company even though it is not in the best interest of the subsidiary, provided that it is expressly permitted to do so by the constitution of the company and the prior agreement of the shareholders (other than its holding company) is obtained.
The adjusted fiduciary duty has been adopted in Australia only in respect of a company that is a wholly-owned subsidiary of another. Section 187 of the Australian Corporations Act 2001 (“ACA”) provides that a director of a wholly-owned subsidiary will be taken to have acted in the best interest of the subsidiary if the following conditions are satisfied: (i) the constitution of the subsidiary expressly authorises the director to act in the best interests of the holding company; (ii) the director acts in good faith in the best interest of the holding company; and (iii) the subsidiary is solvent at the time when the director acts and does not become insolvent because of the director’s act.
Notwithstanding the limited recognition of the special position of nominee directors by statute, the Australian courts have long accepted that it is unrealistic and in some cases, impossible, to expect nominee directors to approach every company problem with a “completely open mind”. The case of Re Broadcasting Station 2GB Ltd [1964-65] NSWR 1648 sets out the general principle that a nominee director is entitled to take into account the interests of his appointing shareholder as long as the director honestly believes those interests are consistent with the interests of the company as a whole and such belief is not unreasonable.
In Re Broadcasting Station, Jacobs J rejected the idea that nominee directors could not take into account the interests of their appointors. Instead, he took the view that there would only be a violation of the directors’ duties if the directors had knowingly sacrificed the interests of the company while acting in accordance with the wishes of their appointor. According to Jacobs J, to require a higher standard of nominee loyalty would be to “ignore the realities of company organisation [and] … make the position of a nominee or representative director an impossibility.”
The United Kingdom
The position in the UK appears to place greater emphasis on a company’s wider interests rather than focus solely on the interests of the shareholders. Section 172(1) of the UK Companies Act 2006 (“UKCA”) allows a director of a company to act in the way he considers, in good faith, to be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so, may have regard to various factors, such as (i) the likely consequences of any decision in the long term; (ii) the interests of the company's employees; (iii) the desirability to maintain a reputation for high standards of business conduct; and (iv) the need to act fairly as between members of the company.
Indeed, in Re Neath Rugby Limited  EWCA Civ 291, the UK Court of Appeal held that a nominee director could take the interests of his nominator into account without being in breach of his duties to the company, provided that his decisions as a director were taken in what he genuinely considered to be the best interests of the company.
Further, section 175(4)(b) of the UKCA allows a director to act in circumstances where there would otherwise be a conflict of interest if the other directors have authorised such action. In addition, section 180(4)(b) of the UKCA allows the company’s articles of association to authorise certain conflicts of interest whereby any acts or omissions carried out in accordance with those articles would not be a breach of a director’s general duties.
THE CLRC’S VIEWS
Having considered the provisions in the NZCA and ACA, the CLRC, in Consultative Document No. 5 (Clarifying and Reformulating the Directors’ Role and Duties) issued in August 2006, nevertheless took the view that nominee directors must be held to a strict fiduciary duty to act in the best interest of the company. The CLRC acknowledged that this position is “not in line with commercial reality and may not be facilitative to the business needs of companies”, but took the stance that the facilitation of business should not be at the expense of good corporate governance.
The CLRC set out two grounds for adopting the strict approach. First, it would assist nominee directors to understand the nature and extent of their duty. Second, the CLRC was concerned that the adjusted fiduciary duty may not be effectively enforced due to the difficulty in determining or defining with certainty the identity of nominee directors.
Although the CLRC accepted that the strict fiduciary duty may be adjusted in the case of a wholly-owned subsidiary by reason that there “would be no minority shareholders’ interests which needs protection”, this exception was not incorporated into S.132(1E) of the CA 1965 nor section 217(1) of the CA 2016.
The strict fiduciary duty approach has attracted some criticism – some have argued that it infringes market freedom by denying the shareholders the discretion to vary the application of the rule. Proponents of this school of thought contend that shareholders should be permitted to make their own arrangements in relation to their corporate structure so long as the interests of minority shareholders are protected. For example, Mohammad Rizal Salim and Teh Tai Yong in “Market Freedom or Shareholders’ Protection? A Comparative Analysis of the Duties of Nominee Directors”, International Journal of Law and Management, Vol. 50 No. 4, 2008, pp. 168-188, took the view that “where the shareholders have agreed in a shareholders or joint venture agreement to adjust the fiduciary duties of directors so that the directors may act in the best interests of the nominator, there is no reason why this should not be allowed.”
Notwithstanding the arguments by the proponents of the adjusted fiduciary duty, it is clear that unless and until section 217(1) of the CA 2016 is amended, the CA 2016 imposes a strict fiduciary duty on a nominee director to not subordinate his duty to act in the best interest of the company to his duty to his nominator when a conflict arises between these interests.