30 Jan 2008
In the first of many articles, Carlyn Weale discusses the changes recently introduced to the duties of directors as a result of the Companies Act 2006.
Important changes were recently introduced to the duties of directors in company law as a result of the Companies Act 2006 (‘the Act’). These duties, which were previously governed by the common law, have now been codified in legislation. The general duties are defined in sections 171 – 177 of this new Act. Sections 171 - 174 came into recently on 1st October 2007 and are outlined below.
Directors should be aware of these duties in exercising their roles and therefore, we have summarised below, the main effect, if any, of these provisions.
Section 175, which refers to conflicts of interest, does not come into force until 1st October 2008 and therefore is not outlined here. When implemented, this section will introduce significant changes to the law on conflicts of interest. Until such time as it comes into force, directors remain subject to the existing common laws in this area.
Section 176 refers to a director’s duty not to accept benefits from third parties and section 177 regarding directors’ duty to declare an interest in a proposed transaction or arrangement, also do not come into force until 1st October 2008.
The scope and nature of the duties in the new Act continue to be duties owed by a director to the company and are based on the existing common law and equitable principles. They will continue to be interpreted and applied in the same way as the existing law.
You will note that these new provisions merely codify the existing law and should have little impact on the way directors currently exercise their duties. However, some changes have been made, in particular relating to directors’ duty to act in the interests of the company.
The main changes are highlighted below which directors will be expected to comply with in the carrying out of their everyday roles.
Directors are required to act in accordance with their company’s constitution and can only exercise those powers for the purposes for which the powers are conferred. This provision merely reflects the existing law in this area.
This section effectively replaces the existing duty of a director to act bona fide (in good faith) in the interests of the company as whole and bears the most significant change to directors’ duties by the Act.
Directors now must act in way that they consider, in good faith, would be most likely to promote the success of the company for the benefits of its members (shareholders) as a whole. In doing so, they must have regard to (amongst other things), the factors described below. Directors will recognise some of the factors as reflecting their existing obligations but with additional elements including the company’s consideration for the environment.
However, the ‘new’ provisions are matters that any informed and conscientious director should already have regard to and therefore the change in law should not radically alter their day to day role.
This new section states that directors must have regard to the following:
If a conflict arises between the above factors, then it is a matter for the directors to resolve such conflicts using their business judgement and acting in good faith, exercising their skill, care and diligence.
What ‘success’ means for these purposes is for the members (shareholders) to determine. They will set the company’s objectives and then it is for the directors to promote the company’s success in accordance with those objectives, although in many companies the objective may not go beyond achieving the commercial success of the company. However, if a company is set up for a specific purpose, the success will be measured against the objectives in the context of the purpose of the company.
These duties are subject to any other laws which require directors, in certain circumstances, to consider acting in the interests of the creditors of the company (i.e., in insolvency).
There is no legal requirement to maintain records as evidence that directors have given consideration to the factors outlined above. How matters are recorded will be a matter for individual companies to decide, although thorough notes should be taken as a matter of good practice and particularly, as the new Act also brings with it the right for members to bring derivative claims on behalf of the company against a director for negligence or breach of duty. Therefore, it is advisable to produce written notes, particularly when controversial company decisions have been made. This written evidence will serve to illustrate that the company has considered these factors. Furthermore, it will help to demonstrate the directors’ exercise of reasonable care and skill (below).
It is anticipated that the new requirement to provide a business review as part of the director’s report (with the exception of small companies, (sections 417(1), 417(2)), will also help members of the company to assess how the directors have complied and performed under s.172.
Directors have a duty to exercise independent judgment (subject to changes made to the company’s constitution).
This confirms the current legal position. Directors must exercise reasonable care, skill and diligence. This assessment is by the standards exercised by a reasonably diligent person with the general knowledge, skill and experience reasonably expected of a person carrying out the functions carried out by the director, in relation to the company, and also by the general knowledge, skill and experience that the director possesses.
We hope that this information will assist you in the continued success of your business. Carlyn is a trainee solicitor in Rowlands Commercial Department. You can read her profile here.
You can download this article in PDF format for your future reference.