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Directors' Duties - Companies Act 2006

The Companies Act 2006 (“the Act”) codifies the duties of company directors.  Whilst some of these duties are based upon the existing common law duties of director, others reflect a significant departure from the pre-existing legal position.

The new statutory duties are as follows:-

            • to act in accordance with the company’s constitution and only exercise powers for the purpose for which they are conferred (s.171);

            • to act in the way he/she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (s.172);

            • to exercise independent judgement (s.173);

            • to exercise reasonable care, skill and diligence (s. 174);

            • to avoid conflicts of interest (s.175);

            • not to accept benefits from third parties (s.176); and

            • to declare any personal interest on a proposed transaction with the company (s.177).

The first four became effective on 1st October 2007.  The last three will become effective a date to be announced, although there is currently an obligation on directors equivalent to the s. 177 duty.                             

The most controversial of these “new” duties is the second, “to promote the success of the company”.  This replaces the common law duty on directors to act “bona fide in the best interests of the company”.  Section 172 goes on to list a non-exhaustive set of factors to which a director should have regard when discharging this duty, namely:

            • the likely consequences of any decision in the long term;

            • the interest 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; and

            • the need to act fairly as between members of the company.

Section 172 represents the introduction of the doctrine of Corporate Social Responsibility into company law, or as the White Paper on the Act described it “the concept of enlightened shareholder value”.  It is interesting to note that the desirability for the company to make money is not one of the factors listed.

The celebrated economist Milton Friedman wrote in his seminal work, Capitalism and Freedom, “there is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”  Well, it would appear that the government does not share this philosophy, now that there is a legal obligation on directors to consider environmental and social impacts of their companies’ business.

So what does this mean in practice?  Alastair Darling, when Secretary of State for Trade and Industry, informed us that “the statement of duties does not impose new process requirements on directors: directors are not required to keep additional records as a result of the statutory duties; and directors who act in good faith will not be held liable for failing to have regard to one of the factors if this failure would not have altered their business decision”.  Lawyers will advise you otherwise.

The duties owed by the directors are owed to the company, and not to shareholders or employees, or to any person who might be affected by a decision of the directors which impacts the environment or the community.  However, a shareholder can, under new derivative action rules, bring an action against a director or third party if there is any breach or threatened breach by a director of his duties, and whether the breach occurred before or during the time the shareholder was a shareholder.  One of the concerns is that a disgruntled environmentalist (for example) might buy shares in a company just to pursue directors for a decision he did not like.  Although there are safeguards, primarily that the shareholder must prove there is a genuine cause of action as a preliminary before getting the court’s permission to proceed, time will tell whether the new derivative action rules give rise to increased litigation against directors.

With this in mind, directors will need to consider the factors.  In making any decision, not all the factors will be relevant and some may well be contradictory.  Directors will need to decide how much weight should be given to each factor when making key decisions.  Lawyers would argue these should be documented.  However, we would go on to suggest that companies should not be content with minuting these decisions, but should go further and educate not just directors, but key decision influencers, on these factors and how they should be applied.

In relation specifically to directors, we would recommend companies do the following:-

          • review director’s service agreements to incorporate the new duties and the s. 172 factors, so that the directors are aware of these;

          • review your directors’ and officers’ liability insurance to ensure there is cover in the event of there being a derivative action taken against the directors;

          • if you have a corporate responsibility manual, review this and bring it up to date; if not, consider introducing one; and

          • consider how board decisions are minuted, bearing in mind the importance of each decision.

If you need any advice now or require further information, then please contact me.

Nick Hothersall is a Partner at Laytons’ Guildford office. Nick can be contacted on 01483 407017 or at nick.hothersall@laytons.com

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