Due Diligence – A Director’s Life Jacket

ARC News   •   August 10, 2018

Due Diligence – A Director’s Life Jacket

 

The new Companies Act 2016 (“CA 2016”) imposes heavier sanctions for directors who breach the Act. The RM30,000 fine under the old Companies Act 1965 has been raised to a 100-fold increase to RM3,000,000.00. Hence, directors who are found guilty of breaches constituting serious offences, may find themselves facing up to a [1]5-year term of imprisonment, a fine of RM 3,000,000.00 or even both upon conviction. Please also note that CA 2016 has taken away the power of the Registrar to compound any offences to make way for the heavier fines and longer terms of imprisonment.

 

Obviously, there is an increase in accountability of directors in the running of companies.

 

While the CA 2016 sets out a list of duties that directors of companies in Malaysia would have to adhere to, this article only focuses on two common duties and the extent of having due diligence act as a life jacket to directors.

 

Essentially, a breach of duty occurs when a director does not exercise: –

 

  • [2]power for a proper purpose and in good faith in the best interest of the company; and/or
  • [3]reasonable care, skill and diligence as expected of a director.

 

Imagine this scenario, you are one of the directors of Company A. You wish to acquire Company B with the intention that Company A may utilise the factories, machineries and manufacturing licenses; and ride on the goodwill of the trademark that Company B possesses upon the completion of the acquisition at the consideration amount of RM1 million. A few weeks later, Company A received compounds from the local council informing that it has been operating illegally without proper valid licenses and the licences obtained by Company B had long ago been revoked by the relevant government bodies due to incompliance issues. The factories which the director of Company B claimed ownership are in fact rented properties and Company B had not been paying rental in the past 4 months. To rub salt into your wound, you received a cease and desist letter from the lawyer of the actual owner of the trademarks requiring you to stop using the name which Company A thought it owned upon the acquisition of Company B.

 

The shareholders of Company A that suffers incredible losses due to the above said acquisition think that this is caused by your negligence and/or breach of director’s duty and now have taken legal action against you.

 

What do you need to prove that you have acted in good faith and had exercised your duties with reasonable care, skill and diligence?

 

While there are numerous provisions under the CA 2016 that the court will scrutinise to determine if you have acted in good faith and have exercised your duties as the director with reasonable care, skill and diligence, this article will only focus on how conducting a proper legal due diligence may become handy in the above scenario.

 

You must prove that you have exercised your duties with [4]reasonable care, skill and diligence, and with the knowledge, skill and experience reasonably expected of a director having your responsibilities and any additional knowledge, skill and experience that you have in fact.

 

For an acquisition of a business or a substantial number of shares of a company (especially if the purchase price is material), a reasonable and prudent director will surely hire professional advisors to conduct proper reviews to assist him/ her in the decision-making process, or to uncover issues and act as an early warning signal (if any).

 

For example, if you have appointed professionals (such as accountants, legal advisors or financial advisers) to conduct due diligence reviews prior to the acquisition of Company B, the defence of due diligence may be applicable to you under common law and statute.

 

[5]Your reliance will be deemed to have been made on reasonable grounds if it was made in good faith and after making an independent assessment of the information or advice, and opinions, reports or statements, having regard to your knowledge of the company and the complexity of the structure and operation of the company.

 

In case you are wondering what legal due diligence is actually about, treat legal due diligence as a “legal health check” on companies or corporate organizations which are the subject of corporate dealings such as mergers, acquisitions and financing. It is therefore critical that purchasers and lenders conduct a comprehensive legal due diligence to ensure that all potential risks and issues which may affect the transaction are appropriately dealt with during the structuring and negotiation phase of the transaction.

A properly conducted legal due diligence on a target company reduces the likelihood of unpleasant surprises after the completion of a mergers and acquisition process. This would provide the purchaser the opportunity to gain as much background information and understanding about the target’s business. The information obtained in a legal due diligence may also serve as a platform to renegotiate the purchase price of the target’s shares or assets.

The legal due diligence reviews major and minor issues bordering on corporate structure of the target, legal ownership of assets (including legal status of real properties or intellectual properties), contractual obligations of the target, current or pending litigation or disputes involving the target, regulatory or statutory breaches, financial liabilities, licensing and compliance with government bodies and regulators, among others.

Applying to the above scenario, if you have appointed proper legal advisers to conduct legal due diligence prior to the acquisition of Company B, the said due diligence exercise will reveal that Company B is not the registered proprietor of the factories, the licenses were invalid, and the trademarks are not registered with the Intellectual Properties Corporations of Malaysia. Logically, you would then either call off the proposed acquisition altogether or after considering the risk involved, negotiate down the purchase price accordingly.

Now if you are a director of a company, make sure you put on this life jacket before you dive into making any hasty commercial decisions. It may save you from a lot of troubles.

 

Yuki Chong Mei Yoke is a Partner at Messrs. Afif Rahman & Chong

Disclaimer: Every attempt to ensure the accuracy and reliability of the information provided in this publication has been made. This publication does not constitute legal advice and is not intended to be used as a substitute for specific legal advice or opinions. Please contact the authors for a specific technical or legal advice on the information provided and related topics.

 

[1] Section 213(3) of the Companies Act 2016 (Act 777) & Regulations

[2] Section 213(1) of the Companies Act 2016 (Act 777) & Regulations

[3] Section 213(2) of the Companies Act 2016 (Act 777) & Regulations

[4] Section 213 (2) of the Companies Act 2016 (Act 777) & Regulations

[5] Section 215(2) of the Companies Act 2016 (Act 777) & Regulations

2018-10-22T04:35:11+00:00