News

6 October 2008

Directors' duties under Companies Act 2006

The Companies Act 2006 (2006 Act) codifies certain common law and equitable duties of directors.

The most significant change in relation to directors' duties is that there is now a statutory requirement for directors to have regard, among other things, to a list of factors in exercising their duty of good faith.

Position prior to 1 October 2007

Directors' duties under common law and equity, largely derived from the law of agency and trusts, fell into two main categories:

  • Fiduciary duties of good faith and loyalty; and
  • Common law duties of skill and care.

Directors also owed the company an equitable duty of confidence.

Position after 1 October 2007

In summary the seven general duties under the 2006 Act are:

  • To act within powers.
  • To promote the success of the company.
  • To exercise independent judgment.
  • To exercise reasonable care, skill and diligence.
  • To avoid conflicts of interest.
  • Not to accept benefits from third parties.
  • To declare an interest in a proposed transaction or arrangement.

The first four duties came into force on 1 October 2007 and the remainder will come into force on 1 October 2008. 

Who owes the duties?

The general duties will apply to all the directors of the Company.  "Director" is defined as any person occupying the position of director, which will include de facto directors.  However, there is still uncertainty regarding the application of directors' duties to shadow directors.

The codified duties are owed to the company and in most circumstances only the company will be able to enforce them.

It should be noted that certain aspects of the duty to avoid conflicts of interest and the duty to accept benefits from third parties will continue to apply after the person ceases to be a director of the company.

THE DUTIES:

Duty to promote the success of the company

The 2006 Act provides that a director must 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 so doing, the director must have regard (among other matters) 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:

  • The duty will apply to all decisions made by a director, not merely formal decisions made by the whole board.
  • "Success" is not defined. The government has stated that "success" in this context will usually mean "long-term increase in value" for commercial companies, and that what will promote the success of the company, and what constitutes such success, will be for the director's good faith judgment - its view is that this will ensure that business decisions on, for example, strategy and tactics, are for the directors, and are not subject to decision by the courts, provided the directors were acting in good faith.
  • The obligation to have regard to the listed factors is clearly subordinate to the overarching duty to promote the success of the company for the benefit of its members as a whole. However, the obligation to have regard to at least the listed factors, in carrying out the overarching duty, is mandatory.
  • The list of factors is not exhaustive - directors should have regard to other matters relevant to the duty to promote the success of the company.


Duty to act within powers

The 2006 Act codifies the equitable principle under which a director must act in accordance with the company's constitution and must only exercise his powers for their proper purpose.

  • A company's constitution for these purposes includes:
  • The company's articles (and memorandum).
  • Decisions taken in accordance with the articles.
  • Other decisions taken by the members or a class of them, where treated by law as equivalent to decisions of the company.
  • Any resolutions and agreements affecting a company's constitution.


Duty to exercise independent judgment

The 2006 Act provides that a director must exercise independent judgment. The duty will not be infringed by a director acting in accordance with an agreement entered into by the company that restricts the future exercise of the directors' discretion or in a way authorised by the company's constitution. It follows that any powers of delegation should be set out in the articles.

The government has said that this duty will not prevent directors relying on advice, as long as the directors exercise their own judgment in deciding whether or not to follow the advice.

Duty to exercise reasonable care, skill and diligence

Under the 2006 Act a director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both:

  • The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company (the "objective" test).
  • The general knowledge, skill and experience that the director actually has (the "subjective" test).

So, at a minimum, a director must display the knowledge, skill and experience set out in the objective test, but where a director has specialist knowledge, the higher subjective standard must be met. In applying the test regard must be had to the functions of the particular director, including his specific responsibilities and the circumstances of the company.

Duty to avoid conflicts of interest:

The 2006 Act will replace the no-conflict rule applying to directors, under which a director must not, without the company's consent, place himself in a position where there is a conflict, or possible conflict, between the duties he owes the company and either his personal interests or other duties he owes to a third party.

A director must avoid situations in which he has or can have a direct or indirect interest that conflicts with, or may conflict with, the company's interests. That applies, in particular, to the exploitation of property, information or opportunity, and whether or not the company could take advantage of the property, information or opportunity.
The duty under the 2006 Act will not be infringed:

  • If the situation cannot reasonably be regarded as likely to give rise to a conflict of interest.
  • If authorisation has been given by directors who are genuinely independent (in the sense that they have no direct or indirect interest in the transaction), unless the company's constitution prevents such authorisation.

Board authorisation will only be effective if the required quorum is met without counting the director in question or any other interested director and if the conflicted directors have not participated in the taking of the decision or if the decision would have been valid without the participation of the conflicted directors.


The duty to avoid conflicts of interest will continue to apply after a person ceases to be a director as regards the exploitation of any property, information or opportunity of which he became aware when he was a director.

Duty not to accept benefits from third parties

Under the 2006 Act, directors must not accept any benefit (including a bribe) from a third party which is conferred because of his being a director or his doing or not doing anything as a director.

The duty will not be infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. Benefits conferred by the company, its holding company or subsidiaries, and benefits received from a person who provides the director's services to the company, are excluded.

Any current ability of the members of a company to authorise the acceptance of benefits that would otherwise be a breach of this duty is preserved, and the company's articles may contain provisions for dealing with conflicts. Companies may wish to amend their constitutions to provide that where directors accept benefits under a specified value, they will not be in breach of their duty to the company, for example to ensure that the acceptance of a certain level of corporate hospitality will not cause a director to breach the section.

The duty will continue to apply after a person ceases to be a director in relation to things done or omitted by him before he ceased to be a director.

Duty to declare interest in proposed transaction or arrangement with the company

Under the 2006 Act, directors must declare to the other directors the nature and extent of any interest, direct or indirect, in a proposed transaction or arrangement with the company. The director need not be a party to the transaction for the duty to apply. An interest of another person in a contract with the company may require the director to make a disclosure under this duty, if the other person's interest amounts to a direct or indirect interest on the part of the director.

The declaration must be made before the company enters into the transaction or arrangement.

Where a declaration of interest proves to be, or becomes inaccurate or incomplete, a further declaration must be made, if the company has not yet entered into the transaction or arrangement when the director becomes, or should reasonably have been, aware of the inaccuracy or incompleteness.

No declaration will be required:

  • Where the director is not aware of his interest or where the director is not aware of the transaction or arrangement, but directors will be treated as being aware of matters of which they ought reasonably to be aware.
  • If the interest cannot reasonably be regarded as likely to give rise to a conflict of interest, if the other directors are already aware of it, or if it concerns the terms of the director's service contract which have been (or are to be) considered at a board meeting or board committee.
  • Where the company has only one director.


CONSEQUENCES OF BREACH

Action by the company

As noted above, the codified 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 a derivative action on the company's behalf.

The circumstances in which derivative actions may be brought are extended by the 2006 Act, and such actions are expressly available for a breach of duty by directors, even if the director has not benefited personally from the breach.

However, a member will face a number of procedural hurdles in bringing an action. For example, a court must refuse permission for a claimant to bring a derivative claim where it is satisfied that either:

  • A person acting in accordance with the general duty to promote the success of the company would not seek to continue the claim.
  • The act or omission giving rise to the cause of action has been authorised or ratified by the company.

Remedies

The remedy for a breach of the duty to exercise reasonable care, skill and diligence will usually be damages. Remedies for breaches of other general duties may include:

  • An injunction.
  • Setting aside of the transaction, restitution and account of profits.
  • Restoration of company property held by the director.
  • Damages.
  • Termination of the director's service contract.


Relief from liability

The 2006 Act preserves the current law on ratification of acts of directors, but with a significant change. Any decision by a company to ratify conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company must be taken by the members without reliance on the votes in favour by the director or any connected person. A member connected with the director will include certain family members and may include fellow directors.

Practical steps

As a director of a company you should speak to the Corporate/Commercial team at Beswicks.  We can review your board's policies and procedures and your company's constitution to ensure that these are compliant with the 2006 Act and also ensure that each member of your board is aware of their duties under the 2006 Act.

For further information contact Anne Scheland or Simon Woodings on 01782 205 000.

 

The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. The law may have changed since this article was published.

Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances

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