On 8 November 2006, after many years in the making, the Companies Act 2006 (the “Act”) finally received Royal Assent and became law.

Containing 1300 sections and 16 schedules, not only is it a fundamental re-write of company law, but it is the longest piece of legislation ever to enter the statute books. The contents section alone runs to 60 pages.

Certain of the Act’s provisions (such as those aimed at facilitating electronic communications between a company and its shareholders) are already in force. The remainder are being phased in on three key dates: 1 October 2007, 6 April 2008 and 1 October 2008.

In this issue of The Brief we concentrate on those changes coming into force on 1 October 2007 which relate to directors, especially those creating the new codified directors’ duties. However, other provisions coming into force on the same day include:

  • New provisions for so called “derivative” actions, giving shareholders a statutory right in some circumstances to bring an action on behalf of the company where a director is in default
  • Changes to the information required to be included in a company’s directors’ report and business review
  • Detailed changes to the provisions for holding meetings and passing resolutions
  • Changes relating to the appointment of auditors of a private company.

One of the most significant and controversial features of the Act is its introduction of a statutory statement of directors’ duties, replacing many of the existing common law duties that apply to directors. Although a company may, in its articles of association, impose more onerous duties on its directors, it cannot, as a general rule, dilute the new statutory duties.

So what are the new statutory duties?

To act within powers

A director must act in accordance with the company’s constitution and must only exercise his powers for the purpose for which they are conferred.

To promote the success of the company

A director must act in the way he in good faith considers would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so must have regard to:

  • The likely consequences of any decision in the long term
  • The interests of employees
  • The company’s need to foster business relationships with suppliers, customers and others
  • The impact of the company’s operations on the community and the environment
  • The desirability of maintaining a reputation for high standards of business conduct
  • The need to act fairly as between the company’s members.

To exercise independent judgment

A director must exercise independent judgment, although this does not prevent him from acting in a way authorised by the company’s constitution or in accordance with an agreement entered into by the company which restricts the future exercise of discretion by its directors.

To exercise reasonable care, skill and diligence

A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with the general knowledge, skill and experience that might be reasonably expected of a person carrying out that director’s functions and having the general knowledge skill and experience that the director actually has.

There has been much criticism, especially in the business press, of this codification of directors’ duties and in particular the so called “principle of enlightened shareholder value”, ie the factors with which directors are to have regard to in respect of promoting the success of the company.

The statutory factors are not an exhaustive list and, in any given situation, other relevant factors may need to be taken into account. In having regard to the factors the directors will need to apply their duty to exercise reasonable care, skill and diligence.

Particular concern has been expressed that greater bureaucracy at board level will be created and that directors will be exposed to greater liability, making it harder to find suitable persons willing to act as non-executive directors.

There is no guidance in the Act as to the weight to be given to different factors and how possible conflicts between them might be resolved. However, there would seem to be an important difference between the express overall (and presumably primary) duty to promote the success of the company and the factors to which the directors must have regard in doing so.

In addition, it appears that the duty is owed only to the company and not to individual shareholders or third parties, although in certain circumstances shareholders might “collectively” be able to bring a derivative action against a director.

The stated aim of codification of directors’ duties is to provide greater clarity as to what is expected of directors, to make the law more “accessible” and to make development of the law relating to directors’ duties more predictable.

Many would say that the new provisions, being both ambiguous and inflexible, will have the opposite effect.

The board of a company will need to consider to what extent they feel there needs to be a paper trail (for example, extensive board minutes where decisions are potentially controversial), capable of demonstrating that they have complied with their statutory duties and have taken all the relevant factors into account.

Other changes coming into force on 1 October 2007 relevant to directors include the following.

Register of directors

A company’s register of directors will no longer need to include a list of other directorships and a list of other directorships will no longer need to be included when the post 1 October 2007 equivalent of form 288a is submitted to Companies House recording the appointment of a director. However, in future, a woman’s maiden name will be required to be included as a former name.

Loans to directors

The existing general prohibition on any company making a loan to a director will be abolished, as will the existing prohibition on a public company (or private company connected with a public company) making a quasi-loan to or credit transaction with a director (or similar arrangements with a person connected to a director). Instead, these types of transaction will be permissible if formal shareholder approval is obtained.

Directors’ service contracts and compensation for loss of office

Shareholder approval will be required where a director’s service contract is to last more than two years. This is currently not required unless it is for more than five years.

In addition, there is a general tightening up of the provisions relating to paying directors (or their connected persons) compensation for loss of office and/or employment.