3 August 2022 by and Corporate & Commercial Alert

Can a director be incompetent and still not breach their fiduciary duties?

In terms of South African company law, the directors of a company owe certain fiduciary duties to that company. These duties, though founded in the common law, are codified in the Companies Act 71 of 2008 (Companies Act), to include, inter alia, that a director must not use their position, or any information obtained while acting in the capacity of a director: (i) to gain an advantage for themselves, or for any person other than the company, or (ii) to knowingly cause harm to the company.

Furthermore, directors must perform their functions in the best interests of the company and with the degree of care, skill and diligence that may reasonably be expected of a person carrying out the same functions and having the general knowledge and experience of that director. One would think this means that where a person displays incompetence as a director they would be in breach of their fiduciary duties. However, the decision of the Supreme Court of Appeal (SCA), in the case of Mirchandani v Unica Iron & Steel (Pty) Ltd [2022] JDR 0980 (SCA), relating to the breach of fiduciary duties in terms of the common law, highlights that this is not necessarily the case. 

Case law

Mr. Mirchandani was a technical director of Unica Iron & Steel (Pty) Ltd (the company). Mirchandani was responsible for commissioning and running the company’s steel-rolling mill (Unica 1), which ran successfully. After some years, the relationship between Mirchandani and his two co-directors soured, and his employment was terminated. Following his termination, Mirchandani reported the company to the Gauteng Department of Rural Development, alleging that in establishing Unica 1, the directors deliberately breached the provisions of the National Environmental Management Act 107 of 1998 (NEMA), in that Unica 1 was operating without complying with the provisions of NEMA. He alleged that NEMA was not complied with as a result of a deliberate and conscious decision by the directors of the company not to comply with the provisions of NEMA, as to do so would have delayed Unica 1 coming into operation by up to two years, and the company was eager to begin generating income. It must be noted that NEMA does make provision for the rectification of non-compliance, but this process was never followed. The company was subsequently charged in terms of the Criminal Procedure Act 51 of 1977 and fined R5 million.

The company then lodged a damages claim against Mirchandani for the R5 million penalty on the basis of, inter alia, a breach of fiduciary duty, which was granted by the High Court in Pretoria. However, upon Mirchandani appealing the decision, the SCA formed a different view. The SCA found that during his tenure as director of the company, Mirchandani pursued the interests of the company rather than his own in ensuring that Unica 1 was operational and profitable before his dismissal. The SCA stated, referring to the judgment in Master of the High Court, Western Cape Division, Cape Town v Van Zyl [2019] JOL 41274 (WCC), that a “breach of fiduciary duties entails something materially different from the negligent discharge” of one’s functions; a breach of fiduciary duties “connotes disloyalty or infidelity” to the organisation one serves, and “mere incompetence is not enough”. It was found that Mirchandani was, at most, incompetent in that he (and his co-directors), “with eyes open”, breached the provisions of NEMA in the furtherance of the company’s interests and not his own, and as a result, Unica 1 became operational and profitable. Tsoaka AJA stated that although Mirchandani “may have done his ‘incompetent best’ to see to it that Unica 1 was operational and profitable, it cannot be said that he was unfaithful and disloyal to Unica”. It was thus held by the SCA that the company’s claim for damages arising out of a breach of fiduciary duties in terms of the common law failed.

Conclusion

Although it can be argued that Mirchandani did not attempt to gain an advantage for himself and that he performed his functions in the interests of the company, it is clear that he did not perform with the degree of care, skill and diligence that may reasonably be expected of a director in his position. While it may not have been possible to bring the claim in this case under the provisions of section 76 of the Companies Act, the facts of the case demonstrate a standard of conduct on the part of directors which is objectively unacceptable and illustrates the advantages of the codification of the duty of directors to perform their duties with care, skill and diligence. 

In addition to pursuing a director for a breach of the duty to conduct themselves with the degree of care, skill and diligence that would be expected of someone in their position, where a director has acted incompetently, but still in the interests of the company, stakeholders could, subject to the company’s memorandum of incorporation, adopt an ordinary resolution removing that director in terms of section 71 of the Companies Act or, in terms of section 162(5) of the Companies Act, and apply to court to have the director declared delinquent on the grounds that they acted in a manner that amounted to gross negligence, willful misconduct or breach of trust in relation to their duties to the company.

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