Dear Friends,
As you are aware that a company incorporated under provisions of the Companies Act, 1956 or 2013 is a distinct legal entity separate from its promoters and members. A company acts through human beings and appoint them in different positions to manage affairs of the company. A Directors is a person, designated as such and appointed by the company to look after its affairs. A director is some time called as an agent and some time called representative of the company. They owed fiduciary duties towards company and have to act bona fide for the benefit of the company and its stakeholders and director favours interest of the company above his own interest. If a director on behalf of a company enters into any arrangement or transaction with himself or with a company or firm in which he is interested, that arrangement or transaction may be set aside without inquiry as to whether the company has suffered thereby (self-dealing rule).
THE 'SELF-DEALING' RULE
The most famous expression of the self-dealing and fair dealing rules is that of Megarry V-C in Tito v Waddell (No 2)1
"The self-dealing rule is . . . that if a trustee sells the trust property to himself, the sale is voidable by any beneficiary ex debito justitiae, however fair the transaction.
The fair-dealing rule is . . . that if a trustee purchases the beneficial interest of any of his beneficiaries, the transaction is not voidable ex debito justitiae, but can be set aside by the beneficiary unless the trustee can show that he has taken no advantage of his position and has made full disclosure to the beneficiary, and that the transaction is fair and honest.
The same approach is taken in Australia. In Clay v Clay, 2 a joint judgment of the High Court of Australia, said the following:
The "fair-dealing rule" provides that a transaction whereby the beneficial interest of a beneficiary is purchased by the trustee is not voidable ex debito justitiae, but may be set aside, unless the trustee can show that no advantage has been taken…the "self-dealing rule" is that the sale by the trustee of the trust property to himself is voidable by any beneficiary ex debito justitiae.
These statements represent the orthodoxy in England and Australia in relation to self-dealing and fair dealing. But, closely examined, a single doctrine of self-dealing is, in fact, an illusion.
There are several entirely different situations which are described in the cases and included in a single description of "self-dealing".
They are as follows:
- A trustee, having legal title over an asset purport to convey title to himself or herself.
- A trustee purports to enter a transaction to sell a trust asset to a nominee of the trustee.
- A trustee purports to enter a transaction which will extinguish or overreach the rights of the beneficiary of the trust.
- A company director purports to sell company assets to himself or herself.
- A company director purports to sell company assets to a nominee.
In all of these cases the outcome of the case is easily resolved by reference to well established doctrines without resort to a description such as "self-dealing" and without resort to verbal formulae such as whether the transfer is voidable ex debito justitiae. That is not to say that it is an error to refer to any of these instances as involving 'self-dealing'. But there is grave danger when the same label is used to describe different phenomena which have different effects.
WHAT IS SELF DEALING RULE (INVESTOPEDIA)
Self -dealing is when a fiduciary acts in their own best interest in a transaction, rather than best interest of their clients. It represents a conflict of interest and an illegal act that can lead to litigation,penalties,
and termination of those who commit it. Self-dealing may take many forms but generally involves an individual benefiting or attempting to benefit from a transaction that is being executed on behalf of other party.
KEY TAKEWAYS
1. Self-dealing is an illegal act that happens when a fiduciary acts in their own best interest in a transaction, rather than in the best interest of their clients;
2. Self-dealing can consist of actions such as using company funds as a personal loan, assuming a deal or opportunity for oneself, or using insider information in a stock market transaction.
SELF-DEALING IS ALSO DEFINED AS
Any action taken by a financial professional that results in his or her personal gain at the expense of clients, employers, or colleagues. Acts of self-dealing include:
- Selling investments for less than what they're worth (undermining what is best for their clients)
- Failing to recommend a product or service that is what's best for a client
- Recommending certain investments over others to the benefit of the financial professional and/or his or her firm, not what is best for clients
- Transferring personal assets into your business as a way to avoid paying taxes on them
However, what constitutes an act of self-dealing also varies depending on what state you are in.
Self-dealing may consist of variety of actions seeking inappropriately enrich oneself, such as using company's funds as personal loan, using properties of the company as his personal property, ignoring duty of loyalties towards the company. Acquiring projects of the company for his own name, ignoring interest of the company. A person in a fiduciary position of the company used Price Sensitive Information of the company, while dealing in Stock Market for his won benefit and benefits of his relatives etc.
It means that a director of the company having interested in any arrangement or transactions with the company himself or a firm in which he is partner or a company in which he is director or member or his relatives, should disclosed his interest in the meeting of the meeting of the Board in which the arrangement or transaction discussed. But this is not possible in case of companies, which are family managed or owned. In these companies the directors are also members of the company and they are not able to set aside their interest with the interest of the company. Suppose there is only two directors and members in a private limited company, in this case it is not possible to avoid conflict of interest of directors with the interest of the company.
Self-dealing rules are applicable for disqualified transactions and people who are involved in prohibited transactions. The rules give a clear idea about the transactions that such individuals can't be a part of. The disqualified individuals can include anyone who is closely related to the entity. It can also include legal entities and organizations where the disqualified individual has a significant interest. All transactions which provide indirect financial benefit to such disqualified persons can be considered as prohibited transactions.
Suppose there is single director in the company and that director in a meeting voted for himself and paid him a sum of money from company's account by way of compensation for terminating his contract of employment with the company. The court in this case has directed the director to return the money paid to him as his act was a breach of his duty towards the company.
DISQUALIFIED PERSON
Disqualified person here is the director/trustees/office bearers of the entity. A director is considered as disqualified person till he has not disclosed his interest in the transaction or arrangement with company and entities in which he has interest.
The self-dealing rules include certain specifications when it comes to the transactions between the entity and the disqualified persons. Such disqualified persons are not allowed to sell, lease, or exchange property, provide goods and services, lend money, or transfer the use of the company's/trust's income and assets. The entity also cannot pay excessive compensation to disqualified individuals. The enforceable pledge of such disqualified persons also need not be satisfied. They are also not allowed to make payments to government individuals on the behalf of the trust/foundation.
One of the questions in this case was whether in paying himself so much money the director committed a breach of duty to the company. On this point there was view that because another person had already become so deeply in the affairs of the company that the director legitimately felt that his services were no longer needed and he should be removed. This is the reason, he resolved to pay himself compensation money.
As in case of One Person Company in India, suppose there is only one director and same is member of the company. In this case we know that for dealing of a director with the company provisions of Section 193 of the Companies Act, 2013 are to be followed.
DISCLOSURE OF INTEREST, SELF-DEALING RULE
A Manager-cum-Director of the company disposed of unwanted broodmares to certain syndicates and partnerships in which manager, his wife and partners had interest. The question was whether Manager and his wife were subject to the Self-dealing rule and whether the rule also applied to sales by auction.
The Court Ruled that; a director and agent who owed fiduciary duties to the companies under the agreement, the defendant was subject to Self-dealing rule, which extended to any transaction or arrangement between a company and a director, whether acting as principal or agent, in which he had an interest or a conflicting fiduciary duty. in all such cases the director was required to disclose his interest in the transaction or arrangement and obtained informed consent of the company subject to the Articles of Association of the Company.
Even if transaction or arrangement was sale by auction the Self-dealing rule still applied because inherent conflict of fiduciary's position and there were many ways in which both the sellers' agent and the bidder could influence the outcome of an auction both before the sale and during the bidding process. The strict application of Self-dealing Rule meant that any transaction between the defendant and companies was liable to set aside on the application of the company unless he was able to show that he had obtained the informed consent the owner to the transaction. Accordingly Self-dealing Rule applied to sales of items to partnerships of which the defendant was a member, because of his failure to disclose to the owner his interest in purchase of those items, and his inadequate disclosure of the existence of the partnership that intended to bid for the material meant that any consent given by the owner was not informed consent.
WHAT IS INFORMED CONSENT
It means that the directors in the meeting of the Board or in the meeting of members of the company disclosed his interest in a transaction or arrangement or sale going to be discussed at the meeting and absent himself from discussion and voting in the meeting. He has disclosed his interest in the meeting and same has been considered by the Board or Members.
PLEASE NOTE THAT
Self-dealing Rule did not automatically apply to a dealing with a fiduciary's or director's wife since spouses and domestic partners were not nominees for each other. Nevertheless, in any transaction between a company and a director's close relation, spouse or other partner there existed the potential conflict between his fiduciary duties and personal loyalties, since there was significant risk that he would be compromised by a desire to favor other party. Where there was real risk of conflict between duties and personal loyalties under the Fair-dealing Rule the burden was on director to show that the transaction was demonstrably in the best interest of the company or other persons to whom he owed duties.
The sale of item to defendant's wife and father -in-law was not voidable under the Self-dealing Rule because his wife held her share on her own account and not as nominee for the defendant, and in the absence of the evidence of any common financial interest between the defendant and his father -in-law their relationship was not one which give rise to such a conflict of interest as to impose on the defendant the legal onus of demonstrating that the sale to father-in-law is a fair dealing. [ Newgate Stud Co. Vs. Penfold, (2008)1BCLC 46(ChD)].
CONCLUSION
From the above discussion on Self-dealing Rule,it is clear that a person in a fiduciary position in an entity should keep his duties towards entity or company above his personal interest and loyalties. A person cannot be allowed to enrich himself or his relatives or associates in which he has interest on the cost of company having fiduciary duties towards company. Same way a director has to perform his fiduciary duties towards company for the benefits and advantage of company and not for personal benefits. An interested director should disclose his interest in any transaction or arrangement to the company with any person or entity or relatives of the director. The director should take an informed consent of the company in case he is dealing with a company in which he is a director or member, or a partnership firm in which he is a partner or any of his relatives by disclosing his interest and relationship with these parties to the Board, whendecision on such transaction or arrangement has been taken and absent from the discussion and voting on the matter.
DISCLAIMER: The article presented here is only for sharing information and knowledge with the readers. The views are personal. In case of necessity do consult with professionals for more clarity and understanding on subject matter.
CAclubindia
