Company Law Reform Bill - Essay Example

Introduction The Companies Bill, also known as the Company Law Reform Bill was vali d by Royal Assent on November of this year. Consisting of over One Thousand sections the Companies Act 2006 will be the largest single piece of legislation in the annals of the English Legal System. Containing comprehensive provisions for the regulations of companies, the Companies Bill 2006 not only replaces, but restated by and large, the pre-existing Companies Acts of 1985, 1989 and 2004. Among the many changes afoot as a result of the Companies Bill 2006, directors’ duties have been modified by Sections 171-188 of the 2006 Bill. 1 Alistair Darling, Secretary of State of the Department of Trade and Industry said that while most of the provisions of the Companies Act 2006 will be in force by October next year the entire Act will be in force by October of 2007.2 Overview While the Companies Bill 2006 introduces some new aspects to company law, it might have left the regulations of directors’ duty up to judicial interpretation and company law. The general impression is that the 2006 Bill does nothing much to improve on the director’s duties as enunciated under the provisions of the Companies Act 1985. The only key changes made by the Companies Bill 2006 in respect of director’s duties can be summarized as follows: 1- The Companies Bill codifies directors’ duties with a new requirement that directors actively promote the company’s success. 2- Directors have the option of filing with the companies registry, an address of service dispensing with the duty to file private addresses. 3- The Companies Bill 2006 tightens the Directors’ duties in respect of due diligence by broadening the rights of shareholders to ‘sue directors for negligence and other defaults and rights to bring derivative claims on behalf of the company in certain circumstances.’3 Directors’ Duties and liabilities under Common Law and Equitable Principles Under the provisions of the Companies Act 1985, together with principles of Common Law and Equity, directors have a fiduciary relationship with the company they serve. In their capacity as fiduciaries, directors have three primary duties in respect of the management of the company’s affairs. They are: 1- Directors have a bona fide duty to act in the best interests of the company and cannot act for any collateral interest. 2- If a director uses his position to make a personal profit he is accountable to the company and its members. 3- If a contract is entered into on behalf of the company by a director who has a conflict of interest, the company by its own volition can avoid the contract.4 In Re City Fire Equitable Insurance Co., Romer J added that in the course of exercising his duties as a director, the director was subject to a certain standard in law. That standard he went on to explain was the reasonable skill and care that was generally expected of a business man possessing the relevant skills and training.5 Moreover the common trend in the application of Common Law and Equitable principles was to impose the duty on the directors’ in respect of the company itself rather than in respect individual shareholders. In fact Section 309 of the Companies Act 1985 codified this proviso by requiring that directors owe a duty of care to act in the best interests of both the members and the employees of the company.6 Although this duty necessarily requires a subjective test, it is not altogether accurate. Lord Greene M.R. said that the duty is judged by reference to what a director might deem to be in the best interest of the company, rather than what a court might think.7 On the other hand assessing the best interests of the members of the company and its employees will require, to some extent at least an objective application of the test for how a reasonable business man might exercise his duties.8 The duty to act in good faith when conducting business on behalf of the company or managing its affairs implies that a director cannot use his position for any collateral purpose. 9 An act involving the issuing of shares for the purpose of circumventing the voting power of majority shareholders is an improper act which the court can set aside.10 Courts have been consistent in their interpretation of a director’s fiduciary duties to the company, particularly in incidents involving elements of insider dealing. For instance even when a director secured a contract for himself in circumstances where it was not possible that the company would eventually obtain the contract, the courts have held that act on the part of the director a breach of his duty.11 The rationale behind this strict interpretation of directors’ duties is to be found in an early case where the court held that it is not concerned with looking into the reasons or fairness behind the transaction.12 Moreover, it was of no moment whether or not there actually was a conflict of interest. The mere fact that one might reasonably have existed was sufficient.13 Implicit in this duty is the principle that directors are forbidden to make personal use of the company’s property or any knowledge of information derived as a result of their fiduciary relationship with the company. The nature of fiduciary duties requires an element of confidentiality and this principle is a necessary safeguard against keeping confidential information within the confines of the company.14 It also safeguards against a director reconverting company business elsewhere.15 Directors’ Duties and liabilities under The Companies Act 1985 Part X of the Companies Act 1985 defines the meaning of fair dealing by directors and makes provision for the duties of the director in relation to disclosure. By virtue of Section 317 of the 1985 Act a director is required to disclose any interest and to what extent he might have. Section 317 provides that ‘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’. 16 The disclosure of such information must be presented at a meeting of the board of directors of the company.17 This meeting must include the entire board and not some directors’ committee.18 Directors and those persons described by the 1985 Act as family members and others under the term ‘connected persons’19 are under a duty to disclose and obtain shareholder approval in advance of securing ‘substantial property transactions.’20 In the event these transactions are not disclosed they can be voided by the company.21 Moreover, companies are forbidden to advance funds to directors by way of loan.22 If the loan does not exceed sums in excess of Fine Thousand pounds sterling, the loan may be authorized.23 With the imposition of both statutory duties and duties at common law, it is not surprising that the Companies Bill 2006 seeks to codify directors’ duties. However, it can be argued that the 2006 Bill does no more than modify pre-existing statutory duties as described above by adding on a little more. It can be argued further that the Companies Bill 2006 fails where the 1985 Act by leaving a great majority of the law regulating directors’ duty to the courts. The Companies Bill 2006 The underlying principle of the 2006 Bill is to provide a uniform standard for directors to follow. The idea is dispense with the notion that directors could only learn what their duties were by reference to both statutory provisions and a voluminous stack of precedents contained in case law. But as it turns out, the provisions contained in Section 171 to 188 are too general and will necessarily involve judicial interpretation. Therefore directors will be in no better position than they were prior to the Companies Act 2006. The language contained in the Bill with regards to a director’s general duty, the Bill provides merely that ‘a director must act in accordance with the company’s constitution and only exercise powers for the purposes for which they are conferred.’24 While this codifies the common law principles it fails to provide any sort of guidelines. It becomes necessary to look to the common law for some guidance as to what might constitute or not constitute the purposes for which the ‘power is conferred.’ A director will not know by looking at the wording of the Act that the company’s constitution might not be limited to the company’s articles of association. It could include properly ratified motions. The 2006 Bill also makes provision for the director to promote the company’s success. It provides 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, and in doing so have regard (amongst other matters) to – 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 and others; 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 business conduct; and  f. the need to act fairly as between members of the company.’25 This provision differs from Section 309 of the Companies Act 1985 in that there was no statutory provision requiring directors to take into consideration the welfare of interest of the employees of the company. It also serves to widen the directors duties by making him duty bound to promote the success of the company. The 1985 Act and the common law only made provision for the director to act in good faith in the interest of the interest of the company. Be that as it may, the Bill makes no effort to define success or set guidelines for the meaning of success. Equally as vague are the factors that the director is required to take into consideration when promoting the company’s success. The Bill makes no provision for what weight is to be given to any of those factors. The Companies Bill 2006 provides that the director must ‘exercise independent judgment’.26 This provision is not unlike the 1985 Companies Act which ‘prohibits directors from fettering their future discretion unless they act in accordance with an agreement duly entered into by the company or as authorised by the company’s constitution.’ 27 The new legislation provides that ‘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 – 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.’28   This provision is not unlike the current provisions contained within the Insolvency Act by virtue of section 214.29 Section 214 concerns itself with insider trading. As noted earlier the common law dictates that both a subjective and an objective test is necessary for determining whether or not a director has discharged his duty in respect of insider trading. A director is further required to avoid a conflict of interest under the provisions of the Companies Bill as follows: ‘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.’30 Like the 1985 Act and the common law, this duty applies to property and matters of confidentiality. It makes no difference whether or not the company would or could avail itself of the situation. It also mirrors the common law in that it makes no difference if the conflict is real or not, just that it is possible. There is a minor difference in the application of the Companies Bill. ‘ The duty does not apply if the conflict arises in relation to a transaction or arrangement with the company .The new duty will not be breached if the situation cannot “reasonably be regarded as likely to give rise to a conflict of interest” or if the matter has been authorised by the independent directors (ie, those without a conflict of interest).’31 Under the 1985 Companies Act and the common law principles, directors can escape liability by securing the approval of the company’s members. He can also escape liability if the articles of association make provision for same. What the new clause contained in the Companies Bill 2006 dies is provide an escape mechanism by way of waiver on the part of the members of the company unless the company is a public company. In that case approval can only be waived if the articles of association make provision for such waiver. The Companies Bill 2006 goes on to provide that ‘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.’32 A third party is defined as a person of the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate.’33 Again this provision is merely a restatement of the conflict of interest policies enunciated by the both the provisions of the Companies Act 1985 and the common law precedents. Last but not least, the Companies Bill 2006 provides that ‘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.’ This is no different from Section 317 of the Companies Act 1985 which makes it mandatory for the director to declare his interest in contemplated transactions with the company. The only difference is that he will be required to declare both his interest and the extent of that interest. Conclusion The obvious intent of the Companies Bill 2006 is to place laws regulating companies in one place. The only reason for that is to make it easier for points of reference. However, Company Law has been evolving and developing for many years now and has become far too complex for a uniform code of construction. Rather than clarify the relevant law it has done nothing more than make it necessary for the judicial process to interpret the law and satisfactorily complete the job that the legislators set out to do. No doubt this will result in a mere restatement of common law principles and at the end of the day we will be left with little more than we already had. Directors will not be any wiser as to their duties. More than ever before, they will need to turn to lawyers for assistance with understanding their duties and liabilities Bibliography Aberdeen Railway Co. v. 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[1903] 2 Ch. 506 Re City Fire Equitable Insurance Co. Ltd. [1925] Ch 407 Re Smith & Fawcett Ltd. [1942] Ch 304 Sealy, Len, Directors Duties Revisited, Comp. Law. 2001, 22(3), 79-83 Sealy, The Director as Trustee, (1967) CLJ 83 Software (UK) Ltd v. Fassihi (2002) WL 31599771 The Companies Bill: The Impact on Directors. (July 2006) http://www.nortonrose.com/html_pubs/view.asp?id=4818&pp=1 Viewed December 5, 2006 Williams, Peter. DTI Consults of Director’s Liability. http://images.vnunet.com/v6_static/oracle/pdf/fd/march_complaw.pdf viewed December 5, 2006 Read More