Good Faith and Corporate Governance: Lessons from Malaysian Case Law

‍Introduction

Company directors are vital to the efficient management and functioning of a company. They make key decisions that impact the company and its shareholders, ensuring that their actions comply with legal and ethical standards while serving the company's best interests. A clear understanding of their roles and responsibilities enables directors to meet their obligations while minimizing the risk of civil or criminal liability. It also empowers shareholders to hold directors accountable and promotes responsible and sustainable business operations.

In Malaysia, a director of a company has many duties under common law and the Companies Act 2016. Recently, we published an overview of these directors’ duties, which can be accessed here. One of the most important duties of a director is to act in good faith in the best interest of the company rather than themselves. This duty is found in common law and has been codified in section 213(1) of the Companies Act 2016 (previously, section 132(1) of the Companies Act 1965).

Although this is an essential duty, the concept is abstract and requires further explanation Hence, this article explores relevant case law to provide a clearer understanding of the issue.

A Director as a Fiduciary

A company director is in a position of a fiduciary. Hence, a director has a legal and ethical duty to act in the best interests of the company and avoid conflicts of interest. In law, the fiduciary position and its obligations were succinctly stated by Millett LJ in Bristol and West Building Society v Mothew [1998] Ch 1 as follows:

A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal. This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of fiduciary obligations. They are the defining characteristics of the fiduciary.

The nature of the obligation determines the nature of the breach. The various obligations of a fiduciary merely reflect different aspects of his core duties of loyalty and fidelity. Breach of fiduciary obligation, therefore, connotes disloyalty or infidelity. Mere competence is not enough. A servant who loyally does his incompetent best for his master is not unfaithful and is not guilty of a breach of fiduciary duty.

Board of Trustees of the Sabah Foundation & 2 Ors v Datuk Syed Kechik bin Syed Mohamed & Anor [2008] 5 MLJ 469

The first case is the Federal Court decision in Board of Trustees of the Sabah Foundation & 2 Ors v Datuk Syed Kechik bin Syed Mohamed & Anor [2008] 5 MLJ 469.

Background facts

The case involved two related appeals concerning Datuk Syed Kechik (“DSK”), a director of Sabah Foundation (“SF”) and its subsidiaries. SF, a statutory corporation with charitable objectives, entered into significant development projects, including the construction of the Sabah Foundation headquarters (“the Tower”) and the “Coastal Highway”. DSK was also the managing director of two subsidiaries, Sinsuran Sdn Bhd and Seranum Sdn Bhd, which were involved in these projects.

In the first appeal (“the Zara Appeal”), the plaintiffs were SF and two of its subsidiaries, and they sued DSK and his company, Zara Sdn Bhd, alleging that DSK failed to disclose his personal interest in Zara Sdn Bhd, a company he controlled, which benefitted from these projects. They contended that DSK placed himself in a position of conflict of interest, committed SF to substantial expenditures, and enriched Zara without SF's informed consent. The issue in the appeal was whether DSK was in a position of a fiduciary and if so, whether he had committed any breach of fiduciary duty.

The second appeal (“the Banita Appeal”) involved allegations that DSK had fraudulently concealed his control over Banita Sdn Bhd, a company granted a special timber license by the Sabah State Government. The issue in the appeal was whether a director could be held liable for a breach of fiduciary duty where the corporation was a contractor to the state government, which had granted a benefit to a company nominated by the director.

The Federal Court’s Decision

In respect of the Zara Appeal, the Federal Court held that DSK, as director and trustee, owed fiduciary duties to SF. However, he did not breach his duty because:

• He acted in good faith and did not misuse trust information.
• He did not place himself in a position where there was a conflict of interest.
• He did not unilaterally decide on the projects; instead, they were directed by the then Chief Minister, Tun Mustapha (“TM”).
• TM's dominance meant that DSK and other directors had no real choice but to follow orders.

However, in respect of the Banita Appeal, the Federal Court found DSK in breach of fiduciary duty regarding Banita Sdn Bhd. He had a duty to obtain informed consent from SF before applying for a timber license through Banita. Since he obtained information about Banita’s licensed area while acting as SF's representative, he held that information in trust for SF. The Federal Court held him liable for unjust enrichment. Accordingly, the Federal Court ordered disgorgement of profits.

Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd and another appeal [2018] 2 MLJ 177

Background facts

The case concerns the duty of directors to act in the best interest of the company, particularly in relation to divestments of the company's shareholding in Petra Energy Bhd (“PEB”). The dispute arose between Petra Perdana Bhd (“PPB”), the plaintiff, and its former directors, including Tengku Dato’ Ibrahim Petra (“the first defendant”), Wong Fook Heng, and Tiong Young Kong (“the second and third defendants”).

The plaintiff alleged that the defendants breached their statutory and fiduciary duties under section 132(1) of the Companies Act 1965 (now section 213(1) of the Companies Act 2016) by authorising the sale of PPB's shares in PEB without acting in the company's best interest. The sale resulted in PPB losing control over PEB, with the shares eventually being acquired by Shorefield Resources Sdn Bhd.

The defendants defended their decision by arguing that the divestments were necessary due to PPB's financial difficulties, including a liquidity crisis and potential legal claims from creditors. They maintained that the sales were authorized by the board and executed in good faith to ensure the financial stability of PPB.

The plaintiff also alleged conspiracy, arguing that the defendants fabricated the company's cash flow problems. The defendants denied any conspiracy to injure the plaintiff.

Decision and Court's Reasoning

High Court Decision

The High Court ruled in favour of the defendants, finding that they acted bona fide in the best interests of PPB. The High Court found that the share divestments were necessary to address the company’s liquidity crisis, which was not fabricated but based on genuine financial concerns. The court rejected claims of conspiracy and dishonesty, stating that the sales were collectively authorised by the board and there was no evidence that the defendants personally benefitted from the transactions.

Court of Appeal Decision

The Court of Appeal overturned the High Court’s decision, finding that the divestments were not conducted in the best interest of PPB. It held that the shareholders’ mandate provided the guiding standard for the directors' actions, and the directors failed to adhere to it. The Court of Appeal ruled that the directors had breached their fiduciary duties and that the divestments were not bona fide but part of an elaborate scheme to transfer control of PEB to Shorefield.

Federal Court Decision

The Federal Court reinstated the High Court’s decision, ruling in favour of the defendants. The Federal Court emphasised that directors' powers are not subordinate to shareholders' resolutions, reaffirming that directors must exercise independent business judgment under section 132(1B) of the Companies Act 1965. It found that the Court of Appeal had erred by improperly interfering with the High Court’s factual findings, especially regarding PPB’s financial difficulties and the rationale behind the divestments.

Conclusion

As discussed above, directors have a fundamental duty to act in good faith and in the best interest of the company. This principle was central in both Sabah Foundation v Syed Kechik and Tengku Ibrahim Petra v Petra Perdana, where the courts examined whether the directors in question had breached their fiduciary and statutory duties. In both cases, the courts emphasised that directors must prioritise the company's well-being over personal or external interests. Decisions made in bad faith, or for personal gain at the expense of the company, can lead to legal consequences.

The courts also reaffirmed that directors’ business judgment is generally respected, provided that it is exercised in accordance with the law and in the best interest of the company. In Tengku Ibrahim Petra v Petra Perdana, the Federal Court ruled that directors’ decisions should not be second-guessed unless there is clear evidence of misconduct. This principle is crucial in corporate governance, as it ensures that directors can make strategic decisions without unnecessary shareholder interference, so long as they act in good faith and with reasonable care.

Another important takeaway from these cases is the need to avoid conflicts of interest. In Sabah Foundation v Syed Kechik, the court highlighted the dangers of a director placing himself in a position where his personal interests could interfere with his duty to the company. Failure to disclose such conflicts or to obtain proper approval can result in allegations of misconduct and legal liability. Transparency and adherence to corporate governance frameworks are essential in preventing conflicts of interest.

While directors are accountable for their decisions, the courts also recognise that context matters. In both cases, directors were accused of breaching their fiduciary duties, but the courts examined their decisions within the realities of the business environment. For instance, in Tengku Ibrahim Petra v Petra Perdana, the divestments of shares were justified as necessary to address the company's liquidity crisis. The courts considered whether the decisions were reasonable at the time they were made, rather than assessing them with hindsight.

Importantly, these cases demonstrate that legal judgments are based on evidence rather than mere allegations. The courts relied on board minutes, financial records, and witness testimony to determine whether the directors had acted properly. Accusations alone are insufficient to establish wrongdoing, and directors should maintain proper documentation to support their decisions. Keeping accurate records not only strengthens corporate governance but also provides a clear defense in the event of legal challenges.

Overall, these cases underscore the importance of diligence, transparency, and sound judgment in corporate governance. Directors who act in good faith, avoid conflicts of interest, and document their decision-making process are better protected from legal risks and can effectively fulfil their duties to the company.

This article is written by Raja Nadhil Aqran (Partner). It only contains general information. It does not constitute legal advice nor an expression of legal opinion and should not be relied upon as such.

For more information, contact us at info@aqranvijandran.com.

‍