08/09/2007

Gordons offers practical advice on the Companies Act 2006

James Fawcett, corporate partner

On 1st October 2007, certain provisions of the Companies Act 2006 (“the Act”) come into force. Some of the key provisions coming into force on that date include some of the most controversial aspects of the Act, being the codification of directors’ duties and the rights of shareholders to bring claims against directors.

Directors’ Duties

The Act includes seven general duties (see box below) which directors must act in accordance with and which replace many existing common law duties. The duties are owed to the company and the duties are cumulative, so that where more than one duty applies, directors must comply with all of them.

General Statutory Duties

The seven general duties are:

  • To act within powers.
  • To promote the success of the company.
  • To exercise independent judgement.
  • To exercise reasonable care, skill and diligence.
  • To avoid conflicts of interest. [Coming into force 1st October 2008]
  • Not to accept benefits from third parties. [Coming into force 1st October 2008]
  • To declare interests in proposed transactions or arrangements with the company. [Coming into force 1st October 2008]

One of the key duties is the duty to promote the success of the company. This requires 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 its members as a whole. In fulfilling this duty directors must have regard to:

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

It should be noted that this list of factors is not exhaustive and that the government has indicated that “success” in this context will usually mean “long term increase in value”. It is also for the directors to decide, acting in good faith and with reasonable care and skill, what will promote the success of the company and how the different competing factors should be balanced.

One of the main reasons why directors need to be particularly aware of the codification of directors’ duties is due to the introduction of the new procedure being introduced by the Act to provide for a wider range of circumstances in which derivative actions may be brought by shareholders, including for breach of directors’ duties.

Derivative Action

Under the new provisions, shareholders will be able to bring an action on behalf of a company against a director. An action may be brought in respect of any actual or proposed act or omission involving negligence, default, breach of duty or breach of trust. Therefore, a derivative claim may be brought in respect of an alleged breach of any of the general duties (including the duty to promote the success of the company).

The introduction of this new regime has caused certain parties to express concern that shareholder activists could use the new provisions to launch speculative claims against directors. In order to restrict this possibility, the Act contains a two stage procedure for any applicant seeking permission to continue a derivative action:

  • Stage One. The shareholder will be required to make a prima facie case for permission to continue a derivative claim and the court will be required to consider the issue on the basis of the evidence filed by the shareholder, without requiring evidence from the defendant. The courts must dismiss the application if the applicant cannot establish a prima facie case.
  • Stage Two. The court may require evidence to be provided by the company (prior to the start of the substantive action). At this stage, the court must dismiss the application if (i) either a person acting in accordance with the general duty to promote the success of the company would not seek to continue the claim; or (ii) the act or omission giving rise to the cause of action has been authorised or ratified by the company. In addition, the Act provides for certain other factors that the court must take into account when considering whether to give permission to continue.

It should also be noted that the benefit of any claim will vest in the company which may lead to shareholders thinking twice before launching derivative actions.

Practical Steps

We recommend that companies take the following actions:

  1. Ensure that directors are aware of their duties

    Companies should provide directors with a thorough briefing note on the new duties being introduced by the Act. In addition, all new directors should be briefed at the time of their appointment. It would also be sensible for companies to refer to the duties in directors’ service contracts, descriptions of roles and in any board or committee terms of reference.

  2. Inform Relevant Employees

    Where individuals or groups of employees are required to prepare board papers or presentations on particular matters for consideration by the board, they should be required to consider each of the relevant factors (including those listed in the Act) when preparing their papers and presentations.

  3. Board Minutes

    We would not recommend that board minutes be used to record the extent to which each of the relevant factors was discussed. Such an approach would lead to a substantial increase in the length of board minutes. However, it would be sensible to note when relevant factors have a particularly large bearing on any key decision reached.

    Also, it is likely that lawyers will include wording in board minutes to approve major transactions which records the fact that directors believe such action will promote the success of the company.

  4. Insurance

    Companies should review their directors’ and officers’ liability insurance policies to ensure that defence of derivative claims is covered by the policies.

  5. Indemnity

    Companies may take advantage of the provisions introduced in 2005 which allow companies to indemnify directors against the legal and financial costs of proceedings brought by third parties. Companies may pay directors’ defence costs as they are incurred in civil or criminal cases, even if the action is brought by the company itself. However, a director in this situation will be required to pay any damages awarded to the company and to reimburse the company if he fails in his defence.

If you have any questions on the points raised by this article, please speak to your regular contact at Gordons. Alternatively, please contact James Fawcett on 0113 227 0369 or james.fawcett@gordonsllp.com

This note is only intended to summarise certain provisions of the Act and some of the practical consequences of those provisions, it should not be treated as a comprehensive guide or as specific advice. If you are in any doubt as to the implications of the Act, you should take specific professional advice.