Revisiting Corporate Directors' Powers, Duties, And Liabilities In An Unstable World - Directors and Officers

The recent dramatic failures in the world of cryptos, compared by some with the "dot com bubble" and "Enron" disasters, highlighted, once more, the importance of rigid rules on and clear understanding of directors' powers, duties, and liabilities, not only in terms of business ethics but also in the interest of corporate and investors' safety. This article will address the relevant considerations from a Cyprus perspective, also providing some tax and insolvency insights, in light of the UK Supreme Court's recent case law.

The general legal position of corporate officers' discretion - Powers

The board of directors is the administrative body of the company with the authority to manage the company's operations. The powers conferred on the board of directors of the company are set out in the articles of association (the "Articles") of the company, but are, also, subject to restrictions by the provisions of Cyprus Companies Law, Cap. 113 (the "Law") (i.e., exclusive powers allocated to the general meeting as to the management and operation of the company). In addition, section 29(1)(c) of the Courts of Justice Law provides that the Cyprus Courts will apply the common law and the principles of equity. Thus, corporate management decisions should comply with this legal framework and with the company's Articles.

Directors exercise extensive powers in the management of their companies and influence their company's conduct, being involved in the decision-making process. The authority to exercise the company's powers is delegated to the board as a whole and not to individual directors. Company law states that the "business of the company shall be managed by the directors". This confers on the board all the powers of the company, except those required to be exercised by the members in general meetings in accordance with the Law or the Articles. Although vested in the board as a whole, the Articles may provide that the powers of the directors can be sub-delegated by the board to the managing director, individual directors, other officers of the company, or a third person. For the delegation of powers and responsibilities, express authority, i.e. a board resolution, is needed to delegate powers to specific directors or officers.

Duties

There are certain statutorily provided duties, that is, explicitly by the laws and the company's Articles. Accounting and record-keeping, notification, disclosure, and reporting, particularly regarding the acquisition and disposal of shares of the company are examples of fields in which the Law and other pieces of legislation indicate detailed requirements for the directors. Examples of such provisions are, arts 141, 142, 151, and 185 of the Law.

Moreover, under Cyprus law, the directors are considered to stand in a fiduciary relationship with their company and are subject to specific duties, stemming from their relationship. The Courts have over the years, determined the company director's fiduciary duties, as follows:

acting in good faith, and for a proper purpose;
retaining director's discretion;
avoiding conflicts of interest, i.e., between the directors and the shareholders and/or other stakeholders;
determine whether a transaction is in the best interests of the Company, as a whole.

There is also the duty of care and skill; this one, in common law, includes a duty to be diligent in managing the affairs of the company. Generally, this duty refers to the concept of "a reasonably diligent person" as introduced by common law, according to which the directors must exercise the degree of skill, diligence, knowledge, and experience which may reasonably be expected from persons carrying out the same functions and having the same knowledge and experience as those in question. However, there is no explicit definition of a certain level of skill, diligence, knowledge, and experience. If there is a particular skill or level of expertise, then, the persons in question are required to exercise that in addition to the above-mentioned test.

In general, directors must monitor the company's affairs, its activities, and any relevant risks in a continuous way. In the process of corporate management, the directors should deploy a long-term strategy concerning the impact of their decisions and how the company's reputation in the market is affected. They must also abstain from any actions that serve their personal interests at the expense of those of the company.

General Liabilities

Depending on the duty breached by a director, the liability will vary. In cases of a breach of a statutory duty, the liability will be criminal, civil, or administrative. Directors who are involved in tax-related offenses may be prosecuted. Any breach of the fiduciary duties on behalf of the directors should entail their liability for any loss caused by this breach. If there is a breach of the duty to act in good faith or with all due skill and care, as may be reasonably expected, this will entail claims for damages and the director will be held personally liable to the company. However, concerning the duty of care in common law, the Law in section 383(1) provides further clarification by mentioning that there cannot be a liability on the directors if their actions are honest and reasonable in all the circumstances.

Liability towards third parties in particular

In general, art. 174 of the Law provides that "the acts of a director or administrator are valid regardless of any defect that may later be discovered in his appointment or qualifications". An act of the directors which may be ultra vires the directors but intra vires the company may, nevertheless, be ratified by the members in a general meeting, validating the act of the directors.

According to art. 33A of the Law, the company shall be bound vis-à-vis third parties for the acts or transactions of its officers, even though the said acts or transactions do not fall within the objects of the company, unless these (acts or transactions) are carried out in excess of the powers provided by law or permitted by law to be provided to the officers in question.

The company shall not be bound vis-à-vis third parties, if such acts or transactions do not fall within the objects of the company, if the third party knew the acts or omissions did not fall within the purposes of the company or that it was not possible to ignore the same under the circumstances. According to the Law, the publication of the company's Articles is not, in itself, sufficient evidence of knowledge by a third party. Moreover, restrictions on the powers of the Company's officers arising from the Articles or the decision of the directors (resolution) or the general meeting of the company, may not be objected to by third parties, even if they have been published.

If a third party honestly thinks that the director with whom he negotiates is authorized to act for the company, the company will be bound by the director's actions, under the rule in Royal British Bank v. Turquand (1856) 6 E. & B. 327.

As mentioned above, Cyprus Law follows the English common law which arises from this case: the contracting party to an agreement with the company has the right to assume that the contract has been executed as per the internal regulations of the company and is not obliged to know (unless he/she knows) if there is any breach of /non-compliance with internal rules.

The rule of this case is generally applied when:

the agreement is not fraudulent,
the decision did not have to be submitted by an agreement to the company Register,
the person relying on the exception does not, or could not, or was not obliged to know, that the relevant transaction was not following the corporate regulations/resolutions,
it does not appear clearly (from the circumstances of the case) that the third party should have carried out any relevant search.

It is advisable that the directors conferred with special powers, diligently inform the persons dealing with them about their authorizations, by attaching the relevant corporate decision instrument/resolution to any correspondence/agreements.

The "Creditor Duty" - the particularities of directors' duties in insolvency

In the Sequana case (BTI 2014 LLC v Sequana SA [2022] UKSC 25) of October 2022, the UK Supreme Court clarified that, in the vicinity of insolvency, the duties of a director extend to the company's creditors (the 'creditor duty'), affirming the ruling of another, earlier, English case, the West Mercia Safetywear v Dodd [1988] BCLC 250. The judgment does not recognize a separate duty exclusively owed to the creditors, but rather, an alternative form of the above-described rules requiring the directors to act in good faith in the interests of the company; that is, an extension of this duty to further consider the interests of creditors, along with those of the shareholders, in the vicinity of insolvency.

Directors will have to consider the interests of the creditors (taking also into account the special circumstances of their company at the time), if the company is insolvent/bordering on insolvency, or an insolvent liquidation or administration is probable or the transaction at hand could render the company in one of those two states. The duty will not be applicable simply because there is a remote, abstract future risk of insolvency.

As mentioned also in the case of Turquand, above, considering the nature of common law rulings, Cyprus Courts will follow the general direction of the Supreme Court of the United Kingdom, when a similar matter arises before them.

Place of corporate residence – Determining the Relevant Jurisdiction

The Law only requires that a Cyprus company has a registered address and a resident secretary in Cyprus. Of course, depending on the actual business objectives of the company, banking and tax considerations could entail obligations for a greater presence in Cyprus. These requirements differ significantly, depending on a case-to-case basis. In most of these cases, the indicator of 'management and control' is of significant importance. Further analysis of the tax aspect will be presented below.

The indicator of 'management and control' – Avoiding substance-related tax residence surprises

The general practice under the Cyprus Income Tax Law of 2002, No.118(I)/2002 (the "Income Tax Law") has looked at the notion of 'management and control'. The minimum prerequisites to qualify as a tax resident in the Republic of Cyprus are rather general and factual, and include:

where the majority of directors reside (the majority of the directors need to be Cyprus tax residents);
where the board meetings are held; and
where the general policy of the company is formulated.

The co-existence of all three criteria is essential.

It must be noted that qualification for corporate tax residency has been recently enhanced by including an additional test based on the incorporation principle. Practically, under this new provision, any company incorporated in Cyprus, including those the management and control of which reside in a different country, may be subject to taxation on their worldwide income, unless they can prove that they are tax residents in a different jurisdiction. Real evidence of such tax residency is expected to be asked by the authorities, although no guidance on this issue has yet been issued. However, criteria or, otherwise, substance assumptions, can be some of the following:

a properly constituted board of directors, comprising of individuals with seniority and skills in the respective industry, with a majority consisting of Cyprus residents (individuals), that has the highest powers to make important decisions, and physically holds all its meetings in Cyprus,
all key strategic decision-making being genuinely debated and taking place at those board meetings,
displaying sufficient operational expenses other than audit, accounting, and professional fees; and.

The correct understanding of the tax residence is crucial in terms of prudent corporate management, efficient tax restructurings and the avoidance of tax related offences.

Conclusion

Corporate boards and directors must educate themselves about the above-described parameters of their powers, duties, and liabilities. Fraud aside, misunderstanding of the provisions of the laws, the corporate Articles, and the fiduciary duties can entail damages of great amounts and harm to the corporate reputation, that can even jeopardize the financial stability/survival of the company and the job security of the employees, in these quite unstable times. The consultation of experienced and specialized corporate lawyers is highly advisable, always.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Cyprus: Revisiting Corporate Directors' Powers, Duties, And Liabilities In An Unstable World