Company Law - Directors II (Part 2)

The Companies Act 2006 reforms to directors’ duties

Sections 170-177 Companies Act 2006 have to a large extent codified the case law set out above.

s.170(3): “The general duties are based on certain common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director”.

s.170(4): “The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.”

The duties include:

s.171: Duty to act within powers

A director of a company must:

a) act in accordance with the company’s constitution, and

b) only exercise powers for the purposes for which they are conferred.

s.172: Duty to promote the success of the company

(1) 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.

s.173: Duty to exercise independent judgment

(1) A director of a company must exercise independent judgment.

(2) This duty is not infringed by his acting

a) in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or

b) in a way authorised by the company’s constitution.

s.174: Duty to exercise reasonable care, skill and diligence

(1) A director of a company must exercise reasonable care, skill and diligence.

(2) 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.

a.175: Duty to avoid conflicts of interest

(1) A director of a company 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.

s.176: Duty not to accept benefits from third parties

(1) A director of a company must not accept a benefit from a third party conferred by reason of

a) his being a director, or

b) his doing (or not doing) anything as director.

s.177: Duty to declare interest in proposed transaction or arrangement

(1) If a director of a company 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.

The full effect of these new codified duties is yet to be fully understood, but s.170 (4) expressly requires the rules to be applied in accordance with previous case law. 

See further Companies Act 2006.

Company Law - Diretors II (Part 1)

Introduction – fiduciary duties

In addition to the common law duty of care and skill set out in Session 6, directors are in a position of trust and confidence, and as a result owe fiduciary duties to the company (as oppose to individual shareholders or creditors – Percival v Wright, although this has often been said to equate to the “interests of the general body of shareholders”.

Duty to act bona fide in the interests of the company as a whole

This is often considered to be the primary duty owed, and a breach may only be subsequently ratified by the members (see later) if this primary duty has not been breached.

The director must conduct the business affairs of the company for the benefit of the company as a whole and not for some other collateral purpose.

Charterbridge Corporation Ltd v Lloyds Bank

“The proper test, I think … must be whether an intelligent and honest man in the position of the director concerned, could, in the whole of the existing circumstances, have reasonably believed that the transaction was for the benefit of the company.”

This is difficult to disprove, but is possible:

Re W&M Roith

Facts: A director, who was in very poor health, entered into a new service agreement which was to include a very generous pension for his wife if he were to die. He failed to disclose his poor health, and died soon afterwards.

Held: The director had acted contrary to the interests of the company – his sole intention had been to benefit his wife.

Duty to act for proper purposes/not for collateral purposes

“If a director chooses to participate in the management of a company and exercises powers on its behalf, he owes a duty to act bona fide in the interests of the company. He must exercise the power solely for the purpose for which it was conferred. To exercise the power for another purpose is a breach of his fiduciary duty.”

See Howard Smith v Ampol Petroleum.

Trusteeship of company assets

Directors are answerable as trustees for any misapplication of the company’s assets in which they participated and knew or ought to have known of the misapplication.

See Selangor United Rubber Estates v Cradock.

No conflict of interest

Aberdeen Railway v Blaikie Bros

“A rule of universal application is that no-one having… duties to discharge shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which may possibly conflict, with the interests of those whom he is bound to protect”.

This is a strict duty, and even extends to where there is the possibility of a conflict:

“The reasonable man looking at the relevant facts and circumstances of the particular case would think that there was a real sensible possibility of conflict”.

No secret profits

Following on from the ‘no conflict’ rule (and indeed some textbooks merge the two categories) is the rule against taking a secret profit.

Cook v Deeks
Facts: The directors of a company became aware of a lucrative contract that was about to be offered to the company they worked for. Instead of obtaining it for the company they worked for, they instead resigned and set up their own rival company, winning the contract.

Held: They had acted in breach of their duty, and so had to account for their profits to the original company.

IDC v Cooley

Facts: Mr Cooley had been employed as a director to develop contacts and businesses. He was approached by a third party who did not wish to deal with his employer, but did wish to employ him personally. Mr Cooley then resigned his post due to ‘ill health’ and began working for the third party.

Held: He had improperly taken advantage of information that he had gained in his capacity as director, and had to account for that profit to his original employer.

Although the above two cases involve instances of mala fides (bad faith), the duty is equally applicable to cases of bona fides (good faith):

Regal (Hastings) v Gulliver (House of Lords)

Facts: The company Regal owned a cinema, and wished to obtain a further two cinemas before selling all three as a package. A subsidiary company was formed to obtain the two new cinemas, but the company was unable to raise sufficient finance. To save the deal, the directors put in their own money.

Both companies were eventually sold at a profit for both the parent company and the directors.

The buyers of the companies argued that the directors had exploited their position, and should account for their profits.

Held: “The rule of equity which insists on those, who by use of a fiduciary position make a profit, being liable to account for that profit in no way depends on fraud or absence of bona fides; or upon such questions and considerations as whether the profit would or should otherwise have gone to the plaintiff, or whether the profiteer was under a duty to obtain the source of the profit for 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… been made. The profiteer, however honest and well intentioned, cannot escape the risk of being called to account”.

The directors had to account for their profits to the new owners.

This strict approach is arguably because the judiciary fears that any relaxation could result in directors disregarding the company’s interests in favour of themselves. 

See also IDC v Cooley.

Company Law - Directors I (Part 3)

Statutory power of removal – s.303 Companies Act 1985 s.168 Companies Act 2006

s.168: “A company may by ordinary resolution at a meeting remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him.”

The procedure is that any member who wishes to propose a resolution to remove a director must give the company “special notice” by leaving notice at the registered office at least 28 days before the general meeting. The director whose removal is proposed has the right to make written representations to the members and he can also speak at the meeting, whether or not he is a member.

It should be noted that this power cannot be varied or abrogated by the articles or any other agreement. Therefore, members will always have the right to call a meeting to remove a director, and providing they pass an ordinary resolution in support, will be entitled to remove that director.

However, as mentioned in Session 2, it is possible to avoid the effects of s.303 Companies Act 1985/s.168 Companies Act 2006. The articles cannot include a provision entitling the member to be director because:

(a) this would be an ‘outsider’ right and therefore unenforceable under Hickman; and

(b) would also be void for abrogating the members’ right of removal under s.303 Companies Act 1985/s.169 Companies Act 2006.

Despite this, it is possible to give the member weighted voting. Essentially, this is a clause in the articles which provides that, in the event of an s.303/s.168 resolution, that member would have (for example) 3 votes per share. This figure will be calculated so as to prevent the other members from passing an ordinary resolution (although obviously this will only work where the director holds shares entitling him or her to vote at the meeting). The reason this works is because:

(a) the right to vote is an ‘insider’ right and therefore passes the Hickman filter; and

(b) it does not prevent the other members from exercising their rights under s.303/s.168. They can still call the meeting, and they can still remove the director if they pass the resolution. The clause simply prevents them from having enough votes to pass the resolution.

On a practical basis, where the director has a service contract it is possible that his removal may amount to a breach of his contract with the company. It could therefore be very expensive for the company to get rid of him, particularly where the director has a long fixed-term contract.

Power of removal in the articles

The articles will normally contain conditions upon which a director will normally vacate office or upon which they may be removed. For example, art.81 Table A requires that a director automatically vacate office if, inter alia, he becomes bankrupt, suffers from a mental disorder or is absent without permission for more than 6 months.

Directors’ common law duty of care and skill 
 
A major element of a director’s duty is the common law duty of care and skill. The traditional approach can be found in:

Re City Equitable Fire Insurance Co

A director:

- need not exhibit a greater skill than may be expected from a person with knowledge and experience akin to that of the director;

- is not bound to give continuous attention to the affairs of the company;

- is justified in trusting a delegate to perform the duties in an honest manner unless there are suspicious circumstances.

This subjective standard was pitched at a rather low level, and over time there has been a marked shift towards greater accountability:

Presently, it is more akin to the standard set down in s.214 Insolvency Act 1986 (wrongful trading). Essentially, any greater degree of skill than could be expected from a reasonable, diligent person imputed with the skill and experience that may be reasonably be expected of the holder of the position in question.

Re Barings (No 5)

“Directors have, both collectively and individually, a continuing duty to acquire and maintain sufficient knowledge and understanding of the company’s business to enable them to properly discharge their duties as directors”.

See also Re D’Jan of London.

Company Law - Directors I (Part 2)

The operation of the board of directors

On many issues, this is the final decision-making body which exercises the company’s powers and which enters into transactions on the company’s behalf. However, as mentioned above more important decisions will be decided at a shareholders’ meeting.

Procedure

The procedure is set out in the articles, particularly arts. 88 – 98, Table A. Resolutions proposed at board meetings will be decided by a simple majority (i.e. 50% + 1 vote)

The articles normally give the directors power to appoint one of themselves as chairman (art.91 Table A). The chairman’s main task is to take charge at board and general meetings, and will probably have a casting vote in the event that the votes for and against a resolution are equal (provided the articles permit this). Arts. 88 & 50 Table A give the chairman the casting vote at board and general meetings respectively. Apart from this the chairman has no special powers.

Retirement and removal of directors

Retirement by rotation

Art.73 Table A requires directors to retire by rotation. All the directors will be required to retire from office at the first AGM, but will automatically be re-appointed unless the members pass a resolution to the contrary. At each subsequent AGM one third of the directors must retire by rotation and be subject to re-election.

Executive directors are exempt from the requirement to retire by rotation. The other directors must take it in turns to one of the third to retire. Retirement by rotation is an important safeguard to members as it enables them to consider the removal of a director from office without putting the matter on the agenda for the general meeting.

The articles may exclude retirement by rotation particularly in small companies where the members and directors are largely the same people.

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Company Law - Directors I (Part 1)

The role of the director

Although the company is a separate legal personality, it still requires agents to act on its behalf. As was mentioned in Session 4, members of a company often do not wish to be involved in the day-to-day management. Therefore, this power is delegated to the board of directors.

Directors are in a position of trust and confidence, and wield considerable power. It is necessary to ensure that this power is not abused and so numerous safeguards are build into the company legislation and the articles, restricting and controlling the directors.

The appointment of directors

The first directors will be those persons named as directors on the Form 10. They will automatically become directors on incorporation of the company.

The procedure for appointing subsequent directors will be laid down in the articles of association of the company. Directors can either be appointed by an ordinary resolution of the members in general meeting, or by a resolution of the board of directors.

Where appointment is made by the members, details of the procedure to be followed are set out in arts. 76-79 Table A. This sets out the specific information which must be given to the company and to the members within certain time limits.

The procedure for appointment of a new director by the existing board is simpler. However, under art.79 Table A the newly appointed director holds office only until the next AGM, at which stage he must be re-appointed by the members in order to remain in office.

Once a director has been appointed, he must sign a form (Form 288a) indicating his consent to act as a director.
 

Number of directors

A private company must have at least one and a public company must have at least two. Under art.64 Table A, there must be at least two directors. If a different minimum number is required (for example, if there is only going to be one director) then a special article should be included to this effect on formation of the company or the existing articles should be amended accordingly.

Managing directors

The managing director is appointed by the other directors to take charge of the running of the company on a daily basis. The power to remove the managing director lies with the other directors.

Executive and non-executive directors

Generally, an executive director is an employee and is involved in the day-to-day management of the company. A non-executive director is not an employee and merely attends board meetings to provide general guidance.

Remuneration of directors

A director may receive payments for services given in the office of director. Art.82 Table A states that a director is entitled to such remuneration as the members decide by ordinary resolution in general meeting. See also the case of Guinness v Saunders.

A director may also receive payment under a contract of service, and this will invariably be the case with executive directors. s.318 Companies Act 1985 states that the director’s contract of service must be available for inspection by the members in general meeting.

Where the contract is for a term in excess of five years, the contract must first be approved by an ordinary resolution of the company in general meeting (s.319 Companies Act 1985).

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Company Law - Management & Corporate Governance (Part 3)

The Greenbury Committee report

This report stemmed from criticism of the high levels of directors’ remuneration, published in 1995. It contained a new code of best practice and was aimed at directors of listed companies. This included, for example:

- The interests of both shareholders and directors should be considered by the remuneration committee when determining the level of directors’ remuneration;

- Shareholders should approve long-term incentive schemes.

The recommendations were incorporated into the London Stock Exchange’s listing rules in 1995.

The Hampel Committee report

This committee was established to build upon the Cadbury and Greenbury reports, reviewing the role of both executive and non-executive directors.

It recommended a set of principles and code of good practice embracing its own work as well as that of the Cadbury and Greenbury committees. The London Stock Exchange adopted this ‘Combined Code’ in 1998.

The Turnbull report 
 
The publication of this report in 1999 sought to ensure that directors of a listed company had a system of risk management for identifying and managing key business risks. Directors should consider the following:

- Board evaluation of the likelihood of risk and the categories of risk facing the company;

- Effective safeguards and internal controls to prevent or control risks;

- Transparency of internal controls, incorporating an annual assessment of risk.

The Higgs report

Following the Enron scandal in the US, the UK reviewed its corporate governance practice in an attempt to maintain a competitive edge in retaining confidence in its markets.

The Higgs report wanted to ensure that UK boards have an overriding responsibility to set the company’s standards, values and obligations. The report suggested that non-executive directors, as independent guardians of the interests of investors, should challenge and contribute to the development of corporate strategy by scrutinising the performance of executive directors and management. It recommended that 50% of the board should be made up of independent non-executive directors.

The Revised Combined Code on Corporate Governance 2003 
 
This adopted the recommendations of the Higgs report, as well as adding to the previous Combined Code and Turnbull report.

Companies Act 2006 
 
Section 172 Companies Act 2006 has introduced, as one of the directors’ duties, a requirement to promote the success of the company:

s.172: Duty to promote the success of the company

(1) 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.

It is as yet unclear as to whether this will be effective in practice, and there remain questions as to how a stakeholder other than shareholder can enforce such a duty. 
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Company Law - Management & Corporate Governance (Part 2)

Corporate Social Responsibility in UK

The development of corporate social responsibility in the UK has been slow. This is in large part due to the case of:

Hutton v West Cork Railway Company

Facts: A company was in the process of winding up. At a general meeting of shareholders, a resolution was passed to compensate the corporate officers for their loss of employment, and to pay £1,500 in remuneration for past services of the directors, who had never been paid. This payment was not based on any legal claim that the directors had to payment; rather, it was simply a gratuity.

Held: Profit maximisation was the only permissible goal of a company. To make such payments would be ultra vires.

The result of this case was that it was not permissible to give workers anything unless it was good for the shareholders through an increase in efficiency and therefore profit. For a long period, many developments in English company law were involved with finding an alternative mechanism of achieving corporate social responsibility.

Over time, the ultra vires doctrine was eroded by both case law and statute, and during the 1980’s the UK saw a significant increase in corporate giving to the wider community.

In particular, the Companies Acts of 1980 and 1985 required the directors to have regard to the interests of their employees as well as their members. However, although a step in the right direction, employees faced considerable technical difficulties in achieving any legal remedy.

Europe 
 
Influence also came from the EU. The 1992 Maastricht Treaty on European Union and its annexed Protocol and Agreement on Social Policy resulted in Directives for the information and consultation of employees. Companies of more than 1,000 workers with more than 150 in at least two member states had to establish company-wide information and consultation committees for their employees.

The Cadbury Committee report

This committee was set up by the Financial Reporting Council, the London Stock Exchange and the accounting professions to consider financial aspects of corporate governance. It recommended a code of pest practice, which boards of listed companies would have to abide by as a condition of listing. Coming into force in 1993, it considered the following practices important:

- The appointment of independent non-executive directors to the boards of listed companies;

- Appointments to the post of executive director were to be vetted by a nomination committee, the appointees of which were to be taken mainly from the non-executive directors;

- The role of Chief Executive and Chairman should not be held by the same person to maintain independence;

- Service contracts of more than three years should not be made to executive directors unless approved by the general meeting;

- Salaries of executive directors should be determined by a remuneration committee comprising mostly non-executive directors;

- An audit committee should oversee the company’s financial matters, comprising mostly of non-executive directors.

Each listed company had to include a statement in its annual report acknowledging compliance, or justifying any non-compliance with the code. 
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