Director's Duties Contained in the Company Act 2006 - Essay Example

I. Instructions: The sta y ment of directors duties contained in the Company Act 2006 does little to clarify the confused of the case law. Introduction It is axiomatic that since company directors make gargantuan business decisions for the company, specific duties must be imposed on directors to protect the interests of the company and the shareholders such as - the duty to act in good faith to the best interest of the companies; to avoid conflicts of interest; not to profit from their offices, and the duty of care and skill. While these duties have been etched in common law rules, the principles of equity, and stated in statutes like Companies Act 1985 (the 1985 Act) as amended by Companies Act 1989, the further codification of these duties in the Company Act 2006 (the “Act”) was aimed purportedly at bringing certainty and consistency. The specific aim of the codification is to have “greater clarity on directors duties.”1 But while the Act is intended partially to reform, the parts on duties of directors are attempts to codify the existing law.2 Even if the duties of directors are listed in ss. 170 to 177 of the Act, this list of duties is not a complete enumeration of the current rules as the duties based on the principles of equity will never be defined fully and totally accounted for. These seven general statutory duties as set out in Sections 170 to 181 of the Act will be discussed below. Also, the enumerated duties are not mere restatements of the common law rules such as for instance the duty for a director to act “in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole” (s. 172) The duty under Section 172 necessarily includes other considerations like “the impact of the company’s operations on the community and the environment” (s. 172(1)(d)) clearly attempting to infuse political arguments in the Act going beyond codification. The effect of these various aims (codification, reforms) of the Act could spur numerous litigation to interpret the meaning of these sections. And most probably, the codified “new law” will as a consequence substantially goes back to reflect the old rules. And if litigation is required to interpret the “codified” duties, clearly the avowed purpose of the Government at bringing certainty and consistency or “greater clarity on directors duties is far from having succeeded. Specific duties of the directors will be discussed below and the exiting common and equitable rules to show that the codification of these duties does little to give greater clarity on directors duties. The General Duties of Directors 1. Duty to act within the company’s powers - s. 171 Section 171 requires directors to (a) act in accordance with the companys constitution (as defined in s.257, which is wider than s.17) and (b) only exercise powers for the purposes for which they are conferred. This was a rule from common law that corporate powers must be exercise only for a proper purpose depending on the company’s constitution, or memorandum and articles of association. Since this is a well-entrenched duty, this is less likely to be of limited in its application except on the issue of the definition of “the company’s constitution” where under the Act, the Articles of Association are also defined (s. 18) and the memorandum will have less legal consequence (see s. 8). Nevertheless, the “the company’s constitution” includes the Articles of Association and company decisions (ss. 17and 29) thereby exposing a director to a possible risk when he does not follow company decisions. This is a potential area of dispute which the Act failed to clarify. The constitution is commonly regarded as relevant in limiting a directors authority to act. Section 171(a) makes it clear that non-compliance with these constitutional limitations is a breach of duty by the director. A director who acts in breach of s.171(a) is liable to compensate the company for any loss that the company suffers as a result of the breach. So far as the company and third party are concerned, the validity of a purported act of the company that is not in accordance with the companys constitution depends upon normal rules of agency, assisted by provisions (s. 161) in the Act designed to protect the third parties: Hely Hutchinson v Brayhead Ltd [1968] 1 Q.B. 549, CA; Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 Q.B. 480, CA.] Constitutional limitations on a directors powers, contained in the articles, are generally classified as either (i) restrictions in the companys objects that limit the companys (and therefore its directors) capacity to act in certain ways; and (ii) limitations on the directors authority to act on behalf of the company, even though the contemplated transaction is within the companys capacity. The difference between these restrictions is immaterial to a breach of s.170, but may have ramifications for third parties in determining whether purported engagements with the company are binding. The same liability exists at common law,3 but the directors may be relieved of it by ordinary resolution of the shareholders in general meeting: Grant v United Kingdom Switchback Railways Co (1888) 40 Ch.D. 135; cf. Boschoek Proprietary Co v Fuke [1906] 1 Ch. 148. This does not amend the articles (the usual formal procedures must be followed to do that), but it absolves the directors. Under the Act, the rules on ratification by the shareholders have been made strict. Section 171(b) codifies the proper purposes doctrine as it applies to directors, thus putting to rest earlier debates about whether such a duty exists. The precursor equitable duty to "act bona fide in what directors consider is in the interests of the company, and not for any collateral purpose”: Smith and Fawcett Ltd, Re [1942] Ch. 304, CA. The Act now separates the two - the proper purposes in s.171 while the reformulated "interests of the company" doctrine as the "duty to promote the success of the company" in s.172. This separation of the proper purposes doctrine clearly allows greater judicial intervention in corporate affairs. The Act therefore thus little to clarify these duties. Similarly, the positive formulation of the proper purposes duty in s.171(b) as against the negative phrasing in Smith and Fawcett, not to act for any collateral purpose, aligns the duty more closely with the common law.4 2. Duty to promote the success of the company – s. 172 Section 172 specifies that the directors duty is to promote the success of the company for the benefit of its members as a whole (not for the benefit of other stakeholders or constituencies). This rejects the "pluralist approach" and adopts the "enlightened shareholder value" recommendations of the Law Commissions and CLR5. One important reason for this choice is that the pluralist view risks leaving directors accountable to no one, since there is no clear yardstick for judging their performance.6 The duty favours a long-term, rather than short-term, outlook in corporate decision-making (see s.172(1)(a)). Under the old rule, the general duty was to act in the bona fides interest of the company. Be that as it may, a controversial issue will be how far will courts intervene in “good faith” company decisions. Corollary to this, courts will have to formulate new notions of loyalty and/or success either by way of developing statutory principles or through equitable rules. Moreover, court will have to determine what success is. While Hansard postulated that that this is taken from context Lord Goldsmith postulated success as “long-term increase in value.” In addition, the Act enumerated six factors to be considered: “(a) the likely consequences of any decision in the long term,(b) the interests of the company’s employees, (c) the need to foster the company’s business relationships with suppliers, customers andothers,(d) the impact of the company’s operations on the community and the environment,(e) the desirability of the company maintaining a reputation for high standards of businessconduct, and (f) the need to act fairly as between members of the company.” Clearly, this codification of duties does little to clarify the old common law rules on directors’ duties. 3. Duty to exercise independent judgement – s. 173 Directors must exercise independent judgment (traditionally expressed as "directors must not fetter their discretion"). This duty is not breached if the director merely takes advice, or acts in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or in a way permitted by the companys constitution. The duty does not confer a power on the directors to delegate, but nor does it prevent a director from exercising a power to delegate conferred by the companys constitution (provided the exercise is in accordance with the companys constitution). The Act requires a positive duty on directors to exercise independent judgement and affects tremendously the ‘shadow directors’ who are not active in the management of the company. Simply stated this duty requires a director to exercise independent judgment but this duty may exist simultaneously with s. 172 on the duty to promote success and s. 175 on conflicts of interest. There has been several cases in common law about this duty. The problematic area however is how to define “outside interest” especially in amtters of corporate governance where a director is a bank nominee7 or a nominee on a subsidiary’s board.8 With the codification of this duty, it is probable that the new law will still follow the old rules and hence, does not contribute to clarify the common law rules. 4. Duty to exercise reasonable care, skill and diligence – s. 174 Section 174 codifies the common law rule of duty of care and skill requiring that degree of ‘care, skill and diligence’ expected from a director or that care, skill, diligence that would be exercised by a reasonably diligence person with “a. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and b. the general knowledge, skill and experience that the director has.” Courts have been reluctant to interfere in cases of mere negligence as against deliberate breach of duty. In Re City Equitable Fire Insurance Co [1925] Ch 407, the standard is to ask the questions regarding the relative standard of skill and care, the degree of diligence required and the degree of permissible delegation. While the traditional approach allows a significant degree of delegation, the modern conceptual framework is more focused on strictly objective standards to align the rigid standards in s. 214 of the Insolvency Act 1986: Re D’Jan of London Ltd[1993] BCC 646. Clearly, common law rules on s. 214 of the Insolvency Act 1986 will likewise be applied and thus, add to the already confused state of rules on directors’ duties. 5. Duty to avoid conflicts of interest – s. 175 The last three provisions will not come into force until October 1, 2008. Hence, before that, common law rules govern. This section is the first of three general sections, appearing in succession addressing the true fiduciary duties of loyalty owed by directors to their companies. Section 175 replaces the equitable no-conflict rule, although only as it applies to conflicts of interest arising from third party dealings by a director (s. 175(3)) Section 175 applies to dealings between the director and third parties, not between the director and the company. Dealings between the director and the company are under the 7th duty, the duty to declare interest to the other directors. Under the Act, there is no need to get shareholders’ approval before contracting with third parties in cases where the interests of the director’s conflict with the company’s interests. Under the Act, directors may secure authorisation from the other directors who are not in conflict provided certain requirements in s175 (5) (6) are satisfied. While the Act‘s definition reflects the approach adopted in IDC v Cooley [1972] 1 WLR 443), the Act allows a more flexible but commercial approach by adopting a common sense test: “whether the situation can reasonably be regarded as likely to give rise to a conflict of interest”: s. 175(4)). The Act’s approach was to avoid stifling “entrepreneurial activity” and allowing flexibility when necessary. The “reasonableness” test has been recognised previously in Bhullar v. Bhullar [2003] 2 BCLC 241, CA). 6. Duty not to accept benefits from third parties - s. 176 Section 176 reformulates and replaces the equitable principle that fiduciaries must not accept bribes or secret commissions: Attorney-General for Hong Kong v Reid [1994] 1 A.C. 324, PC. Under this duty, some issues may have to be considered9. First, how does the Act define a benefit? Others argue and relied on a de minimis rule. Second, is the problem posed by additional directorships. At present, the mere holding of another directorship is not a breach: In Plus Group Ltd v Pyke [2002] 2 BCLC 201, CA. But there is a showing of breach of the duty of loyalty, s. 176 then is breached: British Midland Tool Ltd v Midland International Tooling Ltd [2003] 2 BCLC 523). Again, judicial interference of corporate affairs will have to set in and such issues in s. 176(4) and (5) will be interpreted using the test of reasonableness as used in the duty on conflicts of interest. Hence, instead of clarifying the confused state of law on directors’ duties, the Act relatively added to the state of confusion by incorporating another layer of legal framework. 7. Declare interest in proposed transaction or arrangement with the company – s. 177 Under s. 317 of the 1985 Act, a director must disclose his interest to the board once a transaction is proposed between a director and the company. While s. 317 of the 1985 Act is now reformulated under s.177 of the Act, the new duty goes beyond its predecessor duty by requiring such director to disclose the nature and extent of interest to the other directors. Also, the disclosure has to be made when a director ‘ought reasonably to be aware of’ (s.177 (5)) the conflict. Furthermore, the disclosure extends to persons connected with the director including spouses, ascendants and descendants. Section 177 is more effective than its old counterpart because it contains a broader definition of “connected persons”. Even if the director is not a party to the transaction, he must declare the nature and extent of his interest to the other directors. Again, this calls for judicial interference on company affairs on issues involving conflicts of interest by applying the rest of reasonableness from sections on conflicts of interest (s. 177(6)(a) and s.175(4)). Conclusion In the codification of the Act, the avowed intention of the Government is to codify rather than reform. An examination of the Act however reveals that it is not an entirely accurate description of the Act’s purposes because clearly, there are attempts to infuse reform rather than codify company law. Consequently, the effect of these various aims of the Act could spur numerous litigation to interpret the meaning of the relevant sections. If litigation is required to interpret the “codified” duties, then clearly the avowed purpose of the Government at bringing certainty and consistency or “greater clarity on directors duties is far from having succeeded. As discussed above, the codification does little to give greater clarity on directors duties. References: Associated Provincial Picture Houses Ltd v Wednesbury Corp [1948] 1 K.B. 223 CLR, Modern Company Law for a Competitive Economy: A Strategic Framework, at para.5. Committee on Corporate Governance, Final Report, para.1.17. Company Law Reform Bill--White Paper 2005, para.3.3 Cullerne v London Suburban General Permanent Building Society (1890) 25 Q.B.D. 485 DTI press release 5 June 2006 DTI press release 8 November 2006 Edge v Pensions Ombudsman [2000] Ch. 602 CA. Hunter v Senate Support Services Ltd [2004] EWHC 1085, Ch, [2005] 1 B.C.L.C. 175 Kuwait Asia Bank EC v. National Mutual Life Nominees Limited [1990]BCLC 868, PC Oxford Benefit Building and Investment Society, Re (1886) 35 Ch.D. 502 Quiney, B. The Companies Act 2006: Directors’ Duties, London: 2007. Rolled Steel Products Ltd v British Steel Corp [1986] Ch. 246 ss. 170-178, Company Act 2006 Scottish Co-operative Wholesale Ltd. v. Meyer [1959] AC 324, HL Wrexham Association Football Club Ltd v Crucialmove Ltd [2006] EWCA Civ 237 II (a) The issue in this case is whether Daisy, as a minority shareholder, has a remedy against the majority shareholders of the company. Generally, a minority shareholder has at least two statutory remedies under the Corporation Act 2006 or CA 2006. These remedies are: (1) an application to have the company wound up on the ‘just and equitable’ ground (s 122(1)(g) IA 1986); and (2) an application for an order from the court on the ground that the company’s affairs are being conducted in a manner which is ‘unfairly prejudicial’ (Part 30 CA 206, ss 994-998). The second remedy allows the company to continue its business. In addition to these, there are also various other remedies for specific ‘internal’ situations. The most appropriate remedy that Daisy should avail is the second remedy of applying for an order from the court on the ground that the company’s affairs are being conducted in a manner which is ‘unfairly prejudicial’ under Part 30 CA 206, ss 994-998. Specifically, s 994(1) CA 2006 provides as follows: “A member of a company may apply to the court by petition for an order under this Part on the ground - (a) that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or (b) that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial. The ‘Act or omission’ under this Section can include either an isolated act or omission or a continuing situation, depending on the circumstances. In the given situation, the facts clearly indicate that the company’s affairs are being or have been conducted by the majority in a manner unfairly prejudicial to the interests of Daisy, a minority, because no dividend has been declared while the directors received 60,000 annually as directors’ fees, that is the majority took out any profit from the business as director’s salaries. In the case of Ebrahimi v Westbourne Galleries [1973] AC 360, all profits of the company were given out by directors’ salaries rather than by way of dividend while the minority received no money from the business. While the petition to wind up the company up under s 122 in Ebrahimi was denied, it was stated that Ebrahimi v Westbourne Galleries also applies to s 994 petitions per Lord Wilberforce at 379 and Lord Wilberforce at 374-375. Clearly, these facts constitute a basis to grant an application for an order based on the ground that the company’s affairs are being conducted in a manner which is ‘unfairly prejudicial’ (Part 30 CA 206, ss 994-998). In summary, Daisy as a minority shareholder may file an application for an order from the court on the ground that the company’s affairs are being conducted in a manner which is ‘unfairly prejudicial’ (Part 30 CA 206, ss 994-998). (b) The issue in this case is whether Daisy, as a minority shareholder, has a remedy against the majority shareholders of the company. Daisy as a minority shareholder may likewise file an application for an order from the court on the ground that the company’s affairs are being conducted in a manner which is ‘unfairly prejudicial’ (Part 30 CA 206, ss 994-998). The fact that a furniture worth 15,000 is sold to Bill’s sister in law for just 10,000 clearly shows that the company’s affairs are being conducted in a manner which is ‘unfairly prejudicial’ under Part 30 of CA 206. In fact, an ‘act or omission’ has been interpreted to include an isolated act or omission as opposed to a continuing situation: Re Norvabron Pty Ltd (No 2) (1986) 11 ACLR 33. Hence, Daisy may file an application for an order from the court on the ground that the company’s affairs are being conducted in a manner which is ‘unfairly prejudicial’ (Part 30 CA 206, ss 994-998). Read More