Evolution Director Duties English Company Law

Introduction

Within the modern English company law, there are significant developments in the areas of corporate governance, also translated into law as equitable principles decided by the courts, as well as statutory provisions, enshrined in the Companies Act 2006. Many of these principles are related to the duties of the directors in the company. The statutory duties of the directors include, the duty to promote the success of the company, duty to avoid conflicts of interest with the company, duty to declare interests in a proposed transaction, and duty not to accept benefits from third parties. The ‘enlightened shareholder value provision’ contained in s 172 of the Companies Act 2006, provides the duty of the director to consider the long term consequences of acts, consider the interests of employees, and consider the impact of the company’s operations on the wider community and environment. These duties of the directors of the companies are discussed at length in this essay. This essay critically discusses whether the codification of these duties in the Companies Act 2006 has led to the achieving of the purpose for which the codification was made and added value to the corporate governance of companies.

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The general directors’ duties in the Companies Act 2006

The relationship between the company and the outsiders is an area in which the directors of the company play an important role, and there are settled principles of company law and tort law that is applicable to this field. Particularly, the Rule in Hampshire Land, is relevant here as in this case, the court held that the company cannot be held liable for knowledge of a fraud or breach of duty known to a director but not conveyed to the company. Similarly, the Rule in Turquand’s Case, provides that if the directors have power and authority to bind the company, with the company itself having to undertake some preliminaries before exercise of the directors’ powers, then the person contracting with the directors can presume that the directors are acting lawfully in what they do. These two cases highlight the role of the director and the extent to which directors can bind the company by their actions, as well as the need to ensure that the company is protected from liability arising out of the director’s knowledge of fraud or breach of contract. The Rule in Turquand’s Case is now subsumed by the effects of s. 40 of the Companies Act 2006, which renders ineffective any limitation on the power of the directors to bind the company in a company’s constitution.

The duties of the directors of the company were rooted in the fiduciary position of the director vis a vis the company and its shareholders, so that the interests of the directors and duties towards the company and shareholders were not to conflict. With the codification of directors duties in the Companies Act 2006, many of these duties are now statutory in nature. Each of the seven duties codified, emphasises on the avoidance of conflict of interest between the director and the company.

Under s 171 Companies Act 2006 provides the duty of directors of exercising their powers for the purpose conferred. The powers and purpose are conferred in the Articles of Association. In Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd, the articles allowed that the director could be delegated the powers related to management of the company; the court held that company was bound by the contract entered into by the director as per the powers and the purpose. However, this can also be used to show that if the powers were not used for the purpose they were conferred for, then the director would be breaching his duty by exercising the powers.

The directors have a duty to promote the success of the company and work towards the benefit of its members as well as in the interests of the creditors under s 172 of the Companies Act 2006. Directors also have the duty to exercise independent judgement under s 173 of the Companies Act 2006; however, a director can act in accordance with an agreement to which the company is a party.

The directors have the duty to exercise care and skill under s 174 of the Companies Act 2006. The duty of skill and care relates to the negligence law, as per which the director has to exercise care, skill and diligence to be exercisable by a reasonably diligent person with the general knowledge, skill and experience to be expected of a director and that which the director has. This duty comes into play in different situations. For instance, directors are required to make a recommendation for dividends only after careful consideration of the financial health of the company as held in Re Loquitor. In this case, the court held that prudent directors will not recommend dividends without considering if the company had the financial health to meet the claims of creditors of the company. In Re Loquitor, directors were held liable for acting in breach of their duties as they failed to consider the interest of the creditors and to exercise due care and skill by not retaining sufficient assets to meet future liabilities while making the decision related to giving out dividends.

The duty to avoid conflicts of interest is provided in s 175 of the Companies Act 2006. This has long been recognised as a fiduciary duty of the directors, the rationale of which was explained by the court as that if a director is allowed to enter into an agreement for his personal interest, and this leads to other directors of the company also pursuing the same policy, ultimately the interest of the company will be compromised. Recently, this duty was explained as avoidance of ‘corporate opportunity’ by a director as the opportunity rightly belongs to the company. Company law has looked askance at directors taking corporate opportunities in personal interests, and have made directors to account for profits made under such opportunities. However, the liability can be avoided by disclosing the possible conflict to the board of directors.

Directors have the duty to not accept benefits from third parties under s 176 Companies Act 2006. The duty is based on the principle that directors should not have undisclosed secret profits due to exercise of their powers or position. For instance, directors of a company invested in the shares of the subsidiary company, later sold at profit in a take-over of the subsidiary company, which was held to violate their fiduciary position in the company. In a recent Supreme Court judgement, it has been held that bribes are a secret profit held in trust for the company. It has been held that when a director uses company's confidential information to make a personal profit or leaks information for personal gain, it is a violation of his fiduciary position.

The directors are under a duty to declare interest in proposed transactions or arrangements under s 177 of the Companies Act 2006. This is a part of principle of disclosure, central to maintaining transparency in the company and complying with corporate governance standards. The disclosure regime is structured in a way to specifically put the duty of disclosure on the company and its directors. Directors’ duties of disclosures are provided in different provisions of the Companies Act 2006. For instance, s 182 requires the director to disclose his interest in any transaction or arrangement, entered into by the company. Another example is in s 417(2), which requires directors to produce a business review for the information of members as to how directors have performed their duty under s 172. In Item Software (UK) Ltd v. Fassihi, Arden LJ emphasised that a director who is in breach of the duty of loyalty has the duty to disclose the breach to the company.

As per s 177, director must disclose any interest (direct or indirect), in any proposed transactions of the company. This duty arises where the director can be reasonably expected to have that information. The rationale behind this duty was explained by the court in Re Chez Nico (Restaurants) Ltd, wherein Browne-Wilkinson VC observed that the duty to disclose pending negotiations for the sale of the company’s undertakings before purchasing the shares in the company, arises because directors are in a fiduciary relationship to the company as well as shareholders. The same principle was applied in a recent case, wherein the court held that the director has the duty of loyalty towards the company, and as per this duty, he should disclose any interest that he may have in a proposed transaction of the company, else it will be a breach of loyalty.

Why the duties were codified the rationale behind codification

The duties of the directors have been codified in the interest of corporate governance of the companies. The need to ensure corporate governance has been long recognised as necessary as noted by Tricker: “if management is about running business; governance is about seeing that it is run properly. All companies need governing as well as managing.” Even though the codification of directors duties is a fairly new development, the need for ensuring corporate governance through directors, has always been a matter of concern. For instance, in an early work, Mill viewed director acting almost as a quasi-trustee of the company, so that there were a variety of fiduciary duties owed by the director to the company and its shareholders. In the 20th and 21st century, a number of committees have been established to consider what amendments could be made to statutory law to strengthen corporate governance. Invariably, these committees have emphasised on the duties of directors towards company and shareholders. The Cohen Committee, focussed on safeguards for investors and public interest. The Jenkins Committee, emphasised on duties of directors. The Cadbury Committee, particularly looked at directors’ responsibility for governance. The Greenbury Report, focussed on remuneration of directors. The Hampel Report emphasised accountability to shareholders. The Myners Report, examining trustee aspects of institutional investors. The recent Walker Review, has emphasised on the role of corporate governance in the aftermath of the 2007-8 banking crisis. One common thread running through these different committees is the focus on corporate governance and the linking of corporate governance to the role of the directors.

One of the advantages of codification of directors’ duties is that it has made it easier for derivative actions by the minority shareholders to be filed against the directors of the company. Under the Companies Act 2006, part 11 statutory derivative actions can be filed by minority shareholders. S 260(1) allows derivative claims in respect of a cause of action vested in the company, which arises from an actual or proposed act or omission by a director, which may involve negligence, default, breach of duty or breach of trust. The statutory derivative action structure is different from that under the common law, as noted by Kershaw:

“while in the common law, the shareholder would have to demonstrate that the action fell within one of the exceptions to the Foss rule, under the statutory provisions, the shareholder needs permission from the court to continue with the action after showing that the action relates to an act of the company’s director.”

However, one drawback is still to be noted, which is that where the director is alleged to have breached some duty owed to the company, but the action has been ratified by the majority of the shareholders, then the court may disallow derivative claim by the minority shareholders as per the provisions of ss 263 and 268 of the Companies Act 2006. This is unfortunate because one of the advantages of the derivative claims procedure is that it creates better corporate governance mechanisms as accountability of the directors and majority shareholders can be enforced. If directors in the company, aided by the majority shareholders conduct themselves in such a way that is oppressive conduct by the majority, or fraudulent actions of directors ratified by the majority, then the impact of the same is felt in the corporate governance of the company. As such, the general duties of the directors, provide a basis for derivative actions on the basis of breach of the general duties. Prior to the inclusion of statutory derivative action, there were limitations on the successful pursuit of derivative actions due to the application of the Foss principle. Thus, in Johnson v Gorewood & Co, derivate action was not allowed despite the loss suffered by the company due to breach of duty by directors. Similar rule was applied in Gray v Lewis. With the application of statutory duties of the directors read with the statutory derivative action, it is hoped that there will be a strengthening of the corporate governance of the company; however, with restrictions drawn on the such derivative claims, it is seen that there are still areas where the directors may get away with breach of statutory duties, which may not be aligned to the purposes of corporate governance.

Another point worth considering is that even those directors’ duties that are made specifically to respond to the corporate governance concerns, such as, duty under s 172 of the Companies Act 2006, are enforced within the scope of shareholder interest primacy, so that the directors duties are more focused on shareholder interest and not balancing the interest of other stakeholders as well. In this case, Sales J held that shareholders’ primacy is the core consideration for directors, which is not to be subordinated to any other stakeholders’ concern, leading to a situation where for other stakeholders, s 172 just creates a right but does not provide a remedy. Moreover, the test that the director has to apply under s 172, in order to ascertain whether the actions are in the interest of the company are in interest of the company or not, is a subjective test. This gives discretion to the directors, which can be used to justify actions that may not be entirely in the interest of the company. This comes in the way of fully implementing corporate governance

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Conclusion

The purpose for which the directors’ duties were codified was to strengthen corporate governance. To some extent, the purposes of the codification are achieved because codification provides a basis for ensuring that directors are clear about their duties and also that there are recourses against directors that are not abiding by their duties. Corporate governance is also strengthened by the adoption of statutory derivative actions where directors have breached their duties. However, for minority shareholders it is still difficult to bring such actions where directors’ actions are ratified by the majority shareholders. This is a drawback of the statutory provisions, which comes in the way of achieving a higher degree of corporate governance.

Table of cases

  • Aberdeen Railway Co v Blaikie Brothers [1854] UKHL 1.
  • Bhullar v Bhullar [2003] EWCA Civ 424.
  • Bray v Ford [1896] AC 44.
  • CMS Dolphin Ltd v Simonet [2001] EWHC Ch 415.
  • Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480.
  • Foss v Harbottle [1843] 67 ER 189.
  • Gray v Lewis [1873] 8 Ch App 1035. Guinness plc v Saunders [1989] UKHL 2. HR European Ventures LLP v Cedar Capital Partners LLC [2014] UKSC 45. Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443. Item Software (UK) Ltd v Fassihi [2005] 2 B.C.L.C. 91.
  • Johnson v Gorewood & Co [2001] 2 WLR 72. Re Chez Nico (Restaurants) Ltd [1992] B.C.L.C. 192. R (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 Admin. Regal (Hastings) Ltd v Gulliver [1942] UKHL 1.
  • Re Hampshire Land [1896] 2 Ch 743. Re Loquitor Ltd, IRC v Richmond [2003] 2 BCLC 442. Royal British Bank v Turquand (1856) 6 El & Bl 327.
  • Books

  • Dignam AJ, Hicks A and Goo SH, Hicks and Goo’s Cases and Materials on Company Law (7th edn, Oxford University Press 2011).
  • MacIntyre E, Essentials of business law (Cambridge: Cambridge University Press 2011).
  • Mill JS, Principles of Political Economy (London: 1848)
  • Kershaw D, Company Law in Context: Text and Materials (2nd edn, Oxford University Press 2012).
  • Roach L, Card & James' Business Law for Business, Accounting, & Finance Students (Oxon: Oxford University Press 2012).
  • Tricker B, Corporate Governance: Practices, Procedures, and Powers in British Companies and their Boards of Directors (1984, Gower Publishing: Aldershot)
  • Journals

  • Fung B, ‘The Demand and Need for Transparency and Disclosure in Corporate Governance’ (2014) 2 (2) Universal Journal of Management 72.
  • Lowry J, ‘The Duty of Loyalty of Company Directors: Bridging the Accountability Gap Through Efficient Disclosure’ (2009) 68 (3) The Cambridge Law Journal 607.
  • Wooldridge F and Davies L, ‘Derivative claims under UK company law and some related provisions of German law’, (2012) 90 Amicus Curiae 5.
  • Reports

  • Cadbury A, Report of the Committee on the Financial Aspects of Corporate Governance (London: Gee & Co. Ltd 1992).
  • Greenbury Committee, Directors Remuneration: The Report of a Study Group Chaired by Sir Richard Greenbury (Gee Publishing
  • Hampel, Committee on Corporate Governance, Final Report (London 1998).
  • Jenkins Committee (1962) Cmnd 1749.
  • Myners, Institutional Investment in the United Kingdom: A Review (Stationary Office 2001).
  • Walker Review, A Review Of Corporate Governance in UK Banks and other Financial Industry Entities (London: Stationery Office 2009).

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