The Companies Act 2006 (the “2006 Act”) received Royal Assent on 8 November 2006. The first and second commencement orders were published on 20 December 2006 and 29 March 2007, respectively. The 2006 Act is implemented in stages with the entire Act being in force by 1 October 2008.

This update gives a brief overview of the key changes to the current company law regime affecting directors that come into effect in 2007.

Key changes in force as of 20 January 2007

 Liability for directors’ reports

Section 463 of the 2006 Act introduces a new safe harbour in relation to directors’ liability for the directors report (which includes the business review), the directors’ remuneration report and summary financial statements. Directors are only liable to compensate the company for any loss it suffers as a result of any untrue or misleading statement in, or omission from, such a report if the untrue or misleading statement is made deliberately or recklessly, or the omission amounts to dishonest concealment of a material fact.

This safe harbour addresses the concern of directors over liability for negligence when making, for example, forward-looking statements in the directors’ report, in particular, the business review. The directors’ liability is limited to the company rather than to third parties.

Key changes in force as of 6 April 2007

Disclosure of directors’ interests in shares

The 2006 Act repealed sections 323 to 329 of the 1985 Act which (1) prohibited directors (including shadow directors) from buying put, call or put and call options in listed shares or debentures in the company or another in the same group (section 327 of the 1985 Act extended this prohibition to spouses and minor children of directors), and (2) imposed an obligation on directors (including shadow directors) to disclose to the company their interest in shares in and debentures of the company or any holding or subsidiary company within a group structure, including any interest held by the directors’ children or spouse.

These provisions were not replaced in the 2006 Act. Instead, directors’ dealings in shares and debentures are regulated in chapter 3 of the FSA’s Disclosure and Transparency Rules sourcebook (DTR 3) which requires persons discharging managerial responsibilities (which includes directors) to disclose to the issuer whose shares are admitted to trading on a regulated market (for examples, the Official List but not AIM) transactions conducted on their own account in the shares of the issuers, or derivatives or any other financial instruments relating to those shares. Similar requirements apply to directors of AIM companies (see Rule 17 and Schedule 5 of the AIM Rules). From 20 January 2007, directors of companies whose shares are admitted to trading on a regulated market are also subject to the disclosure requirements of DTR 5 (for further details please see the Wedlake Bell update “The Companies Act 2006: Provisions affecting public companies 2007”).

Age limit for directors

Section 293 of the 1985 Act which provides for a 70 year age limit for directors of public companies, or private companies which are subsidiaries of public companies, has been repealed.

Key changes in force as of 1 October 2007

Directors’ duties

The general duties of directors set out in chapter 2 of Part 10 of the 2006 Act will come into force on 1 October 2007 (other than the provisions relating to directors’ conflict of interest duties which will come into force on 1 October 2008).

The codification of directors’ duties constitutes the centrepiece of the 2006 Act. It introduces a statutory statement of seven general duties owed by directors to their company. The duties will apply to directors, former directors (only with regard to the duty to avoid conflicts of interest and the duty not to accept benefits from third parties) and shadow directors1. They will be owed to the company and only the company will be able to enforce them and obtain damages from directors although, in certain circumstances, a shareholder will be able to bring a derivative suit against a director on behalf of the company (see below).

The statement of directors’ duties provides that directors must:

  • act in accordance with the company’s constitution and exercise powers only for the purposes for which they are conferred (section 171 of the 2006 Act);
  • act in a way that the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (section 172 of the 2006 Act);
  • exercise independent judgment (section 173 of the 2006 Act);
  • exercise reasonable care, skill and diligence (section 174 of the 2006 Act);
  • avoid conflicts of interest (section 175 of the 2006 Act);
  • not accept benefits from third parties (section 176 of the 2006 Act); and
  • declare any direct or indirect interest the director has in proposed transactions or arrangements with the company (section 177 of the 2006 Act).

These general duties will replace the current combination of directors’ statutory and common law duties. They are based on existing common law duties and equitable principles that were developed through case law and, accordingly, the new duties should be interpreted and applied having regard to the existing common law rules and equitable principles. There are, however, some amendments to the existing duties, the most significant of which are the introduction of the new duty to promote the success of the company, and changes to the directors’ duty to avoid conflicts of interest (for further details on these duties please see the Wedlake Bell update on “The Companies Act 2006: Impact on Corporate Transactions”).

Ratification of breaches

The 2006 Act will put on a statutory footing the ability of shareholders (currently often found in the articles of association) to ratify any breach of duty, trust, acts of negligence or default by directors in relation to the company by ordinary resolution (unless the company’s articles require a higher majority or unanimity) (see section 239 of the 2006 Act). Note, however, that votes cast by the relevant director or any person connected with him will have to be disregarded.

Derivative claims

The provisions on derivative claims can be found in Part 11 of the 2006 Act. The new rules put the derivative claim on a statutory footing and extend it beyond the rule in Foss v Harbottle:

  • Shareholders will be able to bring a claim against a director (including former directors and shadow directors) in the name of and on behalf of the company 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”.
  • Claims can be brought by a shareholder holding only one share, and it is not necessary that the shareholder bringing the claim was a shareholder at the time of the alleged wrongdoing.
  • The range of circumstances in which such a claim may be brought will be broader than under current law: For example, it will be available (1) for claims based merely on an allegation of negligence by directors, and (2) even if the director has not benefited personally from the breach. Concerns have been raised about the potential exposure of directors to liability, particularly in connection with the new duty to promote the success of the company (see above), where a claimant argues that as a result of a breach of duty the company has suffered a loss.

As a safeguard against ill-founded or tactical litigation, the 2006 Act requires shareholders to obtain the court’s permission to continue a claim. Most importantly, courts will not allow a case to proceed if the applicant fails to demonstrate a prima facie case or if the court decides that the directors of the company would not choose to continue the claim because doing so would be unlikely to promote the success of the company. This will, in effect, require judges to make a business judgment inevitably involving a considerable degree of discretion. Whether judges are equipped to make such a decision remains to be seen. Directors’ long-term service contracts Under the 2006 Act, shareholder approval will be required for directors’ service contracts in excess of two, as opposed to currently five, years (see section 188 of the 2006 Act).

Loans to directors

Sections 197 to 214 of the 2006 Act will replace sections 330 to 342 of the 1985 Act. The new sections will abolish the general prohibition on loans to directors and replace it with a requirement for shareholder approval for all companies. The list of exceptions where shareholder approval is not required will be expanded.

Substantial property transactions

In the context of acquisitions involving a substantial property transaction where non-cash assets are acquired from, or transferred to, a director of the acquiring or transferring company, the 2006 Act will enable companies to make agreements conditional on shareholder approval being given rather than having to obtain prior shareholder approval. This will give companies more flexibility and speed up the acquisition process as the parties no longer have to wait until a shareholder meeting has been held.

Further information

This update is part of a series of three updates on the Companies Act 2006 published by Wedlake Bell and includes a chart indicating the key implementation dates (“The Companies Act 2006 at a glance”). The other two updates focus on the provisions affecting public and private companies in 2007. An update on the key changes coming into force in 2008 will be available in due course.

Wedlake Bell also recently published two updates giving an overview of the key changes of the Companies Act 2006 to the current company law regime, and in particular highlighting changes that will affect corporate transactions.

These updates are available on www.wedlakebell.com.