The Companies Act 2006 and directors duties
Published : May 2008
There are seven duties to which all directors must adhere as part of the Companies Act. Martin Webster looks at what they mean for your board, and how far you should go in order to comply
It has been a long time in coming, but by October this year, 10 years after the reform process began, we will have in force for the first time a fully codified set of directors’ duties.
After more than a century of judgemade law on what a director can and cannot do, Parliament has set down in black and white a new code for all to follow.
The Companies Act 2006 lists seven duties which apply to all directors, from those in the board rooms of FTSE 100 companies to the husband and wife team running a business from home.
Everyone is covered, whether they are parent company directors or sit on the board of the lowliest subsidiary.
But not all of this is new law. Indeed, much of the commentary on these new duties has simply been a focus on old problems seen in a new light.
Most attention has been given to the new duty to promote the success of the company. The wording may be new, but in reality there is little difference here from the old duty for a director to act in the best interests of his company, taking into account all shareholders, both present and future.
What is new is the need for the board to consider what the government has dubbed “enlightened shareholder value”, or rather, the need for directors to look beyond the narrow interests of shareholders and to consider wider ‘stakeholder’ concerns.
So, when deciding what will promote their company’s success, directors are given six headings to consider, though it is clear the list is not meant to be exclusive:
• Likely long term consequences
• Interests of employees
• Relationships with suppliers, customers and others
• Impact on the community and the environment
• High standards of business conduct
• The need to act fairly between shareholders
Does that mean directors must sit with this checklist in front of them at every board meeting?
Can decisions only be made once you have ticked off each heading? When appointing a new finance director, do you need to consider his environmental impact? One hopes not. Commonsense should prevail and these factors will only come into play where they have some relevance to the decision to be made.
But what if they conflict? The correct long term decision may be to close a factory, but that may not be in the interests of the employees or the community. The answer is that there is no hierarchy and all these factors (where relevant) are meant to go into the mix which ultimately produces the best decision to promote the company’s success.
All you are asked to do is to “have regard” to these things, to think about them, but always in the knowledge that the overriding obligation is to arrive at the right decision for the company’s success.
If that means closing the factory or choosing the short term fix, rather than the long term view, then so be it. As long as you can demonstrate that you considered these issues before reaching your decision, you will have complied with the Act and your duties.
So companies and their boards are being asked to take the broader view, to see their company’s success in the light of these longer term considerations, not just the year end bottom line. Is this government meddling with the market economy, artificially skewing the decisionmaking process towards today’s fashionable concerns? Not a bit of it, they would retort: directors are simply being asked to follow what the best companies have been doing for many years in favouring long term strategic solutions over short term fixes.
But what is the risk with this new regime? What is the sanction a director faces if he is found to be in breach of his duties? The first point to realise is that the directors owe their duties to the company, not to individual shareholders. It is only the company that can complain of a breach and a complaint is only likely to be pursued if the company can show a loss as a consequence. Employees, trade unions and pressure groups have no ability to go after a director for a breach, and even shareholders can only complain where they convince a court the company is acting improperly in not pursuing a claim.
Nonetheless, it would be an unwise board member who ignores this or any other duty. It may be his fellow directors who will decide whether it really benefits the company to launch a claim against him, but boards and their priorities change.
The hapless Equitable Life board members who were sued for millions were targeted by a new board brought in to find someone to blame for their company’s huge losses. And companies get sold, with new owners putting their own nominees on the board who may look again at questionable decisions from the past.
No director can rely on his friends still being around to protect him from a claim for a previous breach of duty. So if the threat of a claim is a real one, how can directors protect themselves from liability? In some cases proper minutes which record the board’s reasoning for a particular decision and its consideration of any relevant factors will be enough; in others, a board paper may rehearse the arguments and show a proper evaluation of the pros and cons.
But avoid formulaic minutes which recite the Companies Act’s six factors without proper consideration: a judge is unlikely to be convinced that proper thought was given to a matter when all he can see is a tick box approach from a standard set of minutes.
Promoting their company’s success is not the only duty placed on board members by the new code of directors’ duties.
They must act within their powers and use them properly for their intended purpose. For example, directors have a general power to issue shares to raise capital; they can’t abuse that power and issue shares to ensure voting control stays in friendly hands. And directors have a duty to exercise independent judgement.
That means directors cannot excuse a bad decision by claiming they only acted as directed by a shareholder. A director owes shareholders the best decision, not blind obedience to their will.
This problem can be at its most stark in joint venture companies where each 50:50 shareholder may appoint a director in the full expectation that its appointee will vote to protect its own interests.
But the law says that directors are in post to protect the interests of all shareholders, not just the person who put them on the board. This conflict between the law on the one hand, and commercial reality on the other, again shows the need for careful thought when board minutes record key decisions.
How good do directors have to be? A seat on the board is one of the few jobs these days which still does not require a formal qualification. But all directors have a duty to exercise reasonable care, skill and diligence as they go about their duties.
This means you must perform to the standard which might reasonably be expected of a director in the same role at the same type of company; but in addition, you must perform to your own strengths. So a chartered accountant will be expected to have general accounting skills above and beyond those of the average company director.
All these duties have been codified into law since October 2007. The final piece of the jigsaw slots into place this October when three duties focusing on directors and conflicts of interest come into force. First, there is a general duty for a director to avoid a conflict of interest, whether an actual or potential conflict, direct or indirect. But any harm can be cured by the board authorising the conflict, though the directors must convince themselves it is in the company’s interests to give that authority.
Second, where a board is considering an issue in which a board member has an interest, he must formally declare that interest to his colleagues. Subject to anything else the company’s articles may say, once the interest is declared and the board is happy, there is nothing to stop the matter going through.
And finally, there is a bar on a director accepting any benefit from an outsider offered to him because of his role as a director.
This won’t apply if no real conflict of interest is likely to arise, but where a conflict exists, it cannot be waived through by the rest of the board. Accepting a supplier’s offer of Centre Court tickets for Wimbledon the day before a large tender is decided may be an obvious breach, but what price the normal run of corporate hospitality which for so long has oiled the wheels of commerce?
Martin Webster is a partner in the Corporate group at Pinsent Masons LLP, an international law firm with over 280 partners and more than 1 ,000 lawyers who provide a full range of corporate and commercial services. The firm ranks among the top 100 global law firms.
