Directors - trying times ahead?
Article Date: Apr 17 2007
The new statutory statement of directors' duties is generally considered to be one of the most controversial aspects of the long-awaited Companies Act 2006. Richard Baxter (Partner) and Nicola Rüütel (Senior Associate, pictured) of law firm Stevens & Bolton LLP highlight what to look out for.
It had been anticipated that the new statutory statement of directors' duties would be implemented some time in 2008, so many were taken by surprise when the Government recently announced that the majority of them will take effect on 1 October this year.
Currently, there are no such duties set out in legislation. Directors' general duties are based in common law (ie as developed by the courts through individual cases), and include the requirement to act in good faith in the best interests of the company as a whole, to avoid conflicts, and to exercise skill and care.
The new duties imposed on a director are:
- to act in accordance with the company’s constitution and exercise powers only for the purposes for which they are conferred;
- to promote the success of the company for the benefit of its members as a whole;
- to exercise independent judgement;
- to exercise reasonable care, skill and diligence;to avoid conflicts of interest;
- not to accept benefits from third parties; and
- to declare an interest in a proposed transaction or arrangement with the company.
Promoting the success of the company
It is the new duty to promote the success of the company that has proved most controversial. It replaces the common law duty to act in good faith in the best interests of the company, but is couched in very different language, raising questions as to what it will entail in practice.
In particular, this duty specifies a non-exhaustive list of elements (so-called "enlightened shareholder value" factors) to which a director must have regard. These are:
- the likely consequences of any decision in the long term;
- the interests of the company's employees;
- 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 environment;
- the desirability of the company to maintain a reputation for high standards of business conduct; and
- the need to act fairly as between members of the company.
Directors must consider all these factors in each case. There is no discretion to disregard any of them and it is not clear how they should be prioritised in the event of a conflict.
The stakes are raised by the fact that it may also be easier for a shareholder, acting on the company's behalf, to sue a director for breach of duty. Currently, such a claim (called a derivative action) is generally only possible where there is a "fraud on the minority". The new Act allows a derivative action to be mounted on grounds of any negligence, default or breach of duty by a director.
While the claims process incorporates procedures designed to filter out groundless allegations, there are fears that, coupled with the new duties, directors will be exposed to an increased risk of claims from disgruntled shareholders. Notably there are concerns that activist groups might use this procedure as a tactical weapon against listed public company directors.
Directors should also be aware that, under the new Act, their ability to obtain the members' ratification of any breach may be curtailed. Currently, there is generally nothing preventing a director who is also a shareholder from voting to ratify his own breach.
Disregarded votes
Moreover, a director who is a majority shareholder can obtain such ratification acting alone. Under the new Act, the votes of the director in breach (and any member connected with that director) must be disregarded. This restriction is particularly likely to affect owner-managed companies where, for the first time, the board may be at the mercy of minority shareholders to secure a ratification.
It has been suggested that these increased risks will protract decision-making as directors seek to evidence compliance with their duties. In particular, there are fears that board minutes will become longer with perhaps a "tick-box" approach taken to the "enlightened shareholder value" factors.
However, the Government is of the view that the decision-making process should not materially change and intends to publish non-binding guidance along these lines. Meanwhile, the GC100 Group (comprising senior legal officers of more than 70 FTSE 100 companies) has taken an early lead and published its views. In particular, it considers that there is no need for a significant change in approach to the taking of board minutes.
Conflicts of interest
Most of the other new duties are similar to existing common law duties and so should not entail major changes in practice. There is, however, a change in approach to conflicts of interests. Importantly, for the first time, independent directors can be enabled to authorise certain types of conflicts, rather than having to seek approval from shareholders, either expressly or through provisions in the articles of association.
Directors will still be required to disclose any interest in a transaction with the company but are now also obliged to disclose matters of which they "ought reasonably to be aware". The new conflict rules have also raised concern, insofar as they are expressed to cover "potential conflicts". It is anticipated that this might cause particular difficulties for directors who sit on more than one board.
Many companies' articles already permit certain types of conflicts. They will continue to have effect, but companies wishing to take full advantage of the new provisions are likely to need to amend their articles. The new conflicts rules, unlike the other duties, come into force in October 2008.
Get prepared!
Ultimately, it remains to be seen how the courts will apply the new law. In the meantime, directors should familiarise themselves with their new duties and ensure they are properly briefed. It is also worthwhile to review D&O insurance policies and consider, if not already in place, whether companies should grant indemnities to their directors, to the extent that this is allowed under company law.
For further information please contact Richard or Nicola at Richard.baxter@stevens-bolton.co.uk / Nicola.ruutel@stevens-bolton.co.uk
