There has been much speculation about the scope of the new directors’ duties introduced by the Companies Act 2006 (the “Act”) and, on 1 October 2007, four of the seven new provisions on directors’ duties, together with the new statutory right for shareholders to bring an action against the directors, will come into force.
Directors of both public and private companies will, therefore, need to ensure they are aware of the codified duties and are in a position to comply, and arguably be seen to comply, with the duties.
The new directors’ duties
The four new directors’ duties which come into force on 1 October 2007 are as follows:
- To act within powers (s.171) – directors must act within the company’s constitution and only exercise powers for the purposes for which they were conferred.
- To promote the success of the company (s.172) – directors must act in good faith to promote the success of the company for the benefit of its members as a whole, with particular regard to six factors:
a. the long term consequences of decisions;
b. the interests of the company’s employees;
c. the company’s business relationships with suppliers, customers, etc.;
d. the community and the environment;
e. maintaining a reputation for high standards of business conduct; and
f. the need to act fairly as between members of the company. 4. To exercise independent judgment (s.173)
5. To exercise reasonable care, skill and diligence (s.174) – judged both objectively (expected of a director, generally) and subjectively (expected of that director with his particular knowledge of facts, experience etc).
The three further directors’ duties which are due to come into force a year later, on 1 October 2008, are:
- To avoid conflicting interests (s.175)
- Not to accept benefits from third parties which give rise to conflicts (s.176)
- To declare any interest in proposed transactions or arrangements with the company (s.177)
The Act did not amend directors’ duties and liabilities which are specific to insolvency situations (and which are set out in the Insolvency Act 1986). Directors (and others involved in management) should, therefore, ensure they are also aware of their additional responsibilities (already in existence) when a company becomes, or is likely to become, insolvent. Above all, they should be aware that, in such situations, their duties switch from acting in the best interests of the creditors to acting in the best interests of the company’s creditors.
Preparing for the new duties
Speculation about the way in which the new directors’ duties will take effect has invariably focused upon: (1) the scope of the duty to promote the success of the company; and (2) what steps directors should take to protect themselves from claims for breach of their duties.
(1) Promoting the success of the company
This general duty replaces the existing common law duty of directors to act in good faith and in the best interests of the company. However, there is some uncertainty about what, if anything, directors should be doing differently.
Clearly, the new duties provide that, each time a director makes a decision, the director should be considering whether the outcome will further the success of the company, having regard to each of the six prescribed factors, together with any other relevant considerations. Parliamentary guidance further suggests that, in practice:
i. the overriding success of a company is generally to be measured by the long-term increase in the value of the company and this is a matter for the directors exercising their judgment in good faith;
ii. where there is conflict between the prescribed factors, this is, again, a matter for the directors exercising their judgment in good faith, giving proper consideration to the competing factors, to reach their decision; and
iii. the Act does not require directors to keep a paper-trail as to how decisions were reached.
Several potential issues arise from the new duties and, in spite of this guidance, there is still a high degree of uncertainty about the effect of the new duties. Directors make a variety of decisions each day – ranging from informal decisions by one director to board-level decisions – and the nature of the decision will necessarily impact upon how a director complies with his / her duties.
Contrary to comments made by the former Attorney General, Lord Goldsmith, and the views of various organisations arguing against increased bureaucracy, directors may consider it prudent to keep evidence about how they reached certain decisions. Whilst this does not mean that directors should keep a record of how they arrived at minor decisions, directors may consider a more defensive practice when required to make contentious decisions which are likely to face challenge from shareholders. For example, where a board of directors plans to develop Greenfield space with the effect of increasing business productivity and providing more jobs, they may want to evidence that they have considered the conflicting factors – such as the community and the environment. This may be achieved in some instances by commissioning and reviewing a briefing note setting out the competing interests. Such a note would not necessarily consider all of the six prescribed factors but would, instead, focus on relevant considerations.
There is a note of caution where directors adopt a policy of producing a paper-trail for some decisions but not others. In particular, there is a risk that, for decisions where the directors chose not to leave a paper-trail – or left a paper-trail which the Court considered insufficient, a Court deciding a challenge by a shareholder may infer that the directors in reaching that particular decision did not give serious consideration to the competing interests involved. In other words, in trying to take additional steps to demonstrate their compliance with the law, directors may actually create more problems.
Directors of larger companies may demonstrate they are complying with their duties by designating responsibility for particular areas to officers or managers (e.g. appointing an employee representative) who can then report to the board. Provided the officer or manager is given sufficient involvement in the decision-making process, this would seem to be a simple and effective way of ensuring that each of the six prescribed factors was seen to be given adequate weight. Again, this approach is untested and any company adopting a similar approach will need to consider how it implements such a policy.
(2) Shareholder claims for breach of duties
From 1 October 2007, shareholders will, under the Act, be able to bring derivative actions in the name of the company against directors (or others) for a proposed act or omission (involving negligence), default, breach of duty or breach of trust by a director of the company.
There was previously some concern surrounding the introduction of this new statutory right and the common cautionary example cited was the hypothetical environmental activist who buys shares in a public company so he / she can then disrupt the internal management decisions of that company through continuous legal proceedings.
In fact, the Act and the new provisions of the Court rules (CPR rules 19.9 to 19.9F) provide that, once a claim has been issued by a shareholder, on behalf of the company, the claimant (i.e. a shareholder on behalf of the company) must:
i. notify the company “as soon as is reasonably practicable after the claim form is issued”; and
ii. before any further substantive steps can be taken in the proceedings, apply to the Court (with written evidence in support) for permission to continue the claim.
As the claim is effectively stayed until the Court gives the necessary permission, vexatious claimants with unfounded claims should, in theory, be unable to prevent a company from acting on its decisions pending the conclusion of potentially protracted legal proceedings. Furthermore, when considering whether to give permission for claims to continue, the Court will consider guidelines set out in the Act (at section 263) and these include whether the shareholder is acting in good faith and whether the claim is consistent with promoting the success of the company.
Accordingly, it seems that – rather than allowing vexatious and trumped-up claims (and related injunctive measures) to interfere with a company’s activities – the new statutory rights will tend to preserve the Court’s general non-interventionist stance in company affairs.
However, where the Court gives permission for reasonable claims to continue, directors are best advised to ensure they take adequate steps, earlier in the life of the company, to protect themselves. This will include the steps listed above but also extends to more basic considerations such as ensuring each of the directors has adequate directors’ and officers’ insurance in place.
Please contact Luke Arbuthnotor Sarah Walkerfor further information or if you would like us to provide a copy of our briefing note on directors’ duties (both generally and during insolvency).