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The Company Law Reform Bill – How will it affect Directors?

By Catherine Baker

Introduction

One of the topics that has been hotly debated during the company law reform process has been the ‘codification’ of directors’ duties. At present, directors’ duties are set out in common law (i.e. they have developed through case law) rather than being set out in a particular piece of legislation. As you will have seen from the article above, the thinking behind codification (i.e. setting the duties down in statute) is that the current position will be clarified and that it is better to have the duties set down in one place. Whilst not all of the proposals from the review process have been carried through (most notably the proposal to repeal the 1985 Companies Act) this is one idea that has made it to the Bill. In this article we examine the implications of this ‘codification’, as well as examining in brief some of the other changes relating to directors.

Directors’s Duties

Whilst at its most simple ‘codification’ represents a setting down in statute of the current position derived from case law, life never is simple! Judgements are, of necessity, directed at particular cases, and even where they appear to state general principles, they will rarely be exhaustive. The guidance notes to the Bill recognise that it is not easy to reconcile the two different approaches taken by the courts, and by legislation, but state that the draft clauses seek to balance precision against the need for continued flexibility and development. In addition, the Bill does also propose new duties on directors, such as the duty to have regard to the longer-term interests of employees, suppliers, consumers and the environment, as well as shareholders.

Looking at the duties in more detail, the primary duty for a director will be to act in a way he or she considers to be in good faith to be most likely to promote the success of the company for the benefit of members as a whole. In fulfilling this duty (and this is where the much talked-about concept of ‘enlightened shareholder value’ comes into play) the director must have regard to (as far as reasonably practicable):

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


The need to take into account these various considerations obviously represents quite a change from the current position. The key question is how effective these requirements will be. There is concern that rather than creating greater certainty for directors, this new ‘codification’ will in fact lead to greater uncertainty and difficulty. For example, the concept of ‘success’ is a difficult one to define. It is also not clear how the requirement to take into account the long term consequences of a decision and the range of different interest groups can be satisfied in the many different situations which directors find themselves in. In addition, one could query how much ‘teeth’ the obligations have. The words ‘as far as reasonably practicable’ clearly acknowledge that directors may legitimately decide that other pressures and constraints outweigh any or all of these statutory factors. However, in the DTI’s guidance on key clauses, the government stresses that the requirements to ‘have regard to’ the statutory factors cannot be discharged merely by paying lip service to them. Directors must exercise the same level of skill, care and diligence as they would in carrying out any other function, at least as far as is ‘practically possible in the circumstances of any particular business decision.’

A director must also:

  • act within his or her powers under the company’s constitution, and only exercise powers for the purposes for which they are conferred;
  • exercise independent judgement,
  • exercise reasonable care, skill and diligence (with the test containing both a subjective and an objective element, in accordance with recent case law);
  • avoid conflicts of interest;
  • not accept any benefits from third parties; and
  • declare his interest in any proposed transaction or arrangement.


Conflicts of Interest

In an attempt to encourage entrepreneurial and business start-up activity, the government has included provisions that will allow non-conflicted directors to authorise a director to proceed with a transaction where the opportunity properly belongs to the company. For public companies, however, this will only be possible where the articles allow it.

As you will see from above, there is a general duty to avoid conflicts of interest, replacing the no-conflict rule currently applying to directors. The Bill pretty much reflects what is currently done in practice, with directors having to avoid a situation in which they have or may have a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. It also provides that a director must not accept a benefit from a third party conferred by reason of his being a director unless the benefit cannot be reasonably regarded as likely to give rise to a conflict of interest. A director must declare the nature and extent of any interest in a proposed transaction with the company, unless it cannot be reasonably regarded as likely to give rise to a conflict of interest.

Other Miscellaneous Points For Directors

Some other points relating to directors are considered below.

Various changes have been made to the rules on substantial property transactions between companies and their directors, on loans to directors, payment to directors for loss of office, and on long-term service contracts, mainly to make the rules more accessible and consistent, and to remove a number of ambiguities. For example, companies will be able to enter into ‘substantial property transactions’ before shareholder approval has been obtained, provided the transaction is made conditional on such approval. Where a company proposes to make a payment to a director in compensation for loss of his or her employment as a director of the company (rather than just for loss of office as director) which goes beyond the existing contractual entitlement, shareholder approval will be required. All companies will be able to make loans to directors, provided the loan is approved by shareholders.

Importantly, all directors will be able to provide a service address for public record, no longer just those at serious risk of violence or intimidation. Finally, the ability for shareholders to bring ‘derivative actions’ (where a wrong has been done to the company by those in control of the company, and this amounts to a ‘fraud on the minority’) has been put on a statutory footing. There had been some concern that this would expose directors to many more claims than at present, but the fact remains that although the process has been made more accessible, any damages recovered will still go to the company, rather than the shareholder personally.

© Davenport Lyons 2005 All rights reserved
This document reflects the law and practice as at January 2006. It is general in nature, and does not purport in any way to be comprehensive or a substitute for specialist legal advice in individual circumstances.

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