During the challenging economic environment created by the COVID-19 pandemic, directors need to be especially focused on the nature and extent of their duties, to whom these duties owed and how they should be exercised in these ambiguous times.
There is no statutory prescription in Bermuda setting out all of the duties of directors of Bermuda companies. A company's memorandum of association and bye-laws, the Companies Act 1981, as amended (Companies Act), industry guidance and relevant case-law delimit and describe the powers and duties of directors.
While the Companies Act decrees that the directors of a company have the responsibility of managing its affairs, there is no precise definition in Bermuda law of a director. The Companies Act defines the term as including ‘any person occupying the position of director by whatever name called'. Such a person, who acts as a director even though not appointed as such, is known as a de facto director and will have the same duties as a de jure director.
The duties of a director of a Bermuda company apply equally to all directors howsoever appointed. Bermuda law makes no distinction between executive and non-executive directors or whether or not a director is appointed by a nominating shareholder.
The Companies Act imposes core duties on directors to:
(a) “act honestly and in good faith with a view to the best interests of the company; and
(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.”
As a general rule the duties of a director are owed to the company and not to individual shareholders or creditors of the company. The company is generally defined by reference to the (present and future) shareholders as a whole. However, in cases of a company in financial difficulty, the focus of a director's duties shifts further towards the company's creditors as a whole.
At common law a director owes two types of duty to the company: a fiduciary duty and a duty of skill and care.
A. Fiduciary duty
The first arm, director's fiduciary duty, has four aspects and imports a position of trust:
- A duty to act in good faith – A director has a duty to act in good faith in what the director genuinely considers is the best interests of the company and not for any collateral purpose.
- A duty to exercise powers for a proper purpose – In the context of a Bermuda company, a proper purpose means a purpose which advances the interests of the company itself as a separate body corporate.
- Conflict of interest with the company – Directors have a duty not to put themselves in a position in which their duties to the company and their personal interests may conflict. They must keep his personal affairs quite separate and subordinate them to the interests of the company. Unless the conflict is fully disclosed, any contract entered into by the company and a company in which a director has an interest may be voidable at the instance of the company and any profit made recoverable by the company.
- Secret profits – Unless the bye-laws specifically provide, a director may not make a personal profit from any opportunities arising out of his directorship, even if he is acting honestly. Any profit made in such circumstances must be paid over to the company.
B. Duty of skill and care
The second arm requires a director to exercise whatever skill he possesses with reasonable care. This duty has three aspects:
- Degree of skill – The standard required from the director is that of a person of his particular knowledge and experience. His performance will be judged by the way he applies any skills which he actually has.
- Attention to the business – A director is not expected to devote all of his time and attention to management of the company. Directors must attend to the affairs diligently and display the “reasonable care…[that] an ordinary man may be expected to take in the same circumstances on his own behalf” given due consideration to the nature of the company's business and the manner in which tasks are in fact distributed between directors and the other officials.
- Reliance on others – A director may entrust operational decisions to and rely in good faith on executives who have been appointed specifically for the purpose of attending to the details of management. The directors typically fulfill a supervisory role. However, directors must be justified in entrusting an executive to perform such duties and cannot absolve themselves entirely of their responsibility by delegation to others.
When are Directors Duties in Sharp Focus?
There are a few situations where the duties and responsibilities of a director (and his exposure to liability) are brought into sharp focus, including:
- in difficult economic times invariably an aggrieved party has suffered pecuniary loss and is looking for someone to sue
By way of example, as a result of the disruptive force and resulting shock to economic activity resulting from Covid-19, directors may be the target of plaintiffs and prosecutors in search of deep pockets and their actions will come under severe scrutiny.
- the conduct of a company's defence to a contested takeover bid
During a takeover, the bidder may be inclined to allege that the directors are not acting in the interests of the company which they serve, but rather are seeking to secure some collateral purpose born of personal considerations. Even if not influenced by any corrupt motive (e.g. his remaining in office) and even if he honestly believes that his decision is in the best interests of the company, a director may not exercise his fiduciary powers to secure a purpose other than that for which the powers were granted.
- the insolvency or impending insolvency of the company in which the director holds or has held office
Where a Bermuda company is insolvent, nearing insolvency or when there is no reasonable prospect of avoiding an insolvent liquidation, the interests of the creditors intrude.
At this juncture, a director is likely to be in breach of his duties should he promote interests which are not compatible with reducing the risks to the companies creditors as a whole. Further, the shareholders no longer have the authority to ratify a breach of duty of directors.
Accordingly, the closer that a Bermuda company gets to an insolvency scenario, the greater is the attention that will be due to the interests of its creditors as a whole (i.e. to ensure that the affairs of the company are properly administered and that its property is not dissipated or exploited for the benefit of the directors to the prejudice of the creditors).
The directors actions may be reviewed and questions may arise as to whether the assets of the company have been diminished in such a way as to deprive creditors of full satisfaction of their proven claims? and, if so, has this been the result of some breach of the directors' duties?
- evaluation by an underwriter of the risk to which a director may be exposed
An underwriting may carefully assess a directors actions in the context of any directors and officers liability insurance policy. Questions will arise around whether there was any negligence and bad faith, in order to inform the underwriters decision as to whether to cover a director in respect of his liability and, if so, at what price.
Can Directors be Exonerated, Exempted or Indemnified for Breach of a Duty?
A company is permitted, by contract or in its bye-laws, to indemnify, exonerate or exempt its directors against liability attaching to them, other than in respect of fraud or dishonesty. In ascertaining the nature and extent of a director's duties and the existence of negligence in the performance of those duties, it will invariably be a matter of dealing with the particular case on its own facts, having regard to the surrounding circumstances.
As an indemnity is only as good as the indemnifier, an essential complement to an indemnity is adequate directors and officers liability insurance.
A Bermuda company may purchase and maintain insurance for the benefit of its directors against liability incurred by them in their capacity as directors. Such insurance will not normally cover liabilities related to a director's failure to act honestly and in good faith with a view to the best interests of the company.
The best insurance policy is for directors to acquire a thorough understanding of the company's business and prospects (in the near and long term), develop trusted relationships with its senior management and professional advisors and adhere to prudent directorship principles.
Directors may be exonerated for breach of duty if they rely in good faith upon reports or financial statements presented by an accountant or other credible professional(s).
As alluded to above, Directors (in absence of ground for suspicion and having regard to the exigencies of the business) are entitled to rely on:
- the skills of their fellow board members, which is why it is important to populate a board with a broad array of relevant skills;
- the advice and counsel of outside professionals such as accountants, financial advisors or attorneys; and
- The expertise of internal officers (e.g. the CFO, COO etc.).
But directors cannot entirely absolve themselves of responsibility by reliance on or delegation to others. It must be reasonable to so delegate and the directors must demand a regular flow of information from such professionals to ensure that they are carrying out their duties responsibly.
The Companies Act provides that a company may exempt a director from any loss arising from or liability attaching to him in respect of negligence, default breach of duty or breach of trust.
A company may advance monies to a director for the costs of defending any civil or criminal action involving allegations of fraud or dishonesty against the director on the condition that the director shall repay the advance if the allegations are proved.
In proceedings for negligence, default, breach of duty or breach of trust, the court may relieve the liable director where he acted honestly or reasonably and that, having regard to all the circumstances of the case, he ought fairly to be excused. The court relief is discretionary.
When the courts are called upon to examine the bona fides of the directors, Bermuda courts are typically loathe to second guess a board's exercise of business judgement. As a general rule, the court will only impugn a director's conduct if there is evidence that he has acted improperly (bad faith or negligence), for an improper purpose, irrationally (i.e. no sensible board could have reasonably come to the conclusions which the directors reached).
In considering these points, the courts do not require that a board have made what in hindsight was the best possible decision provided that, at the time the decision was taken, it was reasonable and the board exercised its duties of skill and care in reaching the decision it took.
The task of a director is serious. The conscience, compass and management of the company is confided to its directors.
Directors must maintain high standards of personal integrity and act to advance the best interests of the company, not their own. Their conduct must be informed, impartial and disinterested. To shoulder these duties, directors need to receive and interrogate accurate, timely and comprehensive information.
During this great suspension, as companies face unique governance challenges, there is an even greater need for invested, collaborative, trusted and resourceful thinkers who are capable of managing ambiguity with gracious decisiveness. Further, while directors duties are owed primarily to the company as a whole, there is a growing trend to hold directors accountable to broader constituencies (including shareholders, employees, customers and creditors, as well as the government, the general public and others that may be affected by the company's operations).
In this evolving landscape, directors must demonstrate principled leadership, be alert and responsive to changing circumstances and remain mindful that their actions cannot simply be justified by invoking the incantation “a decision taken bona fide in the interests of the company”. Passive good intentions are not sufficient. It is important that the disclosure and oversight responsibilities of directors are carried out with due care and diligence have continuing regard to their common law and statutory duties.
First Published in Appleby: Offshore Business Update, April 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.