Date 30 November 2006
Reforms set out in the new Companies Bill, which is expected to come into force next summer, look set to change the duties a director owes his company, and the manner in which shareholders can make claims against him. The existing common law rules are reflected in the codified law, which sets out the seven general duties:
- a duty to act within the powers of the company
- a duty to promote the success of the company
- a duty to exercise independent judgment
- a duty to avoid conflicts of interest
- a duty not to accept benefits from third parties
- a duty to declare any interest in proposed transactions or arrangements with the company
- a duty to exercise reasonable care, skill and diligence.
The first duty can be satisfied by a director only acting in accordance with the company’s constitution, and using his powers for the purposes they were given.
The duty to promote success imparts the responsibility to act in a manner that is most likely to lead to the success of the company for the benefit of the shareholders. Although not an exhaustive list, the factors that must be considered when doing this are:
- the interests of the company’s employees
- the likely long-term consequences of any decision
- the need to cultivate the company’s relationship with customers, suppliers and others
- the company’s impact on the environment and community
- the desirability of the company maintaining a reputation for high standards of business conduct
- the need to act fairly as between members of the company.
Being able to prove that these points have been considered when reaching a decision will be important, and this can be done with documentary evidence. Directors should produce reports considering the impact of these points, or ensure that consideration is paid to them in minuted meetings. The courts will want to see evidence that each factor has been considered in good faith, and shareholders can monitor their directors’ compliance with their duty to promote success in the annual Business Review, which requires an analysis of the company’s position.
This duty imparts complex responsibilities as it requires directors to consider the social impact of their decisions and achieve the best value possible for the shareholders, while still considering the longer-term impact of their decisions and the interests of the company’s creditors.
The duty to avoid a conflict of interest is a wide one, as it even applies where interests “possibly may conflict”. It will be important for directors to make sure that proper authorisations are in place to allow for potential conflicts, especially in cases where a director also holds directorships with different companies. However, the remainder of the board of directors can now ratify a conflict in a meeting (as long as they do not count the conflicted director in the quorum) without referring to the shareholders.
Benefits from third parties must be avoided were the benefit is given as a result of the directorship, or any actions (or inactions) that a director performs in the role. However, a benefit can be accepted if there is no reasonable possibility of a conflict. It will be advisable to have the board consider the gift and decide whether the benefit can be accepted in each individual case.
The requirement to declare any interest in a proposed transaction or arrangement appears to be very similar to the duty to avoid conflicts of interest. This duty however relates to actual transactions, while the former is a more general responsibility to avoid circumstances where a director’s personal interests conflict with those of the business.
The final obligation to exercise reasonable care, skill and diligence borrows the test of whether a director has been negligent from section 214 of the Insolvency Act 1986. This demands that a director must use the same reasonable care, skill and diligence of a reasonably diligent person with a similar role and level of experience. This reflects the fact that different directors will have different levels of ability and knowledge of their companies.
The change in director’s duties is reflected by a change to the rules governing shareholder actions. Any breach of duty can now be subject to a shareholder action. The court will have discretion as to the admissibility of a shareholder’s claim, one of the most important criteria being that it is made in good faith. Whereas it is currently difficult to bring a claim where a wrong has been done to the company by one of its directors, under the new law a minority shareholder can attempt to persuade the court that his claim be allowed to proceed.
One other significant change is that it will be more difficult for directors’ actions to be ratified by a majority of shareholders, as the votes of directors and anyone connected to them will not be counted in circumstances where a director’s actions are being questioned. This shifts the balance of power in favour of minority shareholders, who will now be able to have more say in the way a company is run.
Comment
The new rules will certainly catch some directors out, but there are ways in which you can protect yourself. Always ensure you are acting in a manner that is likely to promote the success of the company and that you have considered each of the factors highlighted above. Always keep records of reports or board meetings to prove that you have considered each point, and avoid delegating that consideration. Gain professional advice where needed (in relation to your company’s impact on the environment, for example) and be aware that the annual Business Review may be scrutinised by shareholders. Finally, as before, seek legal advice where necessary, as there is likely to be an increase in shareholder litigation, and it is unclear whether the new legislative rules will automatically overrule case law when there is a conflict. It is hoped that the Courts will not stifle entrepreneurial behaviour in favour of a more cautious approach to decision making.
For further advice or guidance, please contact Robert Ryall on 01727 798092 or by email at robert.ryall@salaw.com
© SA Law 2006
Every care is taken in the preparation of our articles. However, no responsibility is accepted as being owed to any person or organisation who acts on the basis of information contained in them. You should obtain specific advice in respect of individual cases.