21/01/2008

The Companies Act 2006 and key changes to the Duties of Directors

Tim Ratcliffe, corporate partner

One of the most significant and controversial provisions of the 2006 Act is its codification of directors duties. Prior to the implementation of this part of the Act on 1 October 2007, directors’ duties had evolved through common law and the law of equity – mainly the decisions of the English and Scottish courts.

The Act includes a new statutory statement of directors duties which replaces the common law and equitable rules. These duties are owed to the company, and only the company will be able to enforce them, although in certain circumstances shareholders may be able to bring what is known as a derivative action on the company’s behalf.

Somewhat confusingly, although the Act operates to codify directors duties, it also states that regard must still be had to equitable and common law principles in the existing law for the purpose of applying and interpreting the codified duties. Interestingly, the Department for Business, Enterprise and Regulatory Reform (DBERR), which has replaced the DTI, has published a statement on its web site by the Minister of State for Industry and the Regions giving guidance and including extracts from Hansard in order to assist interpretation of the new duties [http://www.berr.gov.uk/files/file40139.pdf].

This article will not refer to existing duties, but comment on the Act’s codified duties.

1. Duty to act within a director’s powers – this relates to an obligation to act in accordance with the company’s constitution (which includes not only its constitutional documents but also decisions taken by shareholders) and to exercise powers only for a proper purpose.

2. Duty to promote the success of the company – it is going to be interesting to see how the courts will interpret this duty. This is an obligation on the director to act in good faith in a way most likely to promote the success of the company for the benefit of its members as a whole. The director must take into account the likely consequences of any decision in the long term; the interests of the company’s employees; the 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 the company maintaining a reputation for high standards of business conduct; and – if these are not enough (and the list is said not to be exhaustive) – the need to act fairly as between the members of the company. This is the so-called principle of “enlightened shareholder value”. Success, in this context, means “long-term increase in value” in the case of commercial companies; the government has said that it intends to focus on directors’ good faith judgment, allowing business decisions on strategy and tactics to remain ones for the directors and not subject to court interference.

3. Duty to exercise independent judgment – this does not prevent a director acting in accordance with a shareholder agreement properly entered into, or the company’s constitution.

4. Duty to exercise reasonable care, skill and diligence – this is similar to current principles, though it should be noted that professionally-qualified directors have appropriately enhanced duties, as have directors holding specific responsibilities in the company.

5. Duty to avoid conflicts of interest – it follows that the director should actively avoid situations where such a conflict could arise and must declare his interest in all cases. The board can authorise a transaction, thus avoiding a breach of duty by the director.

6. Duty not to accept benefits from third parties and declare an interest in a proposed transaction or arrangement with the company – it is important that not only the nature but the extent of the interest is fully disclosed to protect the director who is transacting with the company. The director need not specifically be a party to the transaction for the duty to apply – and thus indirect conflicts of interest need to be disclosed as well where they involve connected persons. This present article does not allow for a detailed discussion on conflicts of interest, and previous case law will undoubtedly be brought to bear in interpreting this duty.

Comment

Prior to the Act being brought before Parliament, there was much consultation about whether codification of directors’ duties would be beneficial, and in particular whether such a code would lead to the aggressive minuting of directors decisions, in a “box-ticking” fashion, so as to avoid the risk of directors’ liability.

It has always been good practice for minutes to disclose the main tenor of directors’ reasoning, and the Act should not therefore require over-elaborate minuting of decisions, nor should a lack of paperwork lead to an automatic inference that there has been inadequate consideration given. It is worth noting that there is no specific guidance in the Act as to the weight to be given to the different factors, and how conflicts between the various principles must be resolved.

Hopefully the courts will agree that directors exercising good business common sense in good faith should be left to run their businesses without unnecessary interference by the courts.

Gordons regularly advises on company law issues. If you are in any doubt about the implications of this new legislation please contact Tim Ratcliffe on 01274 202202 or email tim.ratcliffe@gordonsllp.com