Legal Insights Issue 1/2018, April 2018 – “A RIGHT TO INSPECT AND A RIGHT TO SUSPEND?”

A RIGHT TO INSPECT AND A RIGHT TO SUSPEND?

Sheba Gumis and Choy Yuin Yi discuss two cases concerning directors’ rights and duties


It is trite law that the accounting and related records of a company are open to inspection by directors (Section 167(3) of the Companies Act 1965 (“CA1965”) and section 245(4) of the Companies Act 2016 (“CA2016”)). However, the extent and limit of this right is not expressly set out in the aforementioned Acts.

Further, as both CA1965 and CA2016 are silent on the right of a company to suspend a director, a question also arises whether a company is entitled to take such action against its directors.

In this article, we examine the recent cases of Dato’ Seri Timor Shah Rafiq v Nautilus Tug & Towage Sdn Bhd [2018] 2 CLJ 103 and Kwan Teck Hian v Insulflex Corporation Sdn Bhd [2018] 2 CLJ 335 where these issues were considered by the High Court.

Both cases were heard by Mohd Nazlan J, who delivered his judgment in Dato’ Seri Timor Shah Rafiq on 15 March 2017, and in Kwan Teck Hian, three months later on 15 June 2017.

DATO’ SERI TIMOR SHAH RAFIQ

Background facts

The plaintiff was a non-executive director of the defendant and a nominee director for the defendant’s minority shareholder, Nautical Supreme Sdn Bhd (“NSSB”). The majority shareholder, Azimuth Marine Sdn Bhd (“AMSB”), controlled the defendant’s board by having the right to appoint a greater number of nominee directors than NSSB.

To investigate what appeared to be serious accounting irregularities, the plaintiff requested a copy of the defendant’s accounting records. The request was denied by the defendant’s board, although the plaintiff was allowed to inspect the documents at the defendant’s office. The board also voted against the plaintiff’s request for the accounting records to be inspected by his auditor of choice.

The defendant raised various counter allegations, the main one being that the inspection request was for the ulterior purpose of pressuring the defendant and AMSB to continue making payments to NSSB, which had stopped after a dispute between the two shareholders.

The plaintiff then applied to Court seeking orders that he be allowed to inspect and make copies of the defendant’s financial records and for the appointment of an auditor to assist him for that purpose.

Right of inspection

The Court, relying on Paul Nicholson v Faber Medi-Serve Sdn Bhd & Ors [2002] 1 MLJ 355, Dato’ Tan Kim Hor & Ors v Tan Chong Consolidated Sdn Bhd [2009] 2 MLJ 527 (CA) and Wuu Khek Chiang George v ECRC Land Pte Ltd [1999] 3 SLR 65 (Singapore CA), held that directors have an unrestricted and direct access to a company’s accounting records and that such right is mandatory in order to enable a director to discharge his responsibilities fairly and equitably for the benefit of the company and its shareholders.

The Court observed that Wuu Khek Chiang George also held that a director is prima facie entitled to inspection and is not required to demonstrate any particular ground or “need to know” basis.

Forfeiting the right of inspection

Mohd Nazlan J, also held that a director’s inspection right can only be forfeited where it is exercised not to advance the interest of the company but for ulterior purposes to injure the company (Edman v Ross, Molomby, Deluge Holdings Pty Ltd & Anor v Bowlay & Ors [1991] 9 ACLC 1486) or for an improper purpose (Oxford Legal Group Ltd v Sibbasbridge Services Plc and Another [2008] EWCA 387).

Drawing on the principles laid down in Tan Kim Hor, the Judge added that the Courts do not have any residual discretion to refuse inspection and that it is for the company resisting the exercise of this right to show clear proof that the director is using the right for some ulterior or improper purpose or to injure the company.

Right to copies of documents

The Court referred to sections 131B and 132 of CA1965 (substantially in pari materia with sections 211 and 213 respectively of CA2016) and stated that the law vests the duty of management of a company in its directors, which must be discharged with reasonable care and diligence in the best interest of the company. Given these positive duties and the potential liabilities, the law accords directors a virtually absolute and unqualified right to inspect the books of a company which they are responsible for. The jurisprudential basis for the directors’ inspection right applies equally to the right to make copies of the documents so inspected, the latter being a subset of the former.

Inspection by director’s agent

The Court held that a director’s right to appoint an auditor to assist him in the exercise of his inspection rights is clearly envisaged in section 167(6) of CA1965. This provision, which is in pari materia with section 245(8) of CA2016, allows the court to order that the accounting and other records of a company be open for inspection by an approved company auditor acting on behalf of a director, subject to a written undertaking given to court that the information acquired by the auditor during the inspection should not be disclosed except to that director.

Whether ulterior motive proved

With regard to the defendant’s main contention that the plaintiff’s request for inspection was made for the ulterior purpose of pressuring the defendant and AMSB to continue making payments to NSSB, the learned Judge said that he did not find evidence of any pressure being brought to bear by NSSB or the plaintiff on the defendant. In any event, the Court added that any dispute as to the payments allegedly due from AMSB to NSSB were of no relevance to the defendant as they were issues between the defendant’s shareholders.

According to the Court, of greater relevance was the fact that the payments were due to NSSB and not the plaintiff, who was not even a shareholder of NSSB. Thus, any suggestion that the request for inspection was for the personal benefit of the plaintiff was misconceived. The Judge further said that the defendant failed to demonstrate any manner in which the purported payment dispute, which did not concern the plaintiff in his capacity as a director of the defendant, amounted to an ulterior or improper purpose unrelated to the discharge of the plaintiff’s duty as a director of the defendant.

The Court also rejected the other arguments raised by the defendant in opposing the plaintiff’s request on grounds that these arguments lacked substance and were an attack on the plaintiff’s application rather than evidence of improper or ulterior motives.

The Judge added that it is not for the plaintiff, as a director, to justify why he needs to examine the records. He reiterated that based on Dato’ Tan Kim Hor, it is for the defendant to show clear proof and to satisfy the court that the grant of the right of inspection would be for a purpose detrimental to the interest of the company. In the absence of such proof, a director’s right of inspection is unbridled and almost absolute. As the defendant had failed to show such proof, the Court ordered that the plaintiff be allowed to inspect and make copies of the defendant’s financial records and to appoint an auditor to assist him in the inspection.

KWAN TECK HIAN

Background facts

The plaintiff was a director of the defendant company, together with two other directors (“Other Directors”).

Without consulting the plaintiff, the Other Directors established an executive committee and determined that certain business transactions for the defendant could only be carried out with the authorisation of the executive committee. The plaintiff was then denied access to the defendant’s accounting and financial records.

At the defendant’s annual general meeting, the plaintiff objected to a proposal by one of the Other Directors to utilise a RM8.5 million loan facility obtained from Public Bank Berhad. The plaintiff then unilaterally issued a letter to five banks, requesting them to freeze the defendant’s monies held with those banks (“the Impugned Acts”).

The defendant then served on the plaintiff a show cause letter demanding an explanation for the Impugned Acts. A notice of a board meeting of the defendant to be held on 8 December 2016 was also served on the plaintiff.

The plaintiff requested the defendant to make available a copy of the updated management accounts at the board meeting and to allow an independent auditor to inspect certain accounting records of the defendant. The defendant reserved its right pending legal advice and proceeded to hold a domestic inquiry against the plaintiff who chose not to attend.

At the board meeting of 8 December 2016, the plaintiff produced a statement explaining the Impugned Acts. The defendant’s board accepted the disciplinary panel’s finding of gross misconduct against the plaintiff and resolved to terminate the plaintiff’s employment and to suspend his directorship.

The plaintiff commenced proceedings (“Originating Summons”) to enforce his inspection right as a director of the defendant. The defendant responded by applying to strike out the Originating Summons.

Principal assertions of the defendant

The defendant’s key contentions concerned the Impugned Acts. According to the defendant, these acts were committed by the plaintiff out of a selfish or personal interest and were not in the best interest of the defendant. It contended that the Impugned Acts were in breach of fiduciary duty on the part of the plaintiff and if the plaintiff had been successful, those acts would have had catastrophic effect on the defendant in that it would have been unable to receive monies through the bank accounts and its operations would likely have ceased, and employees, suppliers and third parties would not be paid.

The defendant also noted that the plaintiff intended to dispose of his shares in three companies to one Pecol Industries Sdn Bhd (“Pecol”) and had copied his letters to the banks to the Pecol. The disclosure of the defendant’s sensitive information to Pecol, a third party, constituted another breach of fiduciary duty by the plaintiff.

Accordingly, the defendant contended that it had rightfully suspended the plaintiff to contain the damage that the latter could potentially inflict on the defendant.

Arising from the suspension of the plaintiff as a director, the defendant submitted that plaintiff did not have the locus standi to initiate the Originating Summons. The defendant further maintained that in view of his suspension as a director, the plaintiff could not enforce his right of inspection.

Can a director be suspended?

Firstly, the Judge noted that a copy of the minutes of the board meeting stated that the plaintiff’s directorship had been suspended. On the other hand, the draft minutes of the same meeting disclosed that the secretary had advised that the defendant’s board had no power to suspend the defendant and the chairman was to seek legal advice on the matter. In light of the conflicting evidence, Nazlan, J said that it was not clear whether a valid resolution had in fact been passed by the defendant’s board to authorise the suspension of the plaintiff.

The Court stated that even if a valid resolution had been passed to suspend the plaintiff, its true legal basis could still be challenged. As there were no provisions in either the articles of association of the defendant or in the CA1965 (or for that matter, CA2016) which authorised the board to suspend a director, the issue is whether the law permits the suspension of a director.

The Court considered two conflicting decisions on the suspension of directors, namely Fong Poh Yoke & Ors v The Central Construction Company (Malaysia) Sdn Bhd (1998) 4 CLJ 112 which held that the board of directors has authority to suspend a director and Jerry Ngiam Swee Beng v Abdul Rahman bin Mohd Rashid & Anor (2003) 6 MLJ 448 which held that the Court does not have the power, nor does the CA1965 have provisions, to suspend directors.

The High Court stated that where a director fails in the proper exercise of his powers as a director, when the powers are exercised for ulterior or improper purposes, or when the acts injure the interest of the company, the board has the right to seek for his removal or for action (including injunctive relief) to be taken for such transgressions. In the absence of any legal basis for the suspension in the articles of association, the rights, duties and powers of a director cannot be affected or whittled down, even less so suspended by a mere decision of the board.

The Court also noted that a suspension of directorship would bring into play a host of uncertainties which are inimical to the proper and efficient management by the board of directors. It would, said the Judge, make little sense for a director to be denied the exercise of his rights and powers without also excusing him from performing his duties as a director which brings with it the potential liabilities for the breach of such duties. The Judge concluded that any action to restrict the powers of a director must be based on clear and specific legal provisions. Resorting to suspension of directorship is woefully inadequate and ought to be avoided.

His Lordship clarified that his ruling only applies to the suspension of the rights and duties vested in the office of a director. If a director is also an executive, e.g. a managing director, suspension of the executive function is not objectionable.

In view of his conclusion that the plaintiff could not be legally and validly suspended of his powers and responsibilities as a director of the defendant, the Judge held that defendant’s objection on the absence of locus by reason of the plaintiff’s suspension was devoid of substance and untenable.

Extent of a director’s right of inspection

In considering the extent of a director’s right of inspection, including the right to obtain copies of documents and for the inspection to be conducted by an independent auditor appointed by the director, the learned Judge in essence reiterated the legal position enumerated in his judgment in Dato’ Seri Timor Shah Rafiq.

Similarly, His Lordship applied the reasoning in Dato’ Seri Timor Shah Rafiq to determine the basis on which a director’s right of inspection may be overridden.

According to the Court, the concerns expressed by the plaintiff as to the defendant’s financial position and on certain items disclosed in the defendant’s financial statements, were certainly matters for a director to be aware of and accountable to. Denial of access would render the director being unable to perform his statutory and fiduciary duty.

Although the Judge acknowledged that the Impugned Acts were committed by the plaintiff without proper authority and should not be condoned, he was of the view that the acts had not caused damage to the defendant’s operations. Most crucially, the Court said that the defendant had failed to show any real connection between the Impugned Acts and the refusal to accede to the plaintiff’s request for access to the defendant’s financial records. Merely asserting a past wrong by a director without identifying the improper motive or establishing the link between the allegedly improper motive to the application for access is patently and grossly inadequate.

The Judge also rejected the defendant’s assertion that the plaintiff’s intention to sell his shares in certain companies to Pecol amounted to an improper exercise of his fiduciary and statutory duty as a director. Nazlan, J said that the plaintiff’s intention to sell his shares was a separate and independent matter and was wholly inconsequential to the denial of the plaintiff’s inspection right. The Court said that there was no suggestion or evidence that the information sought by the plaintiff would have a bearing on the shares allegedly intended to be sold by him.

The Judge acknowledged that it is not easy for a company to demonstrate clear proof that the inspection right would be used by a director for a purpose detrimental to the company. His Lordship cited Mageswary Kanniah v Vithyulingan Miniandy & Anor [2009] 9 CLJ 40 and added, per obiter, that even the fact that a director had set up a competing company does not ipso facto indicate that the director concerned would be using the company’s records for the ulterior motive of benefitting the other company.

The Judge concluded that the defendant’s arguments to resist the plaintiff’s application lacked substance and did not provide clear proof of any ulterior motive or purposes unrelated to the exercise of director’s duties that could justify the striking out of the Originating Summons or the denial of the plaintiff’s inspection rights. Accordingly the orders sought by the plaintiff in the Originating Summons were allowed.

COMMENTS

Kwan Teck Hian does not break new legal ground on the right of a company to suspend a director. By holding that a company cannot suspend a director, the Court followed one of two conflicting High Court decisions, namely Jerry Ngiam Swee Beng instead of Fong Poh Yoke.

Similarly, both cases discussed in this article do not create new law in relation to a director’s right to inspect a company’s documents and were determined by applying the relevant statutory provisions and the principles laid down in existing case law. Nevertheless, both are interesting and well-reasoned. In essence, the principles discussed in these cases on a director’s right of inspection can be summarised as follows –

(1) A director’s right to inspect a company’s accounting and related records is almost absolute - he is not required to justify the need to examine such records;

(2) The right of inspection can only be forfeited if it is used for an ulterior purpose or to cause injury to the company;

(3) The onus lies on the company to provide clear evidence that the right is being used by the director for an ulterior purpose or to cause injury to the company; and

(4) The right of inspection includes the right to make copies of the documents and to have the inspection carried out by a qualified auditor on behalf of the director.

 

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SUBJECT MATTER: CASE COMMENTARY


WRITERS’ NAMES : SHEBA GUMIS (L) & CHOY YUIN YI (R)


WRITERS’ PROFILES

Sheba is a Partner in the Corporate Division of SKRINE. Her practice areas include mergers and acquisitions and investment law.

Yuin Yi is an Associate in the Corporate Division of SKRINE. She graduated from the London School of Economics in 2014.

 

 

 
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