Introduction

Various parts of the Companies Act 2006 (the ‘Act’) will be coming into force on October 2007.  Notable amongst them is Part 10, relating to directors.  One of the headline features of this Part is the codification of directors’ duties – the duties will be set out as a statutory statement, rather than as currently where they have evolved through common law (case law).  This codification has generated a huge amount of debate and discussion, with many involved being concerned about the effect that it will have in practical terms on decision-making. The aim of this note is to cut through all the musings and discussion and give some practical guidance to directors as to what they should be doing from October.  We are aided in this (to some extent) by some additional guidance given just recently by the DTI on this area, together with recommendations from the GC100 (a group representing the general counsel and company secretaries of FTSE 100 companies). 
the duties

• The Act sets out seven general duties:
• to act within the powers of the company;
• to promote the success of the company;
• to exercise independent judgement;
• to avoid conflicts of interest;
• not to accept benefits from third parties;
• to declare any interest in proposed transactions or arrangements with the company; and
• to exercise reasonable care, skill and diligence.

NB:  the provisions relating to directors’ conflict of interest provisions (duties four, five and six) will not be coming into force until October 2008.

What has changed?

The government seems to be wanting to have it both ways, constantly stressing that nothing much has changed, and that the duties pretty much reflect what they are at present (apart from the new procedures dealing with conflicts of interest), but also claiming that the new duties mark a “radical departure in articulating the connection between what is good for a company and what is good for society at large.”

What can be said is that although the essence of many of the duties is unchanged, the way in which they are presented will lead to practical changes for directors, and this will be most relevant for the core duty, the duty to promote the success of the company.

However, it is the case that a director, as now, must work hard and conscientiously and put the interests of the company before their own.  Being a company director is a position of great responsibility, and this will continue to be the case.

It is also the case that the world stands still for no man.  This is something that the government have expressly accepted by stating that directors’ duties will continue to evolve as times change and as societal norms are transformed.

What about day to day decision making?

So why the concern about box-ticking?  Well, this concern relates to the second (central) duty set out in Section 172 of the Act.  A director of a company must act in a way in which he or 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.  The section goes on to list of six factors to which a director must have regard in considering whether a proposed action is most likely to promote the success of the company.  These are (although it is made clear that this is a non-exhaustive list):

• 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 maintaining a reputation for high standards of business conduct; and
• the need to act fairly as between members of the company.

These factors recognise the concept of ‘enlightened shareholder value’.  Basically this recognises that directors will be more likely to achieve long-term sustainable success for the benefit of their shareholders if their companies pay attention to a wider range of matters.  Whilst in themselves these factors arguably represent no more than the matters which a director would in any event have borne in mind where relevant when exercising his normal duty of skill and care, the concern has centred on the way board decisions are made and documented.  There is also concern at the lack of guidance given as to how these factors should be balanced. 

As noted above, the government has just recently given further guidance on this area.  In terms of what is mean by ‘success’, the government seems to view this as long-term increase in value, subject to any particular aims that members want the company to achieve. 

As to the various factors to be taken into account, Margaret Hodge confirmed during a Commons Committee debate on 11 July that: “The clause does not impose a requirement on directors to keep records, as some people  have suggested, in any circumstances in which they would not have to do so now.”  She went on to say on a Commons Report on 17 October that: ”The words “have regard to” mean “think about”; they are absolutely not about just ticking boxes.  If “thinking about” leads to the conclusion, as we believe it will in many cases, that the proper course is to act positively to achieve the objectives in the clause, that will be what the director’s duty is.  In other words “have regard to” means “give proper consideration to”….”. 

By way of demonstrating compliance with this duty, directors will have to report annually to shareholders with a view to helping them to assess how the directors have performed their duty under Section 172 of the Act.  All companies will have to include in the business review some information on both employees and the environment to the extent necessary to understand their business.  Listed companies will have to prepare an “enhanced business review”, including information on their policies with regard to the environment, employees, and social and community issues, and on how effective these policies are.

Another angle causing concern is the new statutory derivative right for shareholders, on behalf of the company, to bring a claim against a director for breach of trust, breach of duty, negligence or default.  The new procedure will make it easier to bring a derivative claim than under current law – no allegation of lack of good faith or benefit to directors will be necessary to bring a claim. However, the government, did, at the last minute, add in a two-stage test in an attempt to address concerns in this area (permission must be given by the court for claims to proceed).  What is unclear is how the courts will look at the criterion which enables them to refuse permission for a claim if they consider the claim would not be pursued by someone acting in accordance with the directors’ duty under Section 172 to promote the success of the company. It is to be hoped that the courts will continue their policy of not second-guessing the commercial judgement of directors and will only allow claims to proceed in cases where there appears to have been a breach of duty that is sufficiently serious to warrant the involvement of the court.  

So what should directors be doing?

Directors should be aware of their duties under the Act.  However, we believe that the default should not be to provide written records of every decision, but to do so where circumstances make this particularly necessary or relevant.  This is the position taken by the GC100.  So, for example, where a particular factor is of importance or sensitivity, it may be appropriate to support decisions with written briefings to record the factors taken into account.  A pure box-ticking exercise shows no proof of actual thought and consideration having gone into a particular decision, and ultimately it is what is actually in the board’s mind that matters, rather than a form of words on paper.  In addition to this, written records showing how all relevant factors have been taken into account could act against the directors, if for example it shows evidence of an omission or mistake.  Although the governmental guidance referred to above states, in its ‘high-level’ guidance box, that directors should make sure that the company keeps records of their decisions, we do not believe that this means that in every instance detailed debate about each of the factors should be recorded in writing. 

It will also be important for all directors and prospective directors to be thoroughly briefed on the new duties, and terms of appointment of directors should refer to these duties.  Companies should also, where relevant (and again this is recommended by the GC100) review existing policies in areas such as human resources, ethics, and corporate responsibility against the background of the duties.