Company Law: Regulations of Corporate Directors Activities - Assignment Example

 Question 1: Regal (Hastings) v Gullivers and Directors’ Duties The House of Lords takes a strict approach to the fiduciary duties of directors specifically in the context of the doctrine of corporate opportunity (Naniwadekar 2008, 197). In short, Regal (Hastings) v Gulliver and Ors [1967] ruled that company directors were not at liberty to take advantage of corporate opportunities as the same was a contravention of the fiduciary duty and the duty of loyalty. Essentially, the House of Lords asserted that the directors could not take advantage of an opportunity that the company could be interested in but did not take up the opportunity. Having determined that the directors in question had obtained a profit from business opportunity that they had come by in the course of their respective offices, the court held that the directors were accountable to the company for those profits. Lord Russell emphasized the strict and narrow interpretation of the equitable principle relative to the fiduciary duties of directors. He expressed the view that those who stood in a fiduciary position and used that position to make a profit, would be “liable to account for that profit” regardless of fraud “or absence of bona fides” (Regal (Hastings) v Gulliver and Ors [1967] 144-145). Lord Russell went on to state, that the liability to account for those profits would also be independent of: questions or considerations as whether the property would or should otherwise have gone to the plaintiff, or whether he took a risk or acted as he did for the benefit of the plaintiff, or whether the plaintiff has in fact been damaged or benefited by his action. The liability arises from the mere fact of a profit having in the stated circumstances been made (Regal (Hastings) v Gulliver and Ors [1967] 144-145). Essentially, the House of Lords in ruling as it did in Regal offered a strict interpretation of the duty of disclosure implicit in the fiduciary relationship between the directors and the company it serves. Regal essentially restated a firmly established equitable principle of company law. The rationale for the equitable principle was explained by Lord Eldon in Ex parte Lacey (1802) as Though you may see in a particular case, that the trustee has not made advantage, it is utterly impossible to examine upon satisfactory evidence in the power of the Court, by which I mean, in the power of the parties, in ninety-nine case out of a hundred, whether he has made advantage or not….if he chooses to deny it, how can the court try that against that denial Ex parte Lacey (1802) 6 Ves 627). The rationale for the principle was also explained by Lord Cranworth in Aberdeen Railway Co. v Blaikie (1854). Lord Cranworth explained that the rule is meant to ensure that the director with a fiduciary duty shall not “place himself in a situation to have his interests conflicting with that duty” (Aberdeen Railway Co. v Blaikie (1854)). Several years later the strength of Lord Cranworth’s rationale for equitable corporate opportunity doctrine was restated and expanded. Sedley LJ said in Plus Group v Pyke [2002] EWCA Civ 370 that the requiring that directors avoid a conflict of interest should be modified to express: An objectionable position is not only one in which duty conflicts with interest but one in which duty conflicts with duty or interest with interest (Plus Group v Pyke [2002] 786). The fact is the ruling in Regal merely adds to the list of circumstances and situations in which directors are required to safeguard the company’s interest. In Boulting v Assn of Cinematograph Television and Allied Technicians [1963] the Court of Appeal referred to the Regal case and noted that while the House of Lords makes it clear that the duty to account for profits does not depend on fraud and the absence of bona fides, it does apply to those situations. In fact the Court of Appeal noted that the rule applies to “all manner of relationships” and an exhaustive list of examples are recorded in the courts’ judgments (Boulting v Assn of Cinematograph Television and Allied Technicians [1963]). The Court of Appeal also noted that the rule enunciated in Regal is intended to protect the company which is entitled to have the “undivided loyalty of its directors” (Boulting v Assn of Cinematograph Television and Allied Technicians [1963]). This is particularly important given the fiduciary relationship that directors have to the companies they serve. This means that under equitable rules a director is required to account to the company for any secret profit (Sealy 1971, 359). This equitable rule is reinforced by Section 199 of the Companies Act 1948 which confers upon the director a statutory duty of disclosure in the absence of which there are criminal consequences (Companies Act 1948, Section 199). The corporate opportunity doctrine and its corresponding duty to disclose have been very consistently applied. Megarry V-C explained the reason for this consistency and inflexibility in Tito v Waddell (no. 2) [1977] Ch. 106 . Megarry V-C explained that equity “is astute to prevent” a trustee’s abuse of his position or “profiting from his trust” (Tito v Waddell (no. 2) [1977] 240). The inflexible and consistent application of rule continues regardless of good faith and the absence of a conflict of interest (Griffiths 2007, 268). Griffiths (2007) explains that the fiduciary duty requiring disclosure differs from the duty to act in good faith on the part of the directors (268). However, the duty of disclosure functions to “reinforce the duty of good faith in circumstances in which it is likely to come under pressure” (Griffiths 2007, 268). The duty of disclosure ensures that the doctrine of corporate opportunity is not unreasonably applied. It permits directors to take advantage of commercial opportunities in circumstances where the company is not able or willing to take advantage of the opportunities. Otherwise the corporate opportunity doctrine would be intrinsically unjustified in terms of commercial efficacy. All the directors are required to do is to disclose the “relevant facts” about the deal to the company (Griffiths 2007, 268). Essentially the equitable principle enunciated in Regal has the effect of perpetuating and strengthening a “procedural” or “reflexive” regulation (Griffith 2007, 268). The reflexive or procedural regulation has an indirect effect in that it prescribes conduct that the directors are obliged to follow so as to “avoid its impact” (Grifiths 2007, 268-269). In this case, the impact of the equitable principle is quite possible not to punish or ban self-dealing contracts, but to ensure that directors fully disclose what may give rise to a conflict of interest (Grifith 2007, 269). Essentially the ruling in Regal draws attention to two aspects of the corporate opportunity doctrine. The first is the prevention of and prohibition against a conflict of interest. The section aspect is the duty prohibiting the making of a secret profit. The only way to avoid consequences is for the director who is acting honestly and in good faith is to provide full and frank disclosure. Disclosure by implication means that the director is acting genuinely and does not intend to divert opportunities away from the company. Regal can be seen as both confirming and strengthening what has been described as “the orthodox position that a strict approach will be taken to the director’s liability” in the context of the fiduciary duty owed to the company (Lowry and Edmunds 1998, 515). Ultimately, the position taken in Regal is justified because it is necessary for ensuring a “high degree of protection and deterrence” (Lowry and Edmunds 1998, 515). The fact remains, any time a company director who takes advantage of a business opportunity for personal gain in circumstances where the business opportunity is closely aligned to the business of the company he serves, there is a potential for a conflict of interest. Regal instructs that directors as fiduciaries are required to avoid putting themselves in a situation where there is a possibility of a conflict of interest. Regal also instructs that when directors take advantage of corporate opportunities they are essentially competing with the companies that they serve. That in and of itself is a conflict of interest. Therefore, to avoid a conflict of interest, the director is required to obtain the company’s consent. This is achieved by full and frank disclosure. Bibliography Textbooks Griffiths, A. Contracting With Companies, Hart Publishing 2007. Sealy, L. Cases and Materials in Company Law, Cambridge University Press, 1971. Articles/Journals Lowry, J. and Edmunds, R. “The Corporate Opportunity Doctrine: The Shifting Boundaries of the Duty and its Remedies” The Modern Law Review, (1998) 61(4): 553-537. Naniwadekar, M. “Regal (Hastings) v Gulliver: An Equitable Principle Stretched too Far?” International Journal of Corporate Governance, (2008)1(2): 197-206. Cases Aberdeen Railway Co. v Blaikie (1854) 1 Macq 461. Boulting v Assn of Cinematograph Television and Allied Technicians [1963] 2 QB 606. Ex parte Lacey (1802) 6 Ves 625 Plus Group v Pyke [2002] EWCA Civ 370 Regal (Hastings) v Gulliver and Ors [1967] 2 AC 134. Tito v Waddell (no. 2) [1977] Ch. 106 Statutes Companies Act 1948 Question 2: Directors’ Fiduciary Duties and the Effect of the Directors Disqualification Act of 2000 Fiduciary duties are imposed on directors to minimize the possibility of abuse of their corporate powers. As a result directors powers are subjected to a variety of controls and constraints that are imposed by statutes namely, the Companies Act 2006, the Insolvency Act 1986 and the Company Directors’ Disqualification Act 2000 as well as common law and equitable principles. In their position as fiduciaries, directors implicitly undertake to “act for, or on behalf of, or in the best interests of the company” (Sheikh 2008, 372). The fiduciary duty in general calls upon directors to ensure that business decisions and business judgments are exercised with a view to maximizing the welfare of the shareholders and at the same time take into account the welfare of a broader class of stakeholders (Sheikh 2008, 372). Specifically, there are a number of standards placed on the director as a result of his/her fiduciary relationship with the company. At common law there is a duty to act in good faith. In other words the director as a fiduciary must act in what he/she rather than the courts perceive as a bona fide (Re Smith and Fawcett [1942]). Implicit in the rule is the fact that the courts are not prepared to impose prescriptions for an objective interpretation of good faith and will therefore apply a subjective test. Essentially, the courts will not go about excessively policing the business judgment of the directors. As fiduciaries, directors are required to manage the company’s affairs by reference to what is in the company’s best interest and that belief must be an honestly held belief (Inland Revenue Commissioners v Richmond [2003] All ER 123). Moreover, a director is required to ensure that his discretion is ex Moreover, a director is required to ensure that his discretion is exercised in an independent way and he/she must no fetter his discretion (Sheikh 2008, 374). At common law the fiduciary duties of directors have evolved to include duty not to act in excess of their respective powers. Moreover, the directors may not make personal profits, may not take advantage of corporate opportunities, they may not put themselves in a position where they compete with the company, they may not act for a collateral purpose and may only use their powers for a proper purpose (Campbell 2007, I-96). Each of these common law fiduciary duties have been codified by the Companies Act 2006. It therefore follows that the fiduciary duty of directors have not been transformed from a common law duty to a statutory duty. Section 171 of the Companies Act provides for the duty not to exceed director’s power. Specifically a company director must “act in accordance with the company’s constitution” (Companies Act 2006, Section 171(a)). In addition the director of a company may “only exercise powers for the purposes for which they are conferred” (Companies Act 2006, Section 171(b)). Building on the body of common law fiduciary duties, Section 172 of the Companies Act provides that the director is under a duty to promote the company’s success. This duty is set out as follows: A director of a company must 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 (Companies Act 2006, s. 172). In promoting the success of the company the director is required to take a number of factors into account including the consequences of “any decision in the long term”; the employees’ interests; the interest of the company’s business associates and consumers; the community and the environment; the company’s reputation and “and the need to act fairly as between members of the company” (Companies Act 2006, s. 172). Section 173 provides for what is essentially the no fettering rule in that the director is required to exercise his/her judgment independently. However, the duty is contravened if the director acts pursuant to “an agreement duly entered into by the company that restricts the future exercise of discretion by its directors” or if the company’s articles permit it (Companies Act 2006, S. 173). The company director must also use reasonable skill, care and diligence. This duty is qualified as follows: This means the care, skill and diligence that would be exercised by a reasonably diligent person with: (a) The general knowledge, skill and experience that may be expected of a person carrying out the functions carried out the director in relation to the company; and (b) The general knowledge, skill and experience that the director has (Companies Act 2006, Section 174). The duty to avoid a conflict of interest was previously contained under Part 10 of the Companies Act 1985. Those duties have now been simplified by Section 175 of the Companies Act 2006. Section 176 restates the nonprofit rule at common law by providing that director may not take any benefits from third parties in his capacity as a director and he/she may not accept benefits from third parties on account of the director doing or not doing something in his/her capacity as a director (Companies Act 1976). Section 177 restates the long tradition of common law relative to the corporate opportunity principle and specifically calls for disclosure. This is reflective of Section 317 of the Companies Act 1985 except the duty of disclosure was not provided for in the 1985 Act. Directors are required to report the “nature and extent” of any interest in a proposed transaction or other arrangement with the company to the other directors of the company. Additionally, the director is required to report a conflict of interest where he/she “ought reasonably to be aware” of the conflict of interest. Disclosure also applies to connected persons (Companies Act 2006 Section 177). The disclosure duty has been modified by Section 177 in that it is no longer strict in its interpretation and application. The duty to disclose is waived if it is not reasonable to look upon the transaction or interest as capable of amounting to a conflict of interest. The duty to disclose is also waived the remaining directors are either already aware of the director’s interest or “ought to reasonably to be aware of the interests” (Companies Act 2006, Section 177). The fiduciary duties of directors are reinforced by the Company Directors’ Disqualification Act 1986 as amended in 2000. Essentially, the Company Directors Disqualifications Act 1986 excludes the appointment of certain persons from the office of director (Company Directors Disqualification Act 1986). By virtue of the 1986 Act, the court may make an order of disqualification . Under Section 2, the order may be made where the person: Is convicted of an indictable offence (whether on indictment or summarily) in connection with the promotion, formation, management, liquidation or striking off of a company with receivership of a company’s property or with his being an administrative receiver of a company (.Company Directors’ Disqualification Act 2000 Section 2). A person who has consistently contravened the companies legislations may also be disqualified by the court (Company Directors’ Disqualification Act 2000, Section 3). However, an application seeking a disqualification order must prove “conclusively” that five years immediately preceding the “date of the application he has been adjudged guilty” of at least three contraventions (Company Directors’ Disqualification Act 2000 Section 3(2). A person is adjudged guilty if he/she has been convicted of contravening the companies legislation or has been the subject of a “default order” in respect of accounting defaults under the Companies Act, reporting defaults under Section 713 of the Companies Act and duties pursuant to receivership under the Insolvency Act 1986 (Company Directors’ Disqualification Act 2000 Section 3(2)). If a person is convicted of an offence relative to the liquidation of a company the court may make an order disqualifying that person as a director (Company Directors’ Disqualification Act 2000 Section 4). Similarly, a person who is convicted of an offence relative to the failing to comply with the companies legislation may be the subject of a disqualification order by the court (Company Directors’ Disqualification Act 2000, Section 5). The court has a duty to disqualify any person from directorship if it is satisfied that: a) He is or has been a director of a company which has at any time become insolvent (whether while he was a director or subsequently), and b) That his conduct as a director (either taken alone or taken together with his conduct as a director or any other company or companies) make him unfit to be concerned in the management of a company (Company Directors’ Disqualification Act 2000 Section 6(a) and (b)). Each of these provisions indirectly polices the conduct of directors to such an extent that they reinforce the duty to act as fiduciaries and to exercise the degree of care and skill enunciated in the Companies Act 2006. Section 9 of the Company Directors’ Disqualification Act 2000 more directly addresses the issue of the director’s fiduciary duty. Section 9 confers upon the courts the authority to make a disqualification order if the company he/she directs infringes competition law or his/her conduct is such that the court deems that he/she is “unfit to be concerned in the management of a company” (Company Directors’ Disqualification Act 2000 Section 9). Section 10 goes even further to address the fiduciary duty in that the court may of its own volition make an order disqualifying a director if that director is “liable to make a contribution to a company’s assets” pursuant to the Insolvency Act 1986 (Company Directors’ Disqualification Act 2000 Section 10). In the event the court makes a disqualification order and the person to whom it applies acts as a director that contravention will constitute a criminal offence (Company Directors’ Disqualification Act 2000, Section 13). Disqualification under the Company Directors’ Disqualification Act 2000 can be applied for a period of time ranging from five to fifteen years. It therefore follows that the fiduciary duties of directors are taken seriously. The fact that a disqualification order can be applied for and granted speaks to the fact that individual acts amounting to a breach of the fiduciary duty will constitute grounds for disqualification. The Company Directors’ Disqualification Act 2000 clearly targets areas that are facilitated by fiduciary duties. For instance the director’s conduct and role in insolvency in terms of reporting accounts can give rise to a disqualification order. A director is not likely to be uncooperative in situations where the director had something to hide Similarly, a director would not likely be liable to contribute to the company’s assets in the insolvency process unless he had been guilty of a breach of his/her fiduciary duties. The director’s fiduciary duties have evolved over the years to such an extent that they formed a long and complex history. Until the implementation of the Companies Act 2006, the fiduciary duties of directors were no more than a historical and perpetually developing common law and equitable principles. With the enactment of the Companies Act 2006, these duties have been simplified and modified and are now contained in one place. Regardless the common law and equitable principles expressed in the various judgments will be useful for applying and interpreting the statutory fiduciary duty. The Company Directors’ Disqualification Act 2000 runs parallel to the Companies Act 2006 as well as any common law and equitable principles. As a result, there is a legal framework for defining and deterring contraventions of the director’s fiduciary duty. Bibliography Textbooks Campbell, C. International Liability of Corporate Directors, Yorkhill Law Publishing 2007. Sheikh, S. A Guide to the Companies Act, Taylor and Francis, 2008. Cases Inland Revenue Commissioners v Richmond [2003] All ER 123 Re Smith and Fawcett [1942] Ch 304. Statutes Companies Act 2006 Companies Act 1985 Company Directors’ Disqualification Act 2000 Insolvency Act 1986 Read More