BULLETIN 6 DUTIES AND LIABILITIES OF DIRECTORS UNDER CYPRUS LAW Cap. 113, Cyprus Companies Law, provides that every private company must have at least one director and every public company must have at least two directors (s.170). There must also be a company secretary who cannot be the same person as a sole director (s.171) except in the case of a private company where the sole shareholder can be the sole director and also the secretary. The Law also provides in favour of a person dealing with a company in good faith that the power of the board of directors to bind the company, or to authorise others to do so, shall be deemed to be free of any limitation under the company s constitution i.e (memorandum and article of association). Section 174 of the Law also provides that acts of a director or a manager are valid notwithstanding any defect which is afterwards discovered in his appointment or qualification. A. DUTIES Categories of Director s Duties (a) Fiduciary Duty (b) Duty to exercise skill and care (c) Statutory duties It must be noted that: There is no difference in principle between «executive» and «non executive directors», The duties are owed to the company and not to individual shareholders. 1. Fiduciary duty A director owes a duty to the company to act in good faith in the best interests of the company and this duty is commonly called the «fiduciary duty» of directors. The overriding duty is to act in the best interests of the company as a whole, and that is normally taken to mean the interest of shareholders both present and future. In practice, this duty can be broken down as follows: (a) Loyalty Directors must act in good faith in what they consider to be the interests of the company, not third party special interests. 1
(b) Compliance Directors must act in accordance with the company s constitution (such as the articles of association) and must exercise their powers only for the purposes allowed by law. The payment of a dividend when there are insufficient profits to permit distribution is an example of breach of this duty. (c) No secret profits Directors must not use company property, information or opportunities for their own or anyone else s benefit, unless allowed to by the company s constitution or in cases where such use has been disclosed to the company in general meeting and the company has consented to it. (d) Independence Directors must not agree to restrict their powers to exercise an independent judgment. However, if they consider in good faith that it is in the interests of the company for a transaction to be entered into and carried into effect, they may restrict their powers to exercise an independent judgment by agreeing to act in a particular way to achieve this. (e) Conflicts of interest If there is a conflict between directors interests or duties and the interests of the company in any transaction, directors must account to the company for any benefit they receive from the transaction. This applies whether or not the company sets aside the transaction. However, directors do not have to account for the benefit if they are allowed to have that interest by the company s constitution, or the interest has been disclosed to the Board and approved by the company in general meeting. (f) Fairness Directors must act fairly as between the members of the company. (g) Creditors If in the course of a the winding up of a company it appears that directors continued to allow a company to incur credit when they know or ought to know that the company has no reasonable prospect of paying, then they may become personally liable for that credit under section 307(v) and 312 of the Companies Law unless they can show that they have taken «every step with a view to minimising the potential loss to the companies creditors as {they} ought to have taken». 2. Duty to exercise skill and care The modern view of the duty of care was set out in Re D Jan of London Limited [1993] B.C.C. 646. The conduct of «a reasonably diligent person means a person having both (a) the general knowledge, skill and experience that may reasonably be expected of persons carrying out the same functions as carried out by that director in relation to the company, and (b) the general knowledge, skill and experience that that director has». 2
The absence of clear authority makes it difficult to explain to directors precisely and clearly how this definition works in practice. It may be helpful to state, however, that the first part of the definition may be described as the «objective» or «benchmark» test of what «the reasonable man» might expect of a director in the particular circumstances. The second part of the test requires that if that particular director has a particular skill or level of experience (for instance a finance director) then he or she is required to exercise that particular skill in addition to the benchmark test. 3. Statutory duties Directors have various statutory duties imposed by the Companies Law and other legislation, such as the Income Tax, VAT, Customs & Excise legislation, health and safety and environmental legislation. Special reference must be made to statutory liabilities imposed under the Companies Law to directors in relation to the company, its shareholders or to the public, such as: (a) (b) (c) (d) Register of Directors and secretary, (s.192) Register of Directors interests, (s.187) Disclosure of payment for loss of office made in connection with transfer of shares in a company, (s.185) Disclosure of interests in contracts, (s.191) (e) Loans to directors, (s.188 and 189) (f) Prospectus offers (see in detail below), (s.31 to s.39) (g) Pre-emption rights /Transfer of shares (s.71 to 82) (h) Fraudulent trading (s.311), (i) Profit and loss account and balance sheet (s.142) (ia) Falsification of books or destroying company documents, 308 (ib) Duties antecedent to or in course of winding up (s.207 tos. 213) (ic) Directors report and annual return (s.151) Breach of the above directors duties under Companies Law is a criminal offence with penalties ranging from fine of CYP20 per day of violation to 2 years imprisonment. In addition the directors are liable to personally compensate the company in respect of any loss resulted by the breach of their duties. B. LIABILITES 1. Breach of common law duties (fiduciary duties) and the duty of skill and care Breach of the duty of acting in good faith in the best interests of the company (fiduciary duty) and of the duty of skill and care will render a director personally liable to the company in damages or injunctive relief. It should be noted that the liability is to the company not to individual shareholders. It is therefore for the company (or its 3
liquidator) to take the necessary action. In the recent case of Queens Moat Houses v. Bairstow and others [2000] 1B.C.L.C. 549, the directors were found to have been in breach of fiduciary duty when they paid dividends in respect of which the company had insufficient distributable reserves. The directors were ordered personally to repay over CY40 million representing the unlawfully paid dividends. If a director has made a secret profit he will be liable to pay that profit to the company. 2. Breach of Statutory Liabilities Breach of a Statutory duty may result in criminal, civil or administrative liability or all the above. In order to avoid directors hiding with impunity behind the veil of their companies limited liability it has been the practice to include in various statutes (such as, the Consumer Protection Legislation, the Health and Safety of Work Law, Law 89 (1)/96, the Consumer Credit Law, 39(1)/2001, and the Environmental Protection Legislation) the following section by which directors and other officer of a limited liability company are subject to criminal liability. «where an offence committed by a body corporate is proved to have been committed with the consent or connivance of, or to be attributable to any neglect on the part of any director, manager, secretary or other similar officer of the body corporate or any person who was purporting to act in such capacity, he as well as the body corporate shall be guilty of that offence and shall be liable to be proceeded against and punished accordingly. In other instances such as the VAT legislation (see below) the directors liability is strict. Offences under the VAT legislation do not require proof of mens rea in respect of one or more elements of actus veus. In respect of these elements the offence is one of strict liability. Criminal liability is substantiated once it is proved that the accused violated the law irrespectively of its purpose (mens rea) to produce the illegal result. A director can also be prosecuted under section 20 (c) of the Cyprus Criminal Code as a persons who aids or abets the company in committing an offence. 3. Tax related issues Directors may be liable for prosecution by the Inland Revenue or Customs & Excise in respect of tax related offences. There is a very thin line between legitimate tax avoidance or mitigation and tax evasion. Experience shows that many people do not fully understand where that line is drawn and that they may consider entering into transactions, or concealing matters from the tax authorities, in such a way that tax evasion is involved. In addition to powers to impose a vast array of civil penalties and interest charges, both the Inland Revenue and Customs & Excise have the power to prosecute and to bring criminal proceedings against individuals involved in tax evasion, either personally or through their companies. 4
There is no offence of «tax evasion» as such, but the evasion of tax by deceitful means represents fraudulent conduct. The three possible channels of prosecution will include cheating the public revenue, false accounting and conspiracy to defraud. Prosecution will normally follow in only a small number of cases. Typically the Inland Revenue and Customs & Excise will give the individual the opportunity to «come clean» and provided that full disclosure is made, a criminal prosecution is unusual and the Inland Revenue will rely upon civil penalties (administrative fines). However, it is worth noting that the Inland Revenue is much more inclined to bring criminal proceedings against a professional adviser, who may be liable to a conspiracy related charge if he/she helps his/her client to evade tax. For instance and as an example of strict liability is the provisions under s53(1) and s54 of the Cyprus VAT legislation. If a legal entity is guilty of any of the offences referred in the law responsibility of such an offence except from the legal entity is also with (a) all the members of the board of directors of the company and (b) the general manager or the director or the chief executive director of the company. Apart from criminal liability (fine and/or imprisonment of at least 2 years) under section 55 of the VAT legislation directors bear also civil liability for any tax that is payable by the company to the state. C. RELIEF FROM LIABILITY Under section 197 of Cap.113, its not possible to grant a general exemption in advance to directors in respect of liability to the company. Any provision in a contract or in the articles of association of the company which attempts to exempt a director or indemnify a director who has been in breach of his duty of care and skill is void by virtue of. This section does not prevent a company from taking out directors liability insurance. D. SOLUTIONS FOR PERSONAL RISK MANAGEMENT A compliance strategy Sensible governance procedure as regular board meetings and regular reporting, audit and remuneration commitee and the appointment of non-executive directors. Directors and officers insurance. E. LIABILITY AS TO PROSPECTUSES The Directors responsibility in respect of prospectuses derives from various provisions of (a) the Companies Law, (b) the Stock Exchange Laws and Regulations and (c) the general law, such as the common law, law of torts and the Criminal Code. 5
CIVIL LIABILITY COMPANIES LAW, CAP. 113 The Director s civil responsibility under the Companies Law is governed by S.43; It creates liability for directors and other persons, for untrue statements in a prospectus. Potential claimants are only subscribers. Persons who have bought shares on the market on the basis of a prospectus, or in whose favour shares have been renounced, have no rights to claim under this section, but may have such a right under other provisions as explained below. Once it is proved that the statement is untrue, and that the-claimant subscriber has taken the shares on the faith of the prospectus and sustained damage, such subscriber is entitled to sue every director for compensation. The law shifts the burden of proof; once the statement is proved to be untrue the director is prima facie liable. To escape liability, the director must prove affirmatively that he had reasonable grounds to believe the statement to be true and that, in fact, believed it to be true. The misstatement must have been material i.e. one which was likely to influence the mind of a reasonable investor, and must in fact have influenced the conduct of the investor who claims compensation. A director cannot escape liability for non-disclosure of a material fact by professing ignorance of the materiality or by suggesting that he left the matter to his legal advisers. To escape liability, a director who sanctions the issue of a prospectus, must show that he was not responsible for the prospectus, which substially means that he was defrauded or deceived into giving his sanction to it. In relation to statements made or purported to be made by experts a director may be exonerated from liability if he proves that he had reasonable grounds to believe and did believe that the expert was competent to make the statement and had given his consent to the issue of the prospectus. In the case of untrue statements purporting to be made by official person or contained in official documents, a director is exonerated from liability, if the statement in the prospectus is a correct and fair representation of the official statement. The director s prima facie liability arises by him merely being a director. He is exonerated from liability if he proves that the prospectus was issued without his knowledge or consent and on becoming aware of its issue he forthwith gave reasonable public notice that it was issued without his knowledge or consent; 6
CRIMINAL LIABILITY (a) Stock Exchange Laws S.68 of the Law provides that is an offense to make false, misleading of fraudulent statements in providing information for the purposes of the Law or the Stock Exchange Regulations. This provision covers the Information Reports aw well. The Directors are expressly made liable when it is proved that they have consented or collaborated in the committal of the offence. S.69 expressly provides that the persons who have criminal liability for the offence aforesaid are jointly and severally liable for any damage caused to third parties as a result of their action which constitutes the offence. With reference to Prospectuses, this provision of the Stock Exchange Law does not add anything of substance to the provisions of the Companies Law or the general law; it may be interpreted however, as having a wider range with regard to the persons who may have a right to claim. Under the Companies Law, as stated above, the right to claim is limited to subscribers. Possibly S.69 of the Stock Exchange Law has a wider connotation and affords a right to claim to any third party who can prove that he was induced to purchase shares on the strength of a false statement in an Information Report, or indeed any other information supplied pursuant to the Stock Exchange Law or Regulations. Under Law 9(1)/2001, a law amending the stock Exchange Law, it s illegal for a company and it s directors to collect funds in view of listing securities with the Stock Exchange prior obtaining a final permission towards its application for listing by the Stock Exchange authorities. The Law makes the Directors also personally liable for the refund of the collected funds in all cases where a right to refund is afforded by the said law. The law creates an absolute liability in this regard. (b) Criminal Code The general law, basically the Criminal Code, creates general offences, such as obtaining money by false pretences, which may be invoked in case of false statements in prospectuses. The Criminal Code also creates a more serious offence for directors of a company for making false statements with intent to defraud or induce any persons to become a member or to advance money to the company and provides for a seven years term of imprisonment. (c) Companies Law Under S.44 of the Companies Law, the fact that a statement in a prospectus is untrue constitutes prima facie an offence and any person who authorised the issue of the prospectus is prima facie guilty of an offence, whether such person acts as director of the company or in another capacity in respect of imprisonment and/or a fine of CYP1.500. Please contact a member of our staff for further information and/or clarifications. 7