Company Law Reform Bill - Essay Example

___________ ____________ ____February 2007 Company Law: Company Law Reform Bill The Companies Bill (earlier popular as the CompanyLaw Reform Bill) is a major step towards extensive reform of UK company law. The government considers that these principles while long established lack certainty and are not easily accessible. Very often, directors have to take advice in these areas so as to ensure that they do not inadvertently breach any duty enshrined in the case law. The government therefore believes that codification of directors' duties will make the law in these areas more consistent, certain and accessible. Companies Act 2006 ('the Act'), which received Royal Assent on the 8th November 2006, codifies directors' duties including the long-established fiduciary duties as well as the common law duty of care and skill into a statutory statement of seven general duties. The main proposals in respect of the Directors' duties include: a statutory statement of directors' general duties; and an extended power for shareholders to sue directors for negligence and other defaults. Presently the general duties that a director owes to the company were invariably established though case law rather than statute making it difficult for such duties to be comprehended and pressed for implementation. The Bill includes a statutory statement of directors' general duties both to make the law in this area more accessible and to change the law where it no longer corresponds to modern business practice. The clauses 170-187 of the Companies Bill 2006 carry a major portion of such codification Other changes are made which affect directors, including simplification of the law relating to transactions between a company and its directors. This paper would discuss the changes brought about in the new legislation in respect of directors' duties and how these changes present an altered and improved stance over the hitherto adopted practice of deriving directors' duties through interpretation of case laws. The Stance of the Company Law Reform Bill versus the Case Laws The governments intended to plain speak on the directors' duties so as to make the law more "consistent, certain, accessible and comprehensible". This was achieved through a statutory statement of directors' general duties along with a plain language guidance explaining the duties. On the issue of the liability of directors, the governments Government recognised that the law has to balance the need to deal fairly with directors who have been negligent or dishonest against the need for companies to have a diverse pool of high-quality candidates wishing to act as directors, and who are willing to take informed and rational risks. The Bill implements a Law Commission recommendation making it easier for shareholders to sue directors for negligence, default, breach of duty or breach of trust - a broader range of conduct than at present.1.The various duties envisaged in the new bill can be cited as follows: Duty to act within the company's powers i.e. "A director must act in accordance with the company's constitution and only exercise powers for the purposes for which they are conferred."- this codifies the common law rules that directors should exercises their powers under the terms that were granted for a proper purpose. A director's powers are normally derived from the company's constitution, i.e. its memorandum and articles of association.; Duty to promote the success of the company i.e. "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"- this duty is set out in section 172 of the Act and is a new duty developed from one of the heads of the overriding principles of the fiduciary duties, i.e., duty of good faith to act in the company's best interest. when exercising this duty the director is required to have regards to various non-exhaustive list of factors listed in s.172 (1) including the long term consequence of the decisions as well as the interests of the employees- the relationships with suppliers, customers; and the impact of the decision on community and environment; the desirability of maintaining a reputation for high standards of business conduct;; Duty to exercise independent judgment i.e." A director must exercise independent judgment."- Section 173 of the Act imposes a positive duty Norton Rose.(2006). Companies Bill: the impact on directors.28 July 2006.Retrieved from www.nortonrose.com/publications on February 10, 2007. on a director of a company to exercise independent judgment and there are presumably two elements to this section-one, a director must first exercise a judgment and secondly he must exercise the judgment independently.; Duty to exercise reasonable care, skill and diligence i.e. "A director must exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with -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 the general knowledge, skill and experience that the director has."-this duty is set out in s. 174(1) and it codifies the common law rule of duty of care and skill. S. 174 (2) prescribes the degree of 'care, skill and diligence' expected from a director ; Duty to avoid conflicts of interest i.e. "A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company."- the conflicts of interest provisions are previously contained in Part 10 of the Companies Act 1985 and are quite complex.-the Act restates, amends, and simplifies these provisions to make them more accessible and with a view of assisting modern business practice; Duty not to accept benefits from third parties i.e." A director must not accept a benefit from a third party conferred by reason of his being a director, or his doing (or not doing) anything as director" and a "third party" means a person other than the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate"- this reinstates the existing rule known as 'non profit' in that a director is not permitted to accept a benefit from a third party by reason of (a) his being a director or (b) his doing or not doing anything as a director,and duty to declare interest in proposed transaction or arrangement with the company i.e." If a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors." 1- Section 177 of the Act reflects s.317 of the 1985 Act in that it requires a director to disclose his interest to the board of the company when a transaction is proposed between a director and his company-however, it goes further than the requirement of s.317 of the 1985 Act by requiring a director to declare the nature and the extent of the interest to the other directors. In the above codification of duties there is a generous mix of those duties that represent the existing position of the case laws and that which represent a substantial departure and enter a new area. For instance the directors' duty to act within Company's powers is entirely based on the present case laws' interpretation as consultants state, "This codifies the current common law position that directors should exercise their powers in accordance with the terms on which they were granted and for a proper purpose. Proper purpose is to be judged in the specific context under consideration. The company's constitution for these Norton Rose.(2006). Companies Bill: the impact on directors.28 July 2006.Retrieved from www.nortonrose.com/publications on February 10, 2007. purposes means its articles of association but extends to decisions taken in accordance with the articles and other decisions taken by members if they can be regarded as decisions of the company (for example, where the members informally, but unanimously, consent to an action)"1. Whereas the most controversial inclusion is the duty to promote the success of the company. This is a new duty and various definitional and interpretation based clarifications are needed for proper assessment of fulfillment of this duty. To begin with this duty has been widened to make it accountable a very large constituency of company stakeholders as the directors are expected to promote the success of the company with regard to the interest of all such stakeholders, as opinion states," in doing so[promotion of interest by directors] [they must have] have regard (amongst other matters) to - the likely consequences of any decision in the long term; the interests of the company's employees; (this replaces the existing s309 of the CA);the need to foster the company's business relationships with suppliers, customers and others; the impact of the company's operations on the community and the environment; the desirability of the company maintaining a reputation for high standards of business conduct; and the need to act fairly as between members of the company."1 These factors comprise the objective test of evaluating enlightened shareholders' value and the act of promotion of the success of the Norton Rose.(2006). Companies Bill: the impact on directors.28 July 2006.Retrieved from www.nortonrose.com/publications on February 10, 2007. company itself is a subjective test. Even the term success of the company in terms of achieving shareholders' enlightened value is a lacking proper definition. In common law directors are held in fiduciary relationship to the company and act as an agent cum trustee who is bound by loyalty and good faith to his principal, the Company.2 As legal opinion states in respect of the governments' criteria of the success of the company, "The Government has stated that for commercial companies "success" will mean, normally, "long-term increase in value". For other companies such as charities, it means "achievement of their objectives". The DTI's guidance notes on the Bill (the Guidance) state that the decision as to what will promote the success of the company, and what constitutes such success, is for the directors' good faith judgment. The Government's view is that provided that the directors make a decision in good faith, and have exercised reasonable care, skill and diligence in reaching that decision, it should not be open to challenge in the courts. This would preserve the courts' reluctance to overturn directors' commercial decisions provided they have been made in good faith, commonly called the business judgment rule"1. Juxtapose this position with what Farrar & Hannigan (1998) state in relation to the three essential aspects of the fiduciary duty reposed with a director," Firstly, that directors are under a duty to act bona fide in the interests of the company and that they must not exercise their assigned Norton Rose.(2006). Companies Bill: the impact on directors.28 July 2006.Retrieved from www.nortonrose.com/publications on February 10, 2007. 2 Sealy, (1967).The Director as Trustee. CLJ 83. See also Great Eastern Railway Co. v. Turner (1872) 8 Ch App 149 at 152 per Lord Selborne and Re Lands Allotment Co [1894] 1 Ch 616 at 631. powers for any collateral purpose; secondly, that a director who profits from the use of his position as director within a company, is liable to account for that profit and, thirdly, where a director becomes involved in a situation where his duty to the company and any relevant personal interests conflict, any contract derived from such a situation is voidable at the behest of the company"3. There was a robust parliamentary debate on the issue of linking a company's business review process and directors' liability as contained in their duties .This was with a view to crystallize the concept of enlightened shareholders' value. An excerpt from the debate throws much more light on the governments' mind on the issue," I turn now to the amendments to the new clause tabled by the noble Baroness, Lady Noakes. I am grateful to her for tabling Amendment No. 197, as it gives me the opportunity to explain the Government's rationale behind specifying the purpose of the business review under the new subsection (2). Our reasons are twofold. First, specifying for whom the business review is intended is an important part of the package concerning liability. Specifying that the review is to inform members of a company is intended to make clear that the business review is designed for the benefit of members as a whole so that they may exercise their governance rights more effectively. It is not designed to help individuals decide on investment 3 Farrar, J.H.; Hannigan, B.M..(1998).Farrar's Company Law, London Edinburgh and Dublin, Butterworths (1998) at p378. decisions, nor is it targeted at the wider public in the sense that they should be entitled to rely on it, although they may well read it. The effect of the provision is to limit directors' liability to the company only, and ensure that neither individual investors nor anyone else is entitled to sue. In effect, this has codified an aspect of the Caparo judgment. We consider that making that clear will facilitate open and meaningful reporting. Secondly, we want to make an express link between the business review and the directors' duties under Clause 156. That clause, as we discussed yesterday, embodies the concept of enlightened shareholder value. That is relevant to reporting on matters such as the environment and employees in the business review, which my noble friend Lord Clinton-Davis drew attention to yesterday. As we explained with regard to Clause 156, the Company Law Review concluded that the success of the company could only be promoted taking due account of such factors, which reflect wider expectation of responsible business behaviour. By making the link to directors' duties, it helps to make clear that those factors contribute to the success of the company for the benefit of members as a whole, and it is in that context that directors are being asked to report on them. Subsection (2) is a response to the view of stakeholders during the Government's recent consultation. Business and investor groups alike called on the Government to clarify the position on liability. As I said, specifying the purpose of the business review is one element of the package to limit directors' liability. The direct link to directors' duties was pressed for by a significant number of interest groups. They echoed the Company Law Review in seeing a clear and important link between enlightened shareholder value and narrative reporting".4 The new statute ,in fact ,represents a departure from the current interpretation by the case laws and is placed on a much broader spectrum. However it is feared that the governments' dependence on good faith acts of directors may reduce this duty to another round of interpreting case laws. Take the instance of the duty to exercise independent judgment. This largely represents the current case law position. Even Norton (2006) states very clearly, "This duty mirrors the current law, which prohibits directors from fettering their future discretion unless they act in accordance with an agreement duly entered into by the company or as authorized by the company's constitution. Questions have been raised as to whether this duty precludes a director from delegating his functions to committees of the board. However, the Guidance indicates that delegation would be permitted if provided for in the company's constitution. The Government has confirmed that the Bill does not change the position of a nominee director. A nominee must exercise his judgment in the interests of the company, ignoring the interests and wishes of his appointer, unless the nominee is authorized to act in accordance with those interests and wishes by the company's constitution. However, it should be noted that although a nominee may follow instructions, he must also comply with all of his other duties as a director"1. Norton Rose.(2006). Companies Bill: the impact on directors.28 July 2006.Retrieved from www.nortonrose.com/publications on February 10, 2007. 4 House of Lords debates.(2006). Company Law Reform Bill [HL].May,10,2006.Retrieved on February 10, 2007 from www.TheyWorkForYou.com. Then the duty to exercise reasonable care, skill and diligence also largely follows the tenets established by the current and decided law. The current case law underpins the importance of exercising reasonable care and skills on the part of directors well within their fiduciary obligations. This law has imposed an obligation on a director to exercise reasonable skill and care in carrying out his duties as would be reasonably of an individual of his knowledge and experience. This duty was clearly defined and explained in Romer J in Re City Fire Equitable Insurance Co5 where judgment also stated that a director is not bound to give continuous attention to the affairs of the company 6 and that a director is permitted to delegate relevant duties to an official, taking into cognizance the provisions of the Articles of Association of the company and contextual realities of the company. This reasoning of the Courts has been based upon the acceptance of the fact that the directors are better equipped in commercial business judgements.However while reckoning this fact the courts have also taken into account the instances of poor performance of such skills from those that specifically lacked the qualifications or failed to exercise them properly in an attempt to establish minimum standards of such exercise of skills and knowledge.7 where a director signed a form without reading it and was held not to have shown reasonable diligence. This was an instance of emphasis on the objective test of 5 Farrar, J.H.; Hannigan, B.M..(1998-i).Farrar's Company Law, London Edinburgh and Dublin, Butterworths (1998) at p378. [1925] Ch 407. 6 Dorchester Finance Co Ltd v. Stebbing [1989] BCLC 498. 7 Re D'Jan of London Ltd [1994] 1 BCLC 561. having exercised reasonable care and knowledge. As Norton (2006) states," The objective test sets the minimum standard expected of any director and requires that a director exercise the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may be expected of a person carrying out the functions of that director. The subjective test requires a director to carry out his functions with the general knowledge, skill and experience that the director in fact possesses"1. The Duty pertaining to the conflict of interest has also been premised largely on the three aspects of the fiduciary relationship in which a director is held to his company, as has been stated above. Case laws have emphasized the fiduciary aspect in deciding upon issues of the conflict of interests. The courts have been categorical and severe in their decisions in this respect. For instance, wherever directors had procured contracts for their interests abetted by their position as director, even when it was remote possible8 or even largely impossible 9that the company instead would have procured the conract;the courts have come down heavily on directors. The practical principle followed by courts in this strict no-conflict principle has, all along, impled that the Court will not enquire into the 1 Norton Rose.(2006). Companies Bill: the impact on directors.28 July 2006.Retrieved from www.nortonrose.com/publications on February 10, 2007. 8 Industrial Development Consultants v. Cooley [1972] 2 All ER 162. 9 Keech v. Sandford .(1726) fairness or other reasons behind the transaction.10 In fact courts have been supporting the view that it is not as much essential to prove that there is an actual conflict of interest but it would suffice if a real possibility of conflict can be set forth.11,12,13.In respect of the new codified duty Norton(2006) states, "This duty applies in particular to the exploitation of any property, information or opportunity available to the company, irrespective of whether the company could take advantage of it. It covers all conflicts, actual or potential, between the interests of the director and the interests of the company. The duty does not apply if the conflict arises in relation to a transaction or arrangement with the company itself (a director can simply declare his interest in such a transaction at a board meeting, he does not need this to be authorized by the members or the board ). The new duty will not be breached if the situation cannot "reasonably be regarded as likely to give rise to a conflict of interest" 1or if the matter has been authorized by the independent directors (i.e., those without a conflict of interest). The director who is conflicted must not count in the quorum for the meeting or vote on the proposal (or if he does vote, a majority in favor must be achieved without his vote). If the whole board is conflicted, then the shareholders can approve a transaction which involves a conflict. 1 Norton Rose.(2006). Companies Bill: the impact on directors.28 July 2006.Retrieved from www.nortonrose.com/publications on February 10, 2007. 10 Aberdeen Railway Co. v. Blaikie Bros. (1854) 1 Macq 461 at 471-472. 11 Boulting v. Association of Cinematograph Television and Allied Technicians. [1963] 2 QB 606 at 637-638. 12 Boardman v. Phipps. [1967] 2 AC 46. 13 Re Dominion International Group plc. (No 2)[1996] 1 BCLC 572 at 597. Thus while the newly codified duties are carried in simple language and are interconnected at one place for better reference there is a large reliance on establish case laws in their enunciation. In fact they seem to echo the gist of the case decisions over a period of time. However the new bill is a definite improvement in that it interconnects, lays at one place and emphasizes on strict and actual performance of all stipulations rather than just a lip service. This is likely to ensure better environment for companies-large or small, and link directors' duties with the overall schemata of corporate governance. Read More