Directors duties under Companies Act 2006

INTRODUCTION

Although some forms of ancient companies are thought to have existed in Ancient Rome and Greece, the field of company law is a relatively new and most of the major developments in the area are attributed to the end of 90’s. The turn-of-the-millennium financial scandals on both sides of the Atlantic put under question all the existing company law frameworks and revealed that it is not only minority shareholders who are subject to exploitation and oppression.[1] In the scope of the company, as already known, individuals with power are directors. Shareholders may have indirect power or influence and duties owed by directors, but the British common law[2] views the duty to be owed to the company as a whole, as opposed to individual shareholders. Shareholders, presumably, have power only over their own property – their shares. The genesis of the major debates and consequent reforms in the company law, as can be guessed, is the balance of power between directors and the source of capital – shareholders.

Despite the popular misconception that English Law is purely based on ‘judge-made’ law (at least that is what I thought it was), a peculiar feature of English company law is that it is overwhelmingly and increasingly statue-based. Prior to the existing Companies Act 2006, the Companies Act 1985 consolidated a series of Acts passed between 1948 and 1983, and was amended on several occasions.[3] In fact, the CA 1985 had received many criticisms and was perceived as being extremely detailed, fragmented, excessive, and in some respects defective, regulation of the legal relationship between directors and the shareholders.[4] The current legal instrument on company law, the CA 2006 enacted on 8 November 2006 and fully in force from 2009, is the biggest law reform ever passed through the Houses.

REFORMS UNDER CA 2006

With a wider picture of further consequences of the reforms undertaken by the above-mentioned act, the reasoning behind the process did not limit itself only to the form of ‘house-keeping’ through consolidating the existing legislation. In fact, what the Parliament always kept in mind and made the heart of the reforms was to modernise the law as existed prior to the CA 2006 and to enhance the competitiveness of the UK legislation to attract companies, or to prevent them from being attracted elsewhere. Therefore, the primary aim of the CA 2006 is to provide easy access to the corporate form, minimum interference with management, and appropriate investor protection[5]; and hence, the following (among others) are said to be achieved through the reform:[6]  

·     the legal rules were streamlined for the administration of private companies so as to recognise the fact that, in most such companies, ownership and management is in the hands of the same individuals. Private companies no longer need to appoint a company secretary, hold an Annual General Meeting or lay accounts before their members in general meeting. The Act also makes it easier for such companies to pass resolutions in writing.

·     company law was brought up to date by giving new recognition to electronic forms of communication for the purposes of conveying statutory information.

·     new measures were introduced to try to improve the accuracy and integrity of company information on the public record at Companies House.

·     company auditors will be able to negotiate liability limitation agreements with their clients.

·     shareholders have new powers to intervene in the governance of their companies.

GENERAL DUTIES UNDER CA 2006

           The provisions that codify (or as put, ‘are explicitly predicated upon’[7]) the long-standing common law duties of directors are now regarded as general duties in sections 170-177 CA 2006. It would, however, be misleading to say that these provisions only codify the existing common law rules and principles, even though many lines appear to be condensed version of their predecessors. In fact, the CA 2006 introduces a number of important innovations through the general duties.  

As it has been the case under the CA 1985 and common law principles, directors still retain the discretion to make the decision as to what courses of action are right for their company.[8] The law, however, has now extended its scope to the structure of corporate decision-making as it has never done before. The dominant aim behind the creation (the form of concise restatement) of the general duties is to ensure that, in making decisions, directors are aware of all matters which could directly or indirectly have effect on the long-term standing of the company.  In line with the traditional British view on the mission of the company as maximisation of economic value for its shareholders, the new enlightened shareholder value[9] approach is now at the ‘heart’ of the reforms on duties of directors so as to meet society’s changing expectations of responsible corporate behaviour and to provide special guidance on corporate decision-making.

The scope and nature of the general duties suggest that the accumulated experience of the courts will still remain influential, since the duties established under sections 170-177 no longer have direct affect and ‘regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.’[10] Moreover, Section 178 provides that the civil consequences of breach of the statutory duties are the same as would apply if the corresponding common law rule or equitable principle applied.[11] As purpose of the paper is to analyse the changes affecting the balance of power, below discussed are the sections (ss 172, 174 and 175) that not only codify, but also bring in a form of innovations into the existing legislation and principles.  

Duty to Promote the Success of the Company

           Section 172 imposes the already-existing duty under Percival v Wright [1902] 2 Ch 421 to ‘act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.’[12] In the way the new provision seems to be granting more power to directors to make decisions upon the best way to promote the success of the company. However, as Lord Goldsmith argues at Lords Grand Committee (6 February 2006), for the people who invest in company success means long-term increase in value and it is not appropriate ‘a snap poll to be taken at any point in time’ to decide the objective of the company or the shareholders.[13] Obviously, here the “power ball” is not in the court of directors nor it is in shareholders’, since the former still hold both statutory and common law duty to exercise independent judgement (s 173 CA 2006). As regards to the six factors that directors must consider while making decision, the statute requires those factors to have regard, even though they are not of overriding importance in any given context.

           Never before have directors been responsible (or legally obliged) to take into proper consideration the impact of company’s operations on the community and the environment. Hence, the statute is now famous for (or some might say notorious of) supporting the enlightened shareholder value in contrast to short-term fiscal success. Among other factors directors are also obliged to include interests of employees, which were taken into account even prior to the CA 2006 (see ruling in Parke v Daily News [1962] Ch 927 or Re Saul D Harrison & Sons plc [1995] 1 BCLC 14)[14] to the extent as to find appropriate running of the company for the interest of the employees. However, what might seem to be imposing additional burden on directors at first glance, is likely to balance those powers between aforementioned players. It would not be sufficient for directors to ‘pay lip service to this factor’ and the shareholders will loosen their power to affect the directors’ decision to aim the long-term enlightened value including its corporate social responsibility.

Duty of care, skill and diligence

           Logically, it would not be appropriate to require directors to exhibit a greater degree of skill than may reasonably be expected from a person with their knowledge and experience. At least, that was the Romer J’s ruling in Re City Equitable Fire and Insurance Co Ltd [1925] Ch 407 which has become the classic exposition of director’s duties of care, skill and diligence. The propositions of Romer J in the case now form the classic subjective test of care and skill:

·      director need not exhibit on the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience

·      director is not bound to give continuous attention to the affairs of his company

·      director may, in accordance with all laws and articles of association, may properly leave his duties to some other official

The law, however, seems to have moved towards the objective test requiring the general knowledge, skill and experience that may reasonably be expected from a person carrying out the functions of director in relation to the company[15] even prior to the CA 2006. Under Section 214 of the Insolvency Act 1986, the directors and shadow directors of insolvent companies were to carry liability according to the objective test. However, what Hoffman J set out in Norman v Theodore Goddard [1991] BCLC 1028 and Re D’Jan of London Ltd [1994] 1 BCLC 561 was to emphasise the point that s 214 was not making any change from what was already in the common law.[16] Now as the statute establishes directors are subject to both tests:

·      the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and

·      the general knowledge, skill and experience that the director has.

That, in turn, introduces new strict burden on directors and at the same time provides them with part (b) for exceptional cases.

Duty to Avoid Conflicts of Interests

There are two areas, both relating to the regulation of conflicts of interest, where the wording and most probably the application of the statute significantly departs from the existing law.[17] As suggested through the Company Law Review, the principles existing under legislation prior to the CA 2006 and the common law rules were very strict in relation with directors’ conflicts of interests.[18] Provided that the interest is disclosed to the board in a proper manner, most companies, apparently, allow their directors to have an interest in proposed transaction. Additionally, the Law Review Steering Group have taken into consideration the view of promoting entrepreneurial and business start-up activity by the managers of companies through much less stricter legislation.

Direct or indirect interests in proposed transactions or arrangements that conflicts, or possibly may conflict with the interests of the company must be declared under section 177 (in the case of proposed transactions) or under section 182 (in the case of existing transactions) unless an exception applies under those sections.[19] Section 175 also permits board authorisation of most conflicts of interest arising from third party dealings by the director such as corporate resources or opportunities. Such authorisation, however, is legally effective only if the director whose interests under question did not take part in decision-making for authorisation or in the case when the decision would still be valid even without the vote of such director.[20] Hence, it can be encapsulated that above-mentioned reforms eased the strictly-tightened regulations on conflict of interests, providing the greater managerial freedom not only in decision-making but also creating favourable environment for business start-ups.

DERIVATIVE CLAIMS

Two of the three reasons mentioned above for modernising the legislation on company law (minimum interference with management and appropriate investor protection) constitute the central idea of the derivative claims. Thus, to ‘architect’ a relatively competitive regulatory product and to maintain balance between interventions of shareholder into the decision-making process and the autonomy of the managers, the Law Reform Steering Group and English Law Commission recommended the abolition of the existing common law ruling under Foss v Harbottle (1893) 2 Hare 46. The rule at common law was subject to an exception that only minority shareholders could bring derivative claim on behalf of the company against those who are defendants and join the company as defendants. The reforms undertaken in CA 2006, at some level provided ‘speedy, fair, and cost-effective mechanisms for resolving disputes between minority shareholders and those running companies without disturbing the balance of power’[21] and extended the scope of the claimants. Part 11 of the current act describes the mechanism whereby members may be able to enforce the duties on behalf of the company.

Under common law, the courts had full discretion whether to permit an action to be brought. Claimants were usually refused on the grounds that there was another viable remedy or a group of individual shareholders opposed to the action, thus making the minority shareholders vulnerable to majority rule. The CA 2006 explicitly states that derivative action may only be brought under Chapter 11 and only through the procedure laid by the Chapter. A derivative claim, as defined in Article 260 Chapter 11 of the CA 2006, puts three elements: (a) the action is brought by a member of the company; (b) the cause of action is vested in the company; and (c) relief is sought on the company's behalf.[22]

Additionally, the subsection (3) of the mentioned article suggests that a derivative claim “may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company”.[23] The claim, consequently, may be brought in respect of an alleged breach of any of the general duties of directors in Chapter 2 of Part 10 (ss 170-177). Therefore, it can be employed as an effective scrutinising tool for shareholders seeking an action in the name of the company. Also vital to note, the further provisions of the Part 11 Derivative Claims also provide many legislative innovations bringing additional and modernising features to the process of the claims. In particular, subsection (4) further extends the time-scope of the claims stating the possibility of bringing action “in respect of wrongs committed prior to his (the shareholder bringing the action) becoming a member”.[24]

In conclusion, it is clear that all the reforms taken place under CA 2006 have proven at some level to be effective and have reached the targeted purposes. The general duties mentioned in the paper have had significant effect for the way that directors are expected to act and how they account for their actions to their company. And the modernised procedure for bringing derivative claims introduced a form of ‘shield’ for the shareholders from the wrongdoings of the majority shareholders; the improper or fraudulent actions of directors, in the way balancing the powers of directors and providing the necessary protection for the shareholders.

BIBLIOGRAPHY

Andrew Hicks, Cases and Materials on Company Law (5th edn, Oxford University Press 2004).

Arad Reisberg, ‘Derivative Claims Under CA 2006: Much Ado About Nothing’ (2009) University College London < http://www.ucl.ac.uk/laws/economics/WP/WP%2001-08.pdf> accessed 5 December 2012.

Nicholas Bourne, Bourne on Company Law (5th edn, Routledge 2011).

Paula Dalley, ‘Shareholder (and Director) Fiduciary Duties and Shareholder Activism’ (2008) HBTJ <http://www.hbtlj.org/v08p3/v08p3dalleyar.pdf > accessed 5 December 2012. 

Stephen Girvin, Charlesworth’s Company Law (18th edn, Sweet & Maxwell 2010).

USED SOURCES

[1] Paula Dalley, ‘Shareholder (and Director) Fiduciary Duties and Shareholder Activism’ (2008) HBTJ <http://www.hbtlj.org/v08p3/v08p3dalleyar.pdf > accessed 5 December 2012.  

[2] Andrew Hicks, Cases and Materials on Company Law (5th edn, Oxford University Press 2004).

[3] Stephen Girvin, Charlesworth’s Company Law (18th edn, Sweet & Maxwell 2010).

[4] ibid.

[5] Stephen Girvin, Charlesworth’s Company Law (18th edn, Sweet & Maxwell 2010).

[6] ibid.

[7] Stephen Girvin, Charlesworth’s Company Law (18th edn, Sweet & Maxwell 2010).

[8] ibid.

[9] Nicholas Bourne, Bourne on Company Law (5th edn, Routledge 2011).

[10] Subsection (4), Section 170 Chapter 2 Part 10 CA 2006

[11] http://www.legislation.gov.uk/ukpga/2006/46/notes/division/5/30/2

[12] Stephen Girvin, Charlesworth’s Company Law (18th edn, Sweet & Maxwell 2010).

[13] Nicholas Bourne, Bourne on Company Law (5th edn, Routledge 2011).

[14] Andrew Hicks, Cases and Materials on Company Law (5th edn, Oxford University Press 2004).  

[15] Stephen Girvin, Charlesworth’s Company Law (18th edn, Sweet & Maxwell 2010).

[16] Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 284.

[17] Explanatory Notes On Companies Act 2006, <http://www.legislation.gov.uk/ukpga/2006/46/notes/division/5/30/1> accessed 6 December 2012.

[18] ibid.

[19] Explanatory Notes On Companies Act 2006,

<http://www.legislation.gov.uk/ukpga/2006/46/notes/division/5/30> accessed 5 December 2012.

[20] ibid.

[21] Arad Reisberg, ‘Derivative Claims Under CA 2006: Much Ado About Nothing’ (2009) University College London < http://www.ucl.ac.uk/laws/economics/WP/WP%2001-08.pdf> accessed 5 December 2012.

[22] Explanatory Notes On Companies Act 2006,

<http://www.legislation.gov.uk/ukpga/2006/46/notes/division/5/30> accessed 5 December 2012.

[23] ibid.

[24] Subsection (4), Section 260 Companies Act 2006.