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Company director stripped of ill-gotten gains

18 February 2017

The Court of Appeal in a recent case affirmed the view that the courts can and should find practical means of giving effect to sensible and fair principles of commercial morality. It went on to find that a fiduciary relationship between the director and shareholder existed in the case before it and that the director was liable to pay a considerable amount to the shareholder because he had breached that duty. The Court also found in favour of the shareholder on another basis – the director had breached the insider trading provisions of the Companies Act 1993.

The scenario

The company director employed an existing contractor and friend to work for his company. As part of his employment package the friend’s company acquired 10% of the shares in the company and thus became a minority shareholder. The company director controlled the ownership of the other 90% of the shares. The relationship between the company director and the minority shareholder broke down and the company director made the minority shareholder redundant. While the company director was negotiating to purchase the minority shareholder’s shares he was also negotiating a highly lucrative deal. He did not tell the minority shareholder about the lucrative deal. After he had purchased the shares for $1m, which was ultimately found by the court to be more than $3.1m below their “fair value”, the lucrative deal went ahead. The minority shareholder found out about the deal and sued the director for breach of s 149 of the Companies Act 1993 and for breach of fiduciary duty.

Section 149 to prevent insider trading

Section 149 was designed to prevent insider trading arising where directors buy or sell shares when they have confidential information that might affect the value of the shares. Section 149 does not require the director to disclose the information, but it does forbid the director from dealing with the shares unless the dealing is at fair value. The Court decided that the company director had breached s 149 and was liable pay the shareholder their fair value of more than $4.1m.

Breach of fiduciary duty

The other ground on which the Court found in favour of the shareholder was for the director’s breach of his fiduciary duty to the shareholder. A fiduciary is a person who stands in a position of trust and confidence with another person. The fiduciary must be loyal to the other person and put the interests of the other person before his or her own personal interests.

The Court of Appeal explained that there are two categories of fiduciary relationships:
1. Those which are based on a particular type of relationship - such as solicitor and client, principal and agent, trustee and beneficiary, doctor and patient.
2. Those where a fiduciary duty arises because of the special factual circumstances.

The Court noted that the relationship between a director and a shareholder is not within the first category. However, on the facts before it, the Court found a fiduciary relationship under the second category. The reasons for finding a fiduciary relationship were: the company director had complete control of the company; there was an employment relationship between the company and the minority shareholder; and the company director had stronger negotiating power than the minority shareholder.

Courts have power to remedy mischief

This case serves as a reminder to company directors that the courts do have tools to provide redress for shareholders when company directors engage in conduct which falls short of the courts’ view of sensible and fair principles of commercial morality.

 1. Holmes v Kiriwai Consultants Limited [2015] NZCA 149

 

Please email me at barbara.mcdermott@nwm.co.nz with your ideas for future articles. Keep an eye out for next month's column, where I will discuss another relevant rural legal issue.


Barbara McDermott is a partner of Norris Ward McKinnon, specialising in commercial and rural law. With offices in Hamilton and Huntly, we have friendly, expert legal advisors ready to help you with your business and personal legal matters.

 

Barbara McDermott