Directors have powers to take majority business decisions on behalf of the companies. As such, it comes as no surprise that various duties are imposed on them to ensure that the companies' interests are protected. Under the old rules, directors' have duties including the duty to act in good faith to the best interest of the company; the duty to avoid conflicts of interest; the duty not to profit from their offices, and the duty of care and skill.
The government considered that these principles lacked certainty and were not easily accessible. The government believes that codification of directors' duties will make the law in these areas more consistent, certain and accessible. The Companies Act 2006, which started to take effect this year and which will be fully in place by October 2008, codifies directors' duties into a statutory statement of seven general duties. The first of the four general duties - below - take effect from 1 October 2007.
The government hopes the Act could bring benefits of £30 million to £105 million per year as it is hoped that directors will no longer, or be less likely to, need to take advice on these areas.
THE SEVEN GENERAL DUTIES SET OUT IN THE ACT ARE:
1. Duty to act within their powers
This deals with the common law rules that state that directors should exercise their powers under the terms that were granted for a proper purpose. A director's powers are normally derived from the company's constitution, that is, its memorandum and articles of association. The scope of a director's powers may also be affected by the terms of his service contract and other contractual terms such as may be contained in a shareholders' agreement.
2. Duty to promote the success of the company
The Act imposes a duty to act in the way a director considers, in good faith, would be most likely to promote the success of the company. Although this duty is still owed to the members as a whole, when exercising this duty the director is required to bear in mind a non-exhaustive list of factors including the long term consequence of the decision as well as the interests of the employees; the relationships with suppliers and customers; and the impact of the decision on community and environment; the desirability of maintaining a reputation for high standards of business conduct; and the need to act fairly as between members of the company.
It remains to be seen how in practice a director is to balance all of these some times conflicting factors in his decisions. For example, an environmental consideration might not always be consistent with shareholders' interests.
Given the uncertainty in this area, it is important that detailed minutes are taken when taking decisions.
3. Duty to exercise independent judgement
This is a positive duty on a director of a company to exercise independent judgement. Here a director must first exercise judgement and secondly, he must exercise the judgement independently. This rule would affects 'sleeping directors' who play no active role in the management and leave decisions to others. This duty is not infringed if a director acts in accordance with an agreement that was duly entered into by the company. The government has also confirmed that a director will not be in breach of this duty if he exercises his own judgment in deciding whether to follow someone else's judgment on a matter.
4. Duty to exercise reasonable care, skill and diligence
This duty describes the degree of 'care, skill and diligence' expected from a director. That is the care, skill, 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 who is a director of that company; and the general knowledge, skill and experience that the director actually has.
This is the same dual test imposed under the Insolvency Act 1986 in the context of a director's wrongful trading. The first element of the test sets out a minimum objective standard expected of any director. The subjective test requires a director to carry out his duty with the general knowledge, skill and diligence he in fact possess. Therefore, a director who has more experience, knowledge and skill will have a higher threshold in discharging this duty.
5. Duty to avoid conflicts of interest
The conflicts of interest provisions previously contained in the Companies Act 1985 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.
This duty applies to a transaction between a director and a third party, such as the exploitation of any property, information, opportunity. The duty does not extend to a transaction between a director and his own company - that's Rule 7.
The Act makes it easier for directors to enter into transactions with third parties when directors' interests conflict with company's interests. Previously, shareholders' approval was required to enable directors to enter into transactions with third parties. Now, such transactions can be authorised by the non-conflicting directors on the board provided that certain requirements are complied with including who can participate and vote on such authorisation.
6. Duty not to accept benefits from third parties
This restates 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.
Benefits cover both monetary and non monetary including for example, non executive directorship and even corporate entertainment. However, a director will not be in breach of this duty if the acceptance of such benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.
7. Duty to declare an interest in proposed transaction or arrangement with the company
This 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 by requiring a director to declare the nature and the extent of the interest to the other directors. The disclosure must be made where a director 'ought reasonably to be aware of' the conflicting interest. Disclosure also extends to a person connected with the director, for example, his wife and children.
Disclosure is not required where the interest isn't likely to give rise to a conflict of interest, or if other directors are already aware of, or 'ought reasonably to be aware', of the director's interest.
In the long term, it is believed that these changes will bring benefits to companies. But some argue in the short term that it may well create confusing and uncertainty in some areas. It may well result in more claims being brought against directors in the short term as dissatisfied (minority) shareholders armed with a new statutory right of 'derivative actions' could bring test cases: A derivative right is a right of a member of a company to bring a claim on behalf of the company against a director in respect of a director's breach of duty or negligence.
Directors should continue to seek advice if they unsure about their position and should consider overhauling their decision making processes and companies' constitutions. Without changes, directors cannot minimise the risks of claims and other potential legal challenges or take advantage of the benefits introduced by the Act.
Christopher Sykes and Peijun Xia
Christopher Sykes is a Senior Partner; Peijun Xia is a Commercial Solicitor at Sykes Anderson LLP.
Email: chris.sykes@sykesanderson.com;
peijun.xia@sykesanderson.com
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