The Companies Act 2006 (“2006 Act“) codified directors’ duties for the first time. After a phased implementation timetable, all seven new statutory duties are now in force. Previously it was UK common law that prescribed a general fiduciary duty to act at all times in the best interests of a company.
The new duties apply to all companies in England & Wales, whether incorporated under the 2006 Act or otherwise. The duties are owed to the company and it follows that only the company will be able to enforce them. The duties are not owed to individual shareholders although shareholders will be able to enforce duties owed to the company, by bringing a derivative action.
This article examines each of the duties in turn and also provides some practical examples of when a director may find himself faced with this duties in the day to day running of their company.
(1) To act within the company’s constitution and to only exercise powers for a proper purpose
As a director you should exercise your powers in accordance with the company’s constitutional documents and also for their proper purpose. As memorandum of association are being phased out by the 2006 Act, constitutional documents mainly means articles of association. However, the duty also extends to any instructions given to the board by shareholders say in a shareholders’ agreement.
A company’s constitution will gives directors certain powers which enable them to manage the business. However, there may be limits on these power to help protect shareholders.
An example of when this duty may come into play is a requirement that two directors are present at a board meeting in order for the decisions of the meeting to be valid and the meeting to be “quorate”. This will help to prevent one director from making unilateral decisions that could be detrimental to the company and its shareholders.
(2) To exercise independent judgment
You must exercise your own judgement on matters you are required to consider for the benefit of the company as a whole. A director must not use his or her position to further the interests of a single shareholder or a particular group of shareholders.
The duty to exercise independent judgment does not prevent a director from taking professional advice or from using others as a “soundboard”. The director must consider the advice he is given and reach an independent conclusion himself, having regard to the interests of the company as a whole.
As an example, often, a significant shareholder will have a right to appoint a director to the board of a company. The director will usually report to his appointer and inform the other directors of his appointers wishes.
It is however important that this nominee director, also acts in the interests of the company as a whole rather than merely in his appointer’s interests.
(3) To exercise reasonable care, skill and diligence
A director must use reasonable care, skill and diligence when performing his duties. There are two tests for establishing whether a director has exercised reasonable care, skill and diligence.
Firstly, a director must satisfy the “objective test”, that he has the knowledge, skill and experience that would reasonably be expected of a director.
Secondly, a director must show he has used the knowledge, skill and experience that he actually posses. Where a director posses a special skill or discipline, the standard expected of that director in relation to his special skill or discipline will be higher.
For example, a director with accounting experience and accounting qualifications, would be expected to exercise his duties with a higher level of skill when considering the finances of the company than other directors with no such experience or qualifications.
(4) Not to accept benefits from third parties
Directors should not accept benefits from third parties in connection with the performance of their duties. This requirement is not infringed when accepting benefits which cannot reasonably be regarded as likely to give rise to a conflict of interest.
The best advice for directors who are unsure whether they are able to accept a benefit is to discuss this with the other members of the board.
There is a fine line to be drawn between what is and what is not an acceptable gift or perk. Each situation will depend on its own facts. For example, it is normally considered acceptable for a director to accept an invitation to lunch, paid for by a third party. On the other hand, if the lunch is part of an all expense paid week in Paris (paid for by a supplier chasing a new contract), a director is opening himself up to allegations of breach of this new duty.
(5) To declare interests in proposed transactions or arrangements with the company
Directors must declare their interests in proposed transactions or arrangements. Usually, this will involve a director making a declaration at the commencement of the board meeting where the proposed transaction or arrangement is to be discussed. Director’s declarations should be reflected in the board minutes.
The articles of association of the company will usually state whether directors who are interested in a proposed transaction or arrangement will be able to count towards the quorum of the meeting and to vote on the proposed transactions.
As an example, directors are interested in their own service contract and remuneration arrangements. Most directors would be well advised not to vote in meetings to discuss their own remuneration (even where they may be able to do so under the terms of the company’s constitution).
(6) To act in good faith to promote the success of the company
Directors must now act in the way they consider, 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 the following factors:
(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.
The factors listed above are aimed to encourage greater focus on responsible business behaviour and the company’s relationships over the long term with customers, suppliers, employees and the wider community.
The factors should be treated as part of the overall commercial decision process and are not exhaustive.
An example may be when a company’s board has to decide whether to outsource the production process to an overseas factory.
On the plus side it could improve the long term sustainability of the business and reduce damage to the local environment.
On the minus side, it could reduce employment opportunities and have a negative impact on the local community.
(7) to avoid conflicts of interest
The 2006 Act creates a new, positive duty to avoid unauthorised conflicts of interest. The Act also allows conflicts of interest to be authorised by directors instead of by shareholders.
The scope of the section is very wide, covering not only actual conflicts of interest, but possible conflicts of interest as well.
For example a director is in office with Company A which has a supply contract with Company B. Every year there is a negotiation between them on the terms of the supply. Before the new duty, a person could lawfully be a director of both Company A and Company B (albeit after disclosing their interest and “sitting out” on all deliberations).
Under the new duty, “sitting out” will not be sufficient. It will not be possible to remain as a director of both companies without obtaining proper authorisations from the boards of both companies.
Concerns have been expressed that the 2006 Act increases bureaucracy, makes the decision making process more cumbersome and potentially increases the liability of directors.
It is still early days to establish whether, as a result of legislative codification, companies are choosing to evidence in writing their thought processes with regard to factors influencing their thinking. This could expose directors to a greater risk of litigation especially in light of the new derivative action.
Recommended actions include:
• companies ensuring that all directors are aware of their duties under the 2006 Act;
• consider preparing board papers in advance of board meetings ensuring that each of the relevant duties (and factors to promote success) are set out;
• in board meetings, specifically record that there was due consideration of duties and success factors (without setting out all the detailed arguments put forward by individual directors).
Fox Williams’ corporate team are well placed to assist companies with corporate governance issues. We are also able to assist shareholders who consider that the directors of a company may have breached their duties to the company. If you would like to discuss this or any other matter then please contact either Paul Taylor on +44 (0) 20 7614 2512, firstname.lastname@example.org or James Daughtrey on +44 (0) 20 7614 2597, email@example.com