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Shareholder recourse for a director’s breach of fiduciary duties

Fasken
Reading Time 7 minute read
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Overview

A company’s board of directors bears the responsibility for the functioning and management of the company and is ultimately accountable for the company’s performance. In terms of the South African common law and the Companies Act, 2008 ("Companies Act"), directors have certain fiduciary duties. But what happens when the directors breach those duties? What are the rights of the shareholders in that instance?

This article is a reminder to shareholders and directors of the various sections of the Companies Act, how they relate to directors’ fiduciary duties, and what recourse shareholders have when directors breach those duties.

Case Law

In the case of De Bruyn v Steinhoff International Holdings NV and Others (29290/2018) [2020] ZAGPJHC 145; 2022 (1) SA 442 (GJ) (26 June 2020), a Steinhoff shareholder ("De Bruyn") sought authorisation to institute a class action on behalf of various groups of Steinhoff shareholders, holding Steinhoff, its directors and its auditors liable for the shareholders’ losses caused by certain actions of the directors and auditors.

On 5 December 2017, Steinhoff’s share value crashed after it issued a press release disclosing certain accounting irregularities in its 2017 annual financial statements. In essence, Steinhoff’s financial statements, as approved by the board of directors, overstated the company’s assets, income and profits, and understated their liabilities and expenses. As a result, the financial statements were false, misleading and incomplete, and they failed to accurately show the company’s financial state of affairs and solvency. The misstatements about the company’s financial position caused the share price to rise to inflated levels, which led to shareholders and non-shareholders purchasing or retaining Steinhoff shares at inflated prices. Once the misstatements were made public, the share price plummeted, causing the shareholders to suffer considerable financial losses.

De Bruyn’s argument relied on section 218(2) of the Companies Act, which provides that “any person who contravenes any provision of the [Companies]Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention”, as well as section 20(6) of the Companies Act, which states that “each shareholder of a company has a claim for damages against any person who intentionally, fraudulently or due to gross negligence causes the company to do anything inconsistent with the [Companies]Act...”.

She argued that the directors breached their duty of care to the shareholders by making the misstatements, and thus incurred liability at common law way of delict, and that the directors had breached their statutory fiduciary duties by breaching section 22 (reckless trading), sections 28 – 30 (financial information), and section 76 (directors' standards of conduct) of the Companies Act.

Accordingly, in terms of section 77(2)(a), the directors “may be held liable in accordance with the principles of the common law relating to a breach of fiduciary duty, for any loss,  damages or costs sustained by the company as a consequence of any breach by the director of their duties...

Directors duties

Prior to the Companies Act coming into force, directors’ duties were governed by the South African common law. It entailed that the directors must act: (i) with the utmost good faith, (ii) in the best interests of the company, and (iii) with the degree of care, skill and diligence that may reasonably be expected of a person carrying out the functions of a director and having the general knowledge, skill and experience of that director. The Companies Act then codified these duties in section 76 of the Companies Act, and added that directors must not use their position or any information obtained while acting as a director to gain an advantage for themselves or any person other than the company, or to cause harm to the company knowingly.

High Court decision

The issue that then arises is whether the company’s directors owe their fiduciary duties to the company or to the shareholders.

The High Court, in the Steinhoff case, found that, in general, directors of a company owe their fiduciary duties to the company itself, and not its shareholders. It was noted that directors control and manage the affairs and assets of the company, and it is that legal relationship that requires that the fiduciary duties are owed to the company and not the shareholders. Therefore, the company, not the shareholders, may seek redress for a breach from the directors.

The Court also noted that directors might owe fiduciary duties to the company as well as to the shareholders in special circumstances. These special circumstances include where a special factual or personal relationship exists between the directors and the shareholders, for example in a family business where shareholders placed their trust and confidence in a family member and sought advice and information from them. There is no closed list of these special relationships, and they must be looked at on a case by case basis. The Court found that no special factual relationship existed between the Steinhoff directors and the shareholders; the relationship was between the company and the directors, and therefore, fiduciary duties were owed to Steinhoff only, and not the shareholders. The Court stated that any harm suffered as a result of the breach by the directors is actionable by the company to whom those duties are owed. The Court found that De Bruyn and the other shareholders had no right or legal interest to assert a claim against the directors and accordingly did not have a cause of action against the directors to establish a delictual claim at common law.

After considering sections 218(2) and 20(6) of the Companies Act (as noted above), one would conclude that the language of those sections is clear, however the Court looked at them differently. De Bruyn argued that the directors breached their fiduciary duties as contained in section 76 of the Companies Act, and are thus liable to the shareholders for the damages suffered by them in terms of section 218(2).

The liability of directors for a breach of section 76 is set out in section 77(2)(a) (discussed above). The Court found that “section 218(2) cannot be read to render directors liable to shareholders for a breach under section 76 when the common law, incorporated by reference in section 77(2)(a), recognises no such liability to the shareholders.”

It was stated again that under the common law, directors do not owe fiduciary duties to the shareholders. As a result, the Court held that the claim based on section 218(2) cannot be sustained because the specific contraventions relied upon did not grant shareholders a right of action against Steinhoff’s directors. Furthermore, the Court found that section 77 renders a director liable for the loss sustained by the company, and De Bruyn sought relief for losses suffered by the shareholders and not the company.

Section 20(6), on the other hand, grants the shareholders a right of action against those who have cause the company to act unlawfully. Those individuals must compensate the company for the loss suffered by the company. The Court stated that although shareholders have the right of action, there is “no reason why the legislature should wish to compensate the shareholders for what others have caused the company to do, whilst not compensating the company itself.” Accordingly, the Court held that De Bruyn could not rely on this section to claim losses that she and the other shareholders had suffered, but only for the losses that Steinhoff suffered. De Bruyn’s application was dismissed.

Shareholder recourse

The key takeaway provided by the Court in the Steinhoff case, apart from the proper reporting of a company’s financial position, is that a director’s fiduciary duties are owed to the company.

What then are a shareholder’s options when a director has breached their duties?

As mentioned by the Court, a shareholder should be able to succeed in their application if they are able to prove that a special factual/personal relationship exists between the directors and the shareholders so as to require that the fiduciary duties owing to the company are also owed to the shareholders, based on a dependency by the shareholders on information provided to them by the director.

Another option offered by the Court is that the shareholders must look to the company to claim for any loss caused to the company by the directors, and enjoy any restitution through the company.

Additionally, shareholders may –

  • subject to the company’s memorandum of incorporation, adopt an ordinary resolution at a shareholder meeting removing a director in terms of section 71 of the Companies Act; or
  • in terms of section 162(5) of the Companies Act, apply to Court to have a director declared delinquent on the grounds that the director acted in a manner that amounted to gross negligence, wilful misconduct or breach of trust in relation to their duties to the company.

Unfortunately, the last two options will not lead to the shareholders recovering their losses suffered at the hands of the directors, however they do assist in ensuring those directors can no longer breach their duties.

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