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companies act update

Directors duties

The new Statutory Statement of Directors' Duties is due to come into force (in part) with effect from 1 October 2007 and is already viewed as containing the most controversial sections of the new Act. 

It had been intended that the new Statutory Statement of Directors' Duties would have been a codification of the previous law as it applied to directors.  However, as outlined below, the Act goes beyond a mere re-statement of the existing common law rules. 

Sections 170-177 of the new Act sets out seven codified duties which are:

1. The duty to act within the company's powers
2. The duty to promote the success of the company
3. The duty to exercise independent judgement
4. The duty to exercise reasonable care, skill and diligence
5. The duty to avoid conflicts of interest (from 1 October 2008)
6. The duty not to accept benefits from third parties (from 1 October 2008)
7. The duty to declare interests in proposed transactions or arrangements with the company (from 1 October 2008)

By far the most controversial of these duties appears at section 172, namely the duty to promote the success of the company.  It imposes an obligation on a director 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 the members as a whole."  In doing so, the director must have regard, amongst other matters, to the following factors:

1. The likely consequences of any decision in the long-term
2. The interest of the company's employees
3. The need to foster the company's business relationships with suppliers, customers and others
4. The impact of the company's operations on the community and the environment
5. The desirability of the company maintaining a reputation for high standards of business conduct
6. The need to act fairly as between members of the company

This represents a fundamental shift from the previous regime which usually looked at short-term decisions or deals that concerned the direct financial interests of the shareholders.  Up until now, the Courts have only had to determine whether directors have acted in good faith and in the best interests of the company when reaching their decisions.  For this reason, more parliamentary time and column inches have been devoted to this new duty than any other part of the Act. 

Earlier this year the Government indicated that it would publish guidance explaining what directors must do to comply with the new codified duties.  It had been hoped by directors, and lawyers alike, that this guidance from the Government would shed some light as to the effect and consequences of the duty to promote success of the company.  Unfortunately, (as will be seen below) our hopes for an enlightened guidance from the Government have not materialised.

In June 2007 the DTI (as it was then) published the following "simple high-level guidance for directors":

1. Act in the company's best interests, taking everything you think relevant into account
2. Obey the company's constitution and decisions taken under it
3. Be honest, and remember that the company's property belongs to it and not to you or to its shareholders
4. Be diligent, careful and well informed about the company's affairs; if you have any special skills or experience, use them
5. Make sure that the company keeps records of your decisions
6. Remember that you remain responsible for the work you give to others
7. Avoid situations where your interests conflict with those of the company; when in doubt, disclose potential conflicts quickly
8. Seek external advice where necessary, particularly if the company is in financial difficulty

This guidance clearly provides no clarification as how directors should interpret their obligations to promote the success of the company and in particular how the six factors should be balanced.  When this guidance was published the DTI acknowledged that the guidance was equally applicable to the pre-existing law and most directors should be following this guidance as a matter of good practice.  While this is probably correct, it does not assist directors understanding this new duty placed upon them. 

The only reference that the DTI publication made to section 172 was a series of ministerial statements made during the course of the Act's passage through Parliament.  However, these statements themselves are quite opaque and certainly do not fulfil the Government's promise of providing plain English guidance.

Unfortunately, it would seem that directors (and lawyers) must wait for the ultimate guidance to come from the Courts by way of case law as and when the scope of this new duty is challenged. 

In the meantime, the best practical advice is to follow the DTI guidance set out above, paying particular attention to recording decisions indicating that all six factors of section 172 have been taken into account when reaching a decision. 

This uncertainty as to the extent of a director's duties is compounded by the fact that the Act introduces a new statutory derivative procedure.  (A derivative claim is an action brought by a minority shareholder on behalf of a company in order to redress a wrong perpetrated against it.  It is an exception to the normal rule that only the company may sue for injury suffered by it). 

The new statutory procedure paves the way for this kind of action to be brought more frequently in future because it extends the range of circumstances in which such an action can be brought and gets rid of some of the current legal barriers.  The new derivative action can now be brought on the grounds of "negligence, default, breach of duty or breach of trust by a director of the company" (see section 260(3)).  This includes any breach of duty by failing to promote the success of the company.

Under the new procedure it is no longer necessary to show that the wrongdoing directors were in control of the majority of the company's shares and the directors do not have to have benefited personally from their actions.  Unmeritorious claims are intended to be deterred by requiring the claimant to show an arguable case before they can continue the claim.

By way of summary there are certain sections of the Act that contain a number of helpful changes that will assist directors, particularly in relation to area of corporate governance.  However, the potential increase in liability in terms of the new duty to promote the success of the company and the ease at which claims may be brought against directors, is clearly something that directors should be aware of and continue to keep under review.

talk to us

Gordon Monaghan 0115 976 6554 Associate

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The content of this bulletin is provided for the purposes of general interest and information. It contains only brief summaries of aspects of the subject matter and does not provide comprehensive statements of the law. It does not constitute legal advice and does not provide a substitute for it.