Directors Duties In The Spotlight Once Again

Introduction

The collapse of Bernard Madoff's multi-billion dollar Ponzi scheme left ripples across the international investment world and resulted in a multitude of lawsuits around the globe. One of these cases is Madoff Securities International Limited v. Stephen Raven et al.,1 a recent decision released by the High Court of Justice in the United Kingdom. In this case, the Court clarified the scope of a director's duty to act in what he or she believes in good faith to be in the interests of the company. The Court also provided important guidance on how directors are expected to comply with this duty in light of the practical commercial realities of their role; in particular, the need to work together with other directors.

Background

The case concerned the actions of the former directors of Madoff Securities International Limited ("Madoff Securities"), a UK company, with regard to certain payments that were made by Madoff Securities prior to the discovery of the Ponzi scheme and the subsequent conviction of Mr. Madoff in the United States.

There were three sets of payments made by Madoff Securities that were the subject of this litigation. The first series of payments (the "MSIL Kohn payments") involved payments made to Mrs. Kohn for services rendered by her, such as the introduction of important individuals, advice on financial matters, and research. These payments to Mrs. Kohn totalled $27 million over a 15-year period. The second series of payments (the "interest payments") were in the form of interest payments made on personal loans by Mr. Madoff to Madoff Securities. The third series of payments (the "lifestyle payments") made out of the company's director's loan account, concerned goods and services purchased by Madoff Securities on behalf of Mr. Madoff and his family.

Duties of Directors

The liquidators of Madoff Securities claimed that the directors, by permitting these payments, acted in breach of their duties as directors of Madoff Securities. With regard to the MSIL Kohn payments, amongst other allegations, the liquidators claimed that the directors knew Mrs. Kohn's written research was useless and of no value. Therefore, the payments made for the worthless research constituted a breach of the directors' duties. In addition, it was alleged that the interest payments were unnecessary and that the lifestyle payments were an improper use of company funds. With these serious allegations, the Court took the opportunity to revisit the law on the duties of directors and what may constitute a breach of those duties. Throughout the analysis, the Court identified the three main duties of directors as follows:

(1) to act in good faith in the interests of the company;

(2) to exercise power for the purposes for which they are conferred; and

(3) to exercise reasonable care, skill and diligence.

Within English law, these three duties have been legislatively codified in much more detail than in Canadian law. However, although these duties may be provided for through legislation, the case law is very important in identifying what may constitute a breach of these duties.

As with English law, the general duty owed to a company is set out in section 122(1) of the Canada Business Corporations Act2 ("CBCA"), which reads as follows:

122. (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall

(a) act honestly and in good faith with a view to the best interests of the corporation; and

(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.3

In the case of Madoff Securities, the Court identified the importance of this duty on directors. The judge stated:

. . . it is trite law that a director owes a duty to the company to act in what he honestly considers to be the interest of the company. This may be regarded as the core duty of a director. It is a fiduciary duty because it is a duty of loyalty.4

Although these duties are imposed on directors through legislation, they have been interpreted through jurisprudence on several occasions. These court...