Limits Placed by the Companies Act 2006 - Essay Example

?Company Law Facts of the Case The case under consideration is concerned with a company construed under the Companies Act 2006 because it was founded in 2007. This indicates that all case law applicable to this case must take this into consideration because the Company Act 1985 is not applicable to this case. Furthermore, the company was founded in order to construct residential properties only. While the company was being formed, it was also decided that any transactions of the company’s business that exceeded one million pounds would require the consent of the entire board of directors. The company under consideration, Homemaker Limited had three persons on its board of directors namely Jenny, Louis and Chris. Out of these directors, the most active role was played by Chris who also tended to act as the Managing Director though this was never formally recognized in writing. This indicates that Jenny and Louis were more or less passive directors of the company. Homemaker Limited was construed for construction of homes only, but Chris sought to diversify business into equipment and furniture supply. The shortage of work in the construction industry forced Chris to diversify business but he did not register another company to do so. Instead, the platform of Homemaker Limited was utilized by Chris to supply Easy Birds Limited with equipment and furniture which stands in direct violation of the original constitution of Homemaker Limited. Given the fact that Homemaker Limited was struggling with capital requirements, Chris decided to borrow one and a half million pounds from Star Bank. The transactions with Star Bank were executed by Chris and Louis alone without the consent of Jenny. The mutual agreement that the consent of all directors was required for transactions above one million pounds is clearly violated by the behaviour of Chris and Louis in this regard. Poor performance on the part of Homemaker Limited resulted in losses in the equipment and furniture supply domains leading to contractual failure with Easy Birds Limited. The failure of this gamble meant that Homemaker Limited was unable to deal with its fiscal obligation with Star Bank leading to liquidation of the company. A number of problems emerge in regards to Homemaker Limited and its liquidation. The majority of these problems span the domains of director’s conduct and the validity of transactions that resulted. The discussion provided below will cover these issues in detail relating applicable statutes and their interpretation as per case law. 2. Applicable Law In terms of statutory law the current case’s circumstances are covered by the Companies Act 2006 (which expanded on and replaced parts of the Companies Act 1985). Given the fact that the company Homemakers Limited was registered in 2007, the applicable legal elements will be derived from the Companies Act 2006 alone. This also means that previous positions on certain issues will have been revised even if they were fortified by case law on the matter. One of the largest directions taken by the Companies Act 2006 has been the roles, responsibilities and conduct of directors. The duties of directors had already been expounded by the previous Act but the new Act has consolidated these matters further by codifying principal common law as well as the equitable duties of directors. However, it must be borne in mind that the new Act is by no means an exhaustive account of the duties of directors. This therefore tends to indicate that the duties of directors expounded by common law still survive albeit in a reduced form. The Companies Act 2006 has revisited the domain of director’s duties as per Chapter 2, General Duties of Directors. The Chapter has been divided into an introduction, the general duties of directors and the supplementary duties of directors. The new codifications (in context of the duties of directors) will be used to evaluate the conduct of directors at Homemaker Limited. 2.1. Section 170 – Scope and Nature of General Duties This section serves as the introduction to the duties of directors and stipulates that the sections 171 to 177 are duties “owed by a director of a company to the company”1. This section serves as an important guide for this case because it tends to expound on the liability of active and inactive directors through implied legal elements. This part uses the term “shadow directors” for inactive directors and delineates that the general duties are owed by shadow directors much the same way they are owed by other directors2. Hence, all directors of the company are expected to play their role fully in the context of the company and its transactions. This implies that although Jenny and Louis were not acting actively within Homemakers Limited, but they are fully liable for the actions of their company. Therefore, any liabilities that arise out of the company’s transactions will be pitted equally against all directors of the company whether they show active or inactive behaviour. This has far reaching implications for this case – rather than Chris alone being responsible for the entire fiasco, this Section stipulates that all directors are equally responsible. 2.2. Section 171 – Acting within Prescribed Powers The first duty of a director is to act as per the company’s constitution3. This constitution has also been labelled as a company’s articles of association as well as a company’s memorandum. Before the enactment of the Companies Act 2006, it was common for companies in the United Kingdom to have Articles of Association while the new Act has also mandated their use. In terms of the Homemaker Limited case, the stipulation that the consent of the entire board of directors was required to transact one million pounds or more can be seen as an article of association. Any and all directors of the company were bound by this stipulation to act under all circumstances. The Memorandum or the Articles of Association of a company have long been used in order to decide upon the director’s duties. There has been a long and well established tradition to look into these constitutional documents in order to expound the director’s foremost duties and to resolve disputes involving directors. Long before the Companies Act 2006, it was an established tradition that the Memorandum prevailed in the case of any inconsistency such as in Ashbury v Watson4. The Companies Act 2006 has merely codified this position so that any action of the directors is subject to the Articles of Association. The actions of Chris and Louis in transacting more than one million pounds with Star Bank are in clear violation of the Articles of Association for Homemaker Limited. There is no second opinion to the issue that the actions of Chris and Louis were unconstitutional by all given means in this sphere. 2.3. Section 172 – Duty to Promote the Success of the Company This section of the Chapter delineates the various factors that must be ensured by a director and his actions in order to promote the success of the company. Before the Companies Act 2006, there was a vague declaration in statutory law for directors to act in the best interests of the company and its shareholders but the new Act has changed all of that. This section provides a non-exhaustive account of the primary factors that a director must always focus upon in order to make the company successful. Under this codification, the director is expected to take into account the long term consequences of his actions5 as well as accounting for the interests of the company’s employees6. Additionally, the director needs to foster the company’s relationship with its stakeholders7 while minimizing the negative impacts of the company’s interaction with the community and environment8. Furthermore, the director’s conduct must ensure that the company’s reputation is kept high through its business conduct9. Lastly, the director is required to act in a fair manner between various members of the company10. There is also provision in this Section for the director to consider the consequences of his actions when put in context of the company’s creditors such as banks or other kinds of financial institutions, individuals or entities11. When this particular case is analysed using this framework, it becomes obvious that the actions of Chris did not account for long term consequences that have now forced the company into liquidation. In a similar manner, the actions of Chris did not end up protecting the company’s business reputation but instead mauled it further. The manner in which Chris gambled off the company’s interests by choosing an unrelated field to do business in shows his lack of care for the company’s best interests. Another violation stems from the fact that both Chris and Louis did not take Jenny into confidence before signing the company into debt. Such actions on the part of Chris and Louis were unfair in their conduct between members of the company. Another contentious issue is Chris’ behaviour with regards to the creditor’s money. The money borrowed from Star Bank was employed in an unsafe investment leading to loss for both the company and its creditor. Chris’ actions failed to account for the interest of the creditor although statutory law required it of him. These can be seen as straightforward violations of the subject elements of the Companies Act 2006. Here it might be argued that the actions of Chris were bona fide as well as honest and were geared to serve the best interests of the company. Previous case law on the matter suggests that directors should act what they consider to be the best interests of the company and not what the court considers such interests to be12. This would seem to absolve the directors but other case law disagrees with such a position. Instead, it has been held that directors are capable of failing the best interests of the company through bona fide intention. Any transactions that have been carried out such that they damage the company’s interests make the director responsible liable for their actions13. The position has been clarified further by the Mills v Mills14 case where the judge opined that directors are not legally required to be in a realist domain when acting but ought to be “honest and intelligent” when they act. However, the Companies Act 2006 provides clear distinction for what the director ought to have been considering when acting in the interests of the company. The actions of Chris were not in the best interests of the company and cannot be considered intelligent given the switchover of business domain without consultation with other directors. In this manner, Chris has to held liable for his conduct regarding the manner in which business was transacted. Furthermore, Louis must also be held liable for his involvement in the transaction beyond the Articles of Association as it was not a wise move on his part either. 2.4. Section 174 – Duty to Exercise Reasonable Care, Skill and Diligence This section of the Act concerns itself with the duty of directors to exercise “reasonable care, skill and diligence”15. The domain of such diligence has been defined through the apt application of “general knowledge, skill and experience” that could be expected from the director of a company16. When applied to the current case, it becomes clear that Chris and later Louis were both expected to have exercised care in their decision making processes. The move on Chris’ part to diversify the business model without appropriate investigation led to the eventual liquidation of the company indicating the lack of care in making such a decision. Moreover, Louis failed to ask Chris for a complete appraisal as to the new loan being procured leading to eventual failure which can again be seen as a lack of care if not skill and diligence. Based on these statutes, it is obvious that both Chris and Louis did not exercise due diligence and care while making decisions for the company and this leaves them liable to legal action. In terms of case law over the matter, it must be kept in mind that the Companies Act 2006 is essentially little else than codification of existing decisions on the issue. This derivation of the levels of skill, care and diligence on the director’s part can be seen as being framed with respect of the non-executive director(s). Previous proceedings on the matter presented subjective terms to define care and diligence such as in Re City Equitable Fire Insurance Co17 where the judge opined that a director was only expected to perform his duties at a level that could be reasonably expected of him. This form of decision was based more on the belief that shareholders held the means to decide the directors so they should have to put up with the actions of directors and their consequences. However, such an approach has been relegated in more modern times where the court held that the rule from Equitable Fire applied to cases of skill and not to issues of diligence. The judgement from Dorchester Finance Co Ltd v Stebbing18 also opined that the real requirement with respect to diligence was: “… such care as an ordinary man might be expected to take on his own behalf.” It must be noticed here that the previous tests on the issue were more subjective in nature however the more recent tests were both subjective and objective in nature. The recent codification in the Companies Act 2006 can be seen as based on this new subjective and objective testing19. 2.5. Section 178 – Civil Consequences of Breach of General Duties The current case shows that the actions on the part of Chris resulted in civil breaches of contract leading to liquidation of Homemaker Limited. In such circumstances, the Companies Act 2006 expounds that any breaches in its Sections 171 to 177 will be treated similar to “the corresponding common law rule or equitable principle applied”20. In addition this section expounds that the duties of a director are applicable much the same as any other fiduciary duty owed by the director except for Section 174 that deals with the use of care, skill and diligence21. This clearly implies that any breaches of duty on the part of the director resulting in civil matters will be treated under common law. Therefore, the actions of Chris will be dealt with under the corresponding common law rules. However, the matter of obtaining a loan through Star Bank with partial approval will have to be dealt with separately as per the company’s constitution. 2.6. Section 179 – Cases with more than one of the General Duties It has been clearly stated under this section that for any given case more than one general duty may apply22. This means that for the current case, Chris will have to be prosecuted under more than one general duty while Louis will be prosecuted under the one general duty applicable. 2.7. Section 180 – Consent, Approval or Authorisation by Members Under this section, the director must act after approval is provided by members either in an expressed form or an implied form. However, this section deals with the issue of conflict of interest and rejection of benefits provided by third party23. Therefore this section can be seen as inapplicable to the current case and its dimensions because there are no issues of conflict of interest or rejecting thirds party benefits. 3. Conclusion The actions taken by Chris and Louis represent great deviations from the limits placed by the Companies Act 2006. The first major violation of duty occurs on the part of Chris in his business diversification attempt without taking the other directors in confidence. This was followed by a violation of the company’s Articles of Association whereby Chris attempted to transact a million and a half pounds while he was bound to inform all directors of any transactions greater than one million pounds. One of the other directors, Louis is also guilty of this violation because he was informed and failed to inform the other director Jenny. 4. Bibliography 4.1. Books Paul L Davies and L C B Gower, Gower’s Principles of Modern Company Law (6th edn Sweet & Maxwell 1997) John Micklethwait and Adrian Wooldridge, The company: A short history of a revolutionary idea (New York: Modern Library 2003) 4.2. Journal Articles J Cai and J L Garner and R A Walkling, ‘Electing Directors’ in Journal of Finance 64(5) [2009] 2387–2419 4.3. Statutory Law Companies Act 2006 4.4. Case Law Ashbury v Watson (1885) 30 Ch D 376 Clark v Workman [1920] 1 Ir R 107 Dawson International plc v Coats Paton plc 1989 SLT 655 Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 Industrial Development Consultants v Cooley [1972] 1 WLR 443 Mills v Mills (1938) 60 CLR 150 Norman v Theodore Goddard [1991] BCLC 1027 Re City Equitable Fire Insurance Co [1925] Ch 407 Re Smith & Fawcett Ltd [1942] Ch 304 Re W & M Roith Ltd [1967] 1 WLR 432 Teck Corporation v Millar (1972) 33 DLR (3d) 288 Read More