The Companies Act - Essay Example

The Companies Act Introduction: The Companies Act 2006 was enacted to bring about most sweeping changes in law governing the companies and business undertakings in UK in the past 150 years. The law is being introduced in stages to give existing companies the time to fine tune themselves with the proposed changes. Companies Act got Royal Assent in 2006 and some of its provisions have been implemented. The final provisions will be implemented be implemented in three tranches in October 2007, April 2008 and October 2008 (Salmon, 2007). Not only the share holders and directors of the companies being freshly incorporated but those of the companies that are already in existence need to study the general duties of the directors in the Act. Executive Summary: The companies Act in 2006 are a pioneering law contemporary times that places great moral and social responsibility on the directors of the companies. Definitely, UK has taken the lead in calling for a more mature and responsible behaviour on part of the Directors of a company. The Companies Act 2006 replaces the companies of 1985 and 1989. The Act, it is hoped, will usher in an era of more responsible role for people in business leading to “enlightened shareholder approach”. The shareholders will hold the directors more accountable for their acts leading to generation of awareness for social and physical environment. The government feels that business atmosphere, society, and the environment are inextricably linked to each other and positive or negative fallout of one affects the others. History: The registration of companies started in 1848. Earlier in the Companies Act of 1948 originated the “True and Fair View” (Bucheery, n.d.). This entailed upon the directors to give a true and fair view of the fiscal position of the company and the profit and loss were reflected in the annual balance sheet for the knowledge of shareholders. Later this system was incorporated in the fourth directive of Company Accounts of the European Economic Commission (Flint, 1982). Earlier the refrain in the corporate world was to maximize profits at any cost. But with the world coming together due to globalization and the experience of negative fallouts of the trade and commerce like emission of green house gases, deforestation, and a yawning gap between the developing and the developed world, a need was felt for enactment of a law that required greater business transparency, a commitment to the social and physical environment and reinforcement of confidence of the people in business systems. The Companies Act of 2006 legislation is written on 696 pages which makes it biggest legislative document of UK (Lacorix, 2006). Movement of the People: The Trade Justice Movement and Corporate Responsibility (Core), trade unions and other social, environmental and human rights pressure groups had started a movement to ask for more social responsibility from the corporate world. Over 100000 voters in UK contacted their local MPs to voice their concern on people making hay on the expense of environment and public. The activism of different pressure groups paid off and the Companies Act of 2006 incorporating wide range of changes was enacted. We will study the given question case in the context of Companies Act 2006 (The Trade Justice Movement, n.d.). The Context: “Where the board of directors of a company, which is incorporated in the United Kingdom, is contemplating investing company capital in a foreign country, the duties of the board of directors require that it must act in good faith and must not give any consideration to the needs of any individual or person other than the company itself. Failure to comply with this duty will result in the board of directors being sued by the shareholders, without the board of directors having any defence.” The general duties of the Board of directors are explained in the Companies Act 2006. This law is applicable for any company that is incorporated in the UK and is operating anywhere in the world including UK. There Act intends to bring about a cultural and ethical change in the corporate behaviour and it is intended that the change begins from the top. Section 170 describes the scope, extent and what constitutes a duty. The implications of his duties as a director go beyond the time of his directorship. The clause (b) of sub-section 2 forbids him from accepting any favours what he had committed or omitted during his directorship. The duties of a director do not end with the resignation of his position. He is barred from exploitation of information, property or opportunity that he got during his tenure as a director and which may cause a conflict of interest with company with company even after his retirement. The statutory duties of the Directors are described in Sections 171 through 177 of the Act These duties according to the law are owed by the director to the company. Section 171 requires of the director to act in accordance with the constitution of the company. The director is required to exercise the powers for the reason they are conferred on him. Section 172 entails upon the Director to work for the success of the company and states extensively as to what constitutes ‘the success of the company”. It is enjoined of the director to work for the long term goals of the company. The directors should work to protect the interests of the employees of the company, it relationships with customers, suppliers, the impact of company’s operations on the environment, high standards of business conduct, and fair dealing for all members of the company. In case of carrying out a foreign investment the company has to pragmatically consider whether its duties enjoined in Section 172 are being fulfilled. Since investment in a foreign country involves the risk of loss of capital, relationships and may cause harm to the environment, the company on its own must consider all these aspects. A breach here would mean dereliction of duty of the directors of the company and subsequent prosecution. The law in sub-clause 3 asks of the directors to act in interests of the creditors of the company. “There are two ways of looking at the statutory statement of directors’ duties: on the one the hand it simply codifies the existing common law obligations of company directors; on the other – especially in section 172: the duty to act in the interests of the company – it marks a radical departure in articulating the connection between what is good for a company and what is good for society at large” (Ministerial Statements, 2007). Section 173 requires of the directors to show independent thinking and make independent judgment. The duties of directors are generally the same as determined by the case law but it is in the conflict of interests that the Act has taken a major departure from the case laws. However, the law is open to changes in this clause by allowing the companies that wish to, for reversal of change and ask the share holders to decide what constitutes as a conflict of interest. Section 174 required the directors to act with due care and diligence. Explaining this the law states the definition of diligence that is care, skill and diligence exercised by a “reasonably diligent person”. This means the discerning and thinking faculty that is found in an intelligent man and its use while carrying out the functions of the directorship. The directors should avoid such actions that may result conflict of interests with business and the success of the company. However, if the Board so empowers a director, he is authorized to act in a certain way and carry out a particular transaction. Also, if the directors feel that a particular action is not infringement of the interests of the companies, the director is entitled to act in such a situation. The law also specifies that authorization for a director to act this way may be given only after the requisite quorum of the meeting is met. Asking for strict moral conduct the law forbids acceptance of gifts by a director from a third party in Section 170. “Third party” here implies any other individual or a body corporate associated in some way with the company. However, the director will not be infringing his duty in accepting a gift doesn’t lead to rise of conflict. In case a director has interest in a particular transaction, he has to make it clear before the Board of Directors, before the company actually enters a transaction. By the new law he is not required to declare his interest before the share holders. It is deemed of a director that he is aware of any such transaction and interests and conflicts of interests arising thereof. Section 178 states the civil consequences of breach of general duties. With the exception of Section 174 that entails of a director to act in with diligence and care all other above mentioned duties are enforceable as a matter of trust on a director. Any breach of duty will be violative of the principle of common law owed to its directors by a company. Generally, it is for the investments made in the developing countries that the approach of the companies towards society and environment becomes more callous. With high awareness levels and regulatory controls in place in the developed world, the companies seldom commit an action that is violates ethics, environment and sincerity to the company. This includes all acts that are done in negligence or in knowledge and those that are violative of sincerity of a person in the Board. The Board Member will always act in such a way that he promotes the interests of the company both in the long run or short term basis. The duty of the director towards the suppliers, the employees, and the community in which company works should be discharged with honesty and sincerity. Directors are sought to make decisions that are more socially responsible. Social responsibility is required of employees, stake holders, and even suppliers and the particular community in which the company operates. This change is supposed by the political and social activists of having far reaching and global ramifications This is the first time that the words ‘community’ and ‘environment’ have been mentioned in UK company statute in this way and we are not aware of any other country in the world where such a duty exists ( Companies Act—A Verdict, 2007). The act also gives a moral face to the laws that companies working the first time taking care of humanitarian values, which till today have been only aimed at profit maximization at any cost. Skilful management of supply chain environment is permanent feature of the business culture. The act seeks to bring total transparency in the conduct of a business of an organisation that leaves no scope for the directors, the officials conduct something that is questionable. The say of the share holders in prosecuting the directors in case of breach of privileges extended to them have been increased. Since the act is yet to be implemented a lot of questions will only be answered when it goes to the implementation. There seems to be ambiguity in regard to what constitutes the ‘success’ and what steps are to be taken to make the company successful. However social and political activists are observing new companies law with caution. They believe that it would again depend largely on the government how it sees to its compliance and how the court interprets if ever the role of a director is challenged. The rules of conduct are equally applicable to directors and the shadow directors. In Section 174 required the directors to act with due care and diligence. Explaining this law states the definition of diligence that is care, skill and diligence exercised by a “reasonably diligent person”. This means the discerning and thinking faculty that is found in an intelligent man and its use while carrying out the functions of the directorship. The directors should avoid such actions thay may result conflict of interests with business and the success of the company. However, if the Board so empowers a director a director is authorized to act in a certain way and carry out a particular transaction. Also, if the directors feel that a particular action is not infringement of the interests of the companies, the director is entitled to act in such a situation. The law also specifies that authorization for a director to act this way may be given only after the requisite quorum of the meeting is met. Asking for strict moral conduct the law forbids acceptance of gifts by a director from a third party in Section 170. “Third party” here implies any other individual or a body corporate associated in some way with the company. However, the director will not be infringing his duty in accepting a gift doesn’t lead to rise of conflict. In case a director has interest in a particular transaction, he has to make it clear before the Board of Directors, before the company actually enters a transaction. By the new law he is not required to declare his interest before the share holders. It is deemed of a director that he is aware of any such transaction and interests and conflicts of interests arising thereof. Section 178 states the civil consequences of breach of general duties. With the exception of Section 174 that entails of a director to act in with diligence and care all other above mentioned duties are enforceable as a matter of trust on a director. Any breach of duty will be violative of the principle of common law owed to its directors by a company. Through Sections 156 a meeting will be called to discuss a violation of duty by the director. Section 168 lays down the procedure of his removal and Section 169 describes his right to protest against the removal. However the directors will not be asked to additional records as evidence of their compliance to their duties. The law also doesn’t want directors to act like ‘mere ticking boxes’ but they should think and act in a matter that 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. (Margaret Hodge—Ministerial Statements, 2006) There was an expression of anxiety in the companies that the present law would lead to hectic record keeping. However, the government clarified its stance. 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.” (Hodge, 2006) The new law prescribes an exhaustive code of conduct to a director as what constitutes his duty towards the success of the company. The directors along with promoting the success of the company for the sake of share holders will also think and act wherever necessary in the long term interests of a more the stakeholders and the reputation of the company. In the earlier Acts, only share holders in a meeting were authorized to state of conflict to address. In the Companies Act 2006, even other directors (other than the one whose case is being discussed) can decide upon the issue of conflict of interest. Hence the Act is being projected as a comprehensive answer to increasing business and protection of the interests for shareholders and setting standards for future corporate governance This list is of duties in the Act is not exhaustive because Directors on their own relationship with the company are bound much more to company that can be expressed in legal parlance. The directors will continue to discharge their duties that are incumbent upon their positions. “The statement of general duties…is not intended to be an exhaustive list of all the duties owed by a director to his company. The directors may owe a wide range of duties to their companies in addition to the general duties listed. Those are general, basic duties which it is seen as right and important to set out in this way. The statement that these are the general duties does not allow a director to escape any other obligation he has, including obligations under the Insolvency Act 1986.” (Lord Goldsmith, 2006) In the present Act there are certain provisions that make the working of the company smoother. Companies can make changes in their constitution and articles of association wherever they can. In the contextual study, the directors must study full implications of making investments abroad. They should consider it thoroughly whether such an investment will help propagate the interests of the company and the stake holders. Foreign investments should be made in the awareness of political conditions of the destination country. The countries political should be consistently stable. All relevant permissions, sanctions and regulatory devices in the country where investment is to be made should be adhered to. If the destination country is part of a larger economic group like EU, ASEAN of NAFTA then the trade regulations of the body too should be met. Conclusion: Without doubt there will be some litigation when the Act comes into force. About litigation Lord Goldsmith said in the Parliament “One proposition [is] that the result of this codification will be increased litigation. That is not how we see it…as in existing law; the general duties are owed by the director to the company. It follows that, as now, only the company can enforce them. Directors are liable to the company for loss to the company, and not more widely. It is quite rare for companies to sue their directors for breach of duty. That may well continue to be the position.” It will be up to the courts how they interpret the duties of the directors in light of practical situations. Of special importance will be definition of social responsibility, which is a very broad term. It is to be seen how the interests of community, environment become concurrent to the interests of a private profit making company. The government has promised to review the Act after a period of two years and introduce changes with consensus. “Failure to comply with this duty will result in the board of directors being sued by the shareholders, without the board of directors having any defence.” In fact, neither it is the sentiment of law nor is it intended in the present law that the share holders will have the sweeping powers to sue a director without giving right to defence to the director. The right to defence is given in the Companies Act. The Act will definitely prove to be a watershed in ethical corporate behaviour and will set a new paradigm in corporate governance and trade. “We should remind ourselves that being a company director is a wonderful thing for the person who is a company director. But it is a position of great responsibility which involves running the affairs of a company for the benefit of other people. It is a heavy responsibility we should not water down”. (Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 291) The Act implies that failure of a director to comply with a duty leads to culpable actions against him. But Salans (2007) argues that this provision will allow the political activists to basis that they have not properly taken into account the factors they are required to as part of the new duty to promote the success of the company. The Act also provides a judicial remedy to such lapse with provisions are included requiring a claimant to present a good case to the court before the action can be continued, with the court having the ability to make a costs order against an applicant as a deterrent, if appropriate.(Salans 2007). Lacrorix (2006) too expresses concerns over the present legislation The new right to bring an action for breach of any duty, including the new statutory duties, "provides another tool for use by activist shareholders to push for change at underperforming companies." But how useful this tool will be depends on "the court’s willingness to exercise its discretion to intervene in what, in many cases, will be simply commercial decision making by the company, its directors and majority shareholders." It is right to leave those areas, as now, to the courts…” (Lord Goldsmith, 2006) Political and rights activists, trade unionists and campaigners have expressed satisfaction at the enactment of Companies Act 2006 and they are optimistic about more such steps in accountability in future. Our campaigning to ensure that British businesses are responsible and accountable, no matter where in the world they trade, will continue until the Government introduces all the rules necessary to right corporate wrongs and make poverty history. (Glen Tarman, 2006) Part B Context: The Board of Turpin, Dowdle and Bellamy Plc based in UK has taken a decision to start overseas business operations. A factory will be set up in Mumbai, India that will supply goods to the subsidiary of the company in China. The Chinese subsidiary will be set up in Jilin province. The Friends of Environment organisation has stepped up to join hands with company and have a share of 5% in profits. We see the legal implications in light of Companies Act, 2006 Implications The Board has decided to proceed with setting up a manufacturing unit in Mumbai (India) and Jilin province of China. Goods manufactured in a branch of the company in Mumbai will be supplied to the Chinese subsidiary. The Indian Unit falls under the Foreign Direct Investment clause of Companies Act of India. The entire supply of goods manufactured in India will be supplied to the Chinese subsidiary which is allowed under the FDI provisions. But the clearance of the project is subject to Reserve Bank of India (regulations). Such a unit is called 100 percent Export Oriented Unit and is given special privileges in the India industrial sector. Complying with the General Duty in Section 169 of Companies Act of UK, the board should carry out introspection of its decisions. The company needs to find out whether setting up business and subsidiaries overseas is included in the constitution of the company. The Board should make a change in constitution of the company if necessary (Section 17) that allows it to invest overseas. Under Section of 172 of the Companies Act, it needs to be considered by company whether investment in India and setting up a subsidiary in China will definitely lead to the success of the company. Development and manufacturing costs in India are low but both countries have a common drawback of bureaucratic interference and discouraging international business. The long term prospects of the company need to be studied in detail. The economic, social and political climate of Mumbai in India and Jilin province of China needs to be taken into account before making substantial investments. China has a totalitarian regime. Though overall it has an open policy but some of its provinces are still locked for foreign investment. The Chinese policy on foreign investment in Jilin province needs to be enquired. Friends of Environment and the Chinese member of the Board of Directors of the Company will form a steering committee to get requisite permissions from the government. The Chinese government may also be averse to receipt of made goods from Indian branch of the company and may insist on setting up both plants in China. As per Section 172 the long term prospects of investing in India and China need to be considered. This includes ground conditions in both the countries. Availability of infrastructural requirements today and in future, raw materials, equipment and skilled manpower need to be considered. The need to promote relations of the company with suppliers and customers should be met and a long term plan about a strong supply chain link and customer relationship management needs to be done and elaborated as clause c of the sub section 1 of Section 172. Sub-section c wants the company to consider the effects of its operations on the community and the environment. By providing fresh water to the villages in vicinity of Mumbai through a water treatment plant the company will only be fulfilling its legal obligation of not discharging polluted waste water into the environment. The company may have to do somewhat more in the light of sub-section (d) of Section 172. To build lasting relationship with community the company may take up such activities as setting up a school for the children of factory workers with subsidized education for the poor and deprived sections of also. This step will make a lasting impression of the company’s reputation in India. In the Chinese context, the Board, in compliance to its general duties will have to study what kind of activities Friends of Environment (FOE) is actually involved. It needs to be ascertained whether the said organization is working to make a positive difference to the lives of people and the environment of Jilin province. This needs to be considered how the organisation can be helpful in establishing the company in the Jilin province. The purpose, the intent of Friends of Environment and how they will effect in working of the company needs to be clearly stated and put before the members. As per section 173 the directors of the company need to exercise their independent judgement without succumbing to pressures. Maintenance of overseas branch register under section 29 for overseas operations in India and China is mandatory. These are in addition to the register maintained in UK. Under Section 130 of the act a notice to registrar of companies is given for maintenance of an overseas register. A copy of the said register duly updated from time to time be maintained for purpose of inspection. Working with FOE in China and doing community work in India will strengthen the company’s reputation and its Supply Chain Mechanism. The low of cost of production in India and China will give a competitive edge to the company thus increasing its market share leading to success in long term. The presence of a Chinese national and an Indian national In conformance to the Companies Act 2006, it should be seen that company is not giving any unnecessary privilege to Friends of Environment organisation. No member of the Board should be a member of the FOE such that he gets a share in the 5 % profit that is agreed to be shared with the group.. No information, opportunity or property may be shared by with the said organisation that in future may give leverage to the business of Friends thereby meaning a loss to the company. The profit money shared with FOE should go to environmental projects being carried on by the group in China. Further the money aggregated from the Jilin province by giving gainful employment to the local people and transformation of raw material in the region, the investment of 5 percent of the profits in Jilin province will make for a sustainable model of development. Sub section b of the Act also calls for exercise of general knowledge that is applicable in this case to know in detail about the working of Friends of Environment. Section 174 asks the Board members to exercise as far as possible skill, diligence and intelligence in making a decision on the behalf of the company. The Board members should show high level of awareness of their activities before taking a decision of association with them. In case any of the directors has any interest in the promotion of overseas business it should be declared before the commencement of operations under Section 182. Conclusion: Any business that is to be conducted in UK or abroad by a company incorporated in England and Wales has to follow the rules and regulations as enshrined in the Companies Act, 2006. Besides, conformance to legal aspects such a business will be more responsive to futuristic needs of our civilisation. References: 1. The Companies Act, 2006, http://www.opsi.gov.uk/acts/acts2006/20060046.htm#aofs accessed on August 3rd, 2007-08-03 2. The D & O Diary, U.K. Enacts New Directors’ Duties Law, Lacroix, Kevin http://dandodiary.blogspot.com/2006/11/uk-enacts-new-directors-duties-law.html, accessed on August 3rd, 2007 3. United Kingdom: Companies Act 2006, Salmon Paul, http://www.mondaq.com/article.asp?articleid=50674&searchresults=1 accessed on August 3rd 2007 4. Companies Act, An Overview, Companies House, http://www.companieshouse.gov.uk/companiesAct/companiesAct.shtml accessed on August 3rd 2007. 5. 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