Учебный год 22-23 / Critical Company Law

184 Critical company law

in the interests of creditors, such as when the company is in financial di culties.89

Under s 173 a director has a duty to exercise independent judgment which, under subsection (2), is not infringed by acting in accordance with an agreement entered into by the company which restricts that judgment or by acting in accordance with the company’s constitution.90 In understanding the first part of this section reference may be made to cases such as Dawson International plc v Coats Paton plc.91 In this case Dawson International plc (Dawson) alleged that there had been a number of meetings between its directors and the directors of Coats Paton plc to discuss the terms of a takeover of Coats. Both made a joint press announcement of the terms of the bid. Dawson claimed that Coats had also agreed not to co-operate with a rival bidder if one emerged. Coats entered into negotiations with Vantina Viyella plc and an agreed take-over of Coats by Viyella was announced.

Dawson raised an action against Coats in which it claimed that they had breached the agreement not to enter into other negotiations. Coats argued that such a contract would have been contrary to the fiduciary duty that the directors owed to individual shareholders to advise them on the merits of any take-over bid and not to limit their independent judgment. The court held that such a duty was not directly owed to shareholders but if directors took it upon themselves to give advice to current shareholders then they had a duty not to advise fraudulently or negligently but in good faith under ordinary principles of law. However, if the directors decided in good faith that it was in the interests of the company to enter into an agreement such as that with Dawson, which a orded the company a substantial payment, they could enter into such a contract without being in breach of their fiduciary duties.92

The long-anticipated duty to exercise reasonable care, skill and diligence in accordance with both objective and subjective standards is now held in s 174. Previously, the judiciary were prepared to tolerate high levels of incompetence in the company directors. For the most part the courts held that the duty required from a director was not the common law duty of care of the reasonable man but was better described as an equitable duty, analogous to a trustee. In Re City Equitable Fire Assurance Co Ltd,93 a director’s duty was encompassed by three basic propositions. First, a director was expected to exercise no greater care or skill than that expected from a person of his knowledge and experience, a subjective test. Second, there was no requirement that a director should give his full time and attention to a airs of the

89Op. cit., West Mercia Safetywear Ltd (in liq) v Dodd and the Insolvency Act 1986, ss 212–214.

90Section 174(2)(a) and (b).

91[1989] BCLC 233.

92Fulham Football Club Ltd v Cabra Estates plc (1994) BCLC 363. Substantial payments were made for a similarly restrictive agreement.

93[1925] Ch 407.

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company. And, third, where management was properly delegated, a director was justified, in the absence of grounds for suspicion, in trusting an o cial to perform his duties honestly. Again, in Farrar it is noted that ‘the courts regarded directors as pleasant, if sometimes incompetent, amateurs who did not possess any particular executive skills and upon whom it would have been unreasonable to impose onerous standards of care and skill’.94 More recently the courts have adopted a more objective test when assessing a director’s competency. In Dorchester Finance Co Ltd v Stebbing,95 the court rejected the argument that the directors could rely upon the competence and diligence of auditors and renounce all supervisory functions. Here the directors who were non-executives were chartered accountants who were employed for their skills and therefore had to display such skill as could reasonably be expected of persons with their knowledge and experience. They had at all times to take such care as a prudent man would take on his own behalf. Likewise in Re Barings,96 a director was held to be in breach for failing to properly monitor the activities of somebody in a lower management position such as his level of remuneration would have reasonably required of him.

The statutory duty of care and skill reflects the recommendation of the Law Commission that it be a dual test, a ‘twofold objective/subjective test’97 with regard to ‘the function of a particular director and the circumstances of the company’.98 The wording of s 214 of the 1986 Insolvency Act was looked upon favourably by both the Commission and the Review and the 2006 Act reflects this. The level of care and skill required is:

the care, skill and diligence that would be exercised by a reasonable diligent person with–

(a)the general knowledge, skill and experience that may be reasonably be expected of a person carrying out the functions carried out by the director in relations to the company, and

(b)the general knowledge, skill and experience that the director has (s 174(2)(a) and (b))

The duty to avoid conflicts of interest is held in s 175. This section particularly includes conflicts involving corporate opportunities such as the ‘exploitation of any property, information or opportunity’.99 Furthermore and in line with the principles in Regal (Hastings) et al, ‘it is immaterial

94Op. cit., Farrar, p 392.

95(1977) (1989) BCLC 498.

96Secretary of State for Trade and Industry v Baker (No 1) [1998] BCC 583.

97Law Commission No 261, para 5.20, p 52.

98Ibid.

99Section 175(2).

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whether the company could take advantage of the property, information or opportunity’.100 Subsection 1 requires a director to avoid conflicts which con- flict or might possibly conflict with the interests of the company. This di ers from the common law principle that a director should avoid situations in which his self-interest may possibly conflict with his duty to the company in that the new wording requires a possible external conflict with the company, not an internal conflict with the multiple roles a fiduciary might assume. It plays much more closely to the ‘company as a market competitor’ notion and anticipates the forthcoming acceptance of director’s actions which may constitute an internal conflict but do not jeopardise the interests of the company, either objectively or in the view of the directors. Accordingly, subsection 4 states that this duty is not infringed, ‘(a) if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest’. Thus this provision gives a statutory expression to the reasoning in the conflict cases discussed in the ‘company as competitor’ section, and allows the court to decide objectively whether the director’s actions were in conflict with the interests of the company.101 Alternatively, subsection 4 allows a director to avoid liability if ‘the matter has been authorised by the directors’.102

Authorisation may only be given if the company is a private company with nothing in its constitution which invalidates a proposal to authorise.103 Or, if the company is a public company authorisation may only be given if there is a provision in its articles allowing such a proposal.104 In both cases this authorisation is only e ective if the vote of any interested director was not counted and any quorum requirements are met.105

Under s 176 a director may not accept any benefits from a third party (other than payment for services rendered) given because he is a director, if such an acceptance would reasonably be regarded as conflicting or possibly conflicting with the interests of the company. Thus a director may personally benefit from his position if it causes no reasonably identifiable disadvantage to the company, another departure from trustee principles.

Section 177 provides that a director must declare the nature and extent of any proposed transaction or arrangement with the company in which he has a direct or indirect interest. This declaration may be made at a meeting of directors, by notice in writing under s 184 or by general notice under s 185.106 A fresh declaration must be made if the original declaration becomes

100Ibid.

101Eg, op. cit. IEF v Umunna, Peso Silver Mines, Broz v Cellular.

102Section 175(4)(b).

103Section 175(5)(a).

104Section 175(5)(b).

105Section 175(6).

106Section 177(2).

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inaccurate or incomplete107 and it must be made before the company enters into the transaction or arrangement.108 Failure to do the above will constitute a breach of duty. However, this section does not apply if the director is not aware of the transaction and it is reasonable that he is not.109 Furthermore, a director need not declare an interest if it ‘cannot reasonably be regarded as likely to give rise to a conflict of interest’,110 or to the extent that the directors already know about it.111 Lastly he will not need to make a declaration if it concerns the terms of his service contract which are in the process of being considered by the other directors.112

Similar provisions are made in respect of a declaration of interests in existing contracts or arrangements under s 182. Under s 182(1) a director must make a declaration to the other directors which under subsection 2 may be made at a meeting, or by notice in writing or by general notice. A fresh declaration must be made should the original become inaccurate or incomplete and any such declaration must be made ‘as soon as is reasonably practicable’.113 Subsections 5 and 6 are identical to the corresponding subsections in s 177. Under s 183 a director who fails to comply with s 182 commits an o ence and is liable to a fine.114

If any provisions in respect of declarations or consents are complied with then the director will not be in breach of his duty to the company.115 Absent this, any breach of ss 171–177 will result in the consequences that were applicable under the old common law and equitable principles.116 Furthermore, in respect of duties under ss 175 and 176, a director will still be subject to these after he has ceased to be a director. In the case of conflicts of interest under s 175, the duty will continue ‘as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was a director’.117 Or, in respect of the duty not to accept benefits from third parties, ‘as regards things done or omitted by him before he ceased to be a director’.118

In the case of a declaration of interest under s 182 by a shadow director, such a declaration may only be made by notice in writing in accordance with

107Section 177(3).

108Section 177(4).

109Section 177(5).

110Section 177(6)(a).

111Section 177(6)(b).

112Section 177(6)(c).

113Section 182(3) and (4) respectively.

114Replacing s 317 of the 1985 Act.

115Section 180.

116Section 178.

117Section 170(2)(a) following IDC v Cooley.

118Section 170(2)(b).

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s 184.119 A shadow director, encapsulating the ruling in Re Hydrodam,120 is ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act but does not include a professional advisor.

Other chapters in Part 10 include the following important provisions which are given in overview form only.

Chapter 1: The appointment and removal of directors. Sections 154–169

Section 154 requires a private company to have at least one director and a public company to have at least two. Section 155 requires that at least one of these directors must be a natural person, to deal with the problem of the accountability of holding companies who under the previous Act might be the only directors. Under s 157 a director must be at least 16 years of age and any who are not at the time this section comes into force will cease to be directors. Sections 162–167 specify the requirements of a register of directors including the requirement that the company must keep a register of its directors’ residential addresses. Under s 168 a director may be removed by an ordinary resolution of the company’s members but has certain rights to protest under s 169.

Chapter 4: Transactions with directors requiring approval of members

In this chapter, all transactions which require the approval of members are drawn together. All criminal penalties in respect of these transactions are removed and the civil remedies in respect of failure to get members’ approval for substantial property transactions, loans, quasi-loans and credit transactions are aligned. Chapter 4 covers long-term service contracts, substantial property transactions, loans, quasi-loans, credit transactions and payments for loss of o ce.

1. Long-term service contracts

Sections 188 and 189 replace s 319 of the 1985 Act. Member approval is required for all service contracts over two years and failure to get this approval will allow the company to terminate the contract at any time following reasonable notice.

2. Substantial property transactions

Sections 190–196 replace ss 320–322 of the 1985 Act and require members’

119Section 187.

120Section 251.

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approval when the company buys or sells a non-cash asset to a director of the company or a director of its holding company, a person connected with a director of the company or to a director of its holding company worth more than £5,000. Approval is required if the transaction is worth more than £100,000 or 10 per cent of the company’s net assets.

3. Loans, quasi-loans and credit transactions

Section 197 requires members’ approval for loans, quasi-loans and credit transactions made to directors in private companies which are not associated with a public company. Sections 197, 198, 200 and 201 require members’ approval for loans, quasi-loans and credit transactions made to directors in public companies or private companies associated with public companies. Members’ approval is not required for loans, quasi-loans and credit transactions which do not exceed £50,000 if this money is to fund expenditure on company business,121 or for money lent to finance a director’s defence costs for breaches of duty or any related regulatory action,122 or for loans and quasi-loans not exceeding £10,000 and credit transactions under £15,000.123

4. Payments for loss of o ce

Sections 215 to 222 require members’ approval for such payments.

Chapter 5: Directors’ service contracts

This chapter requires that a director’s service contract be available for inspection up to a year after they have left.124 Failure to comply will result in a fine of £1,000 for every o cer in default and £100/day for all subsequent noncompliance. Section 229 allows members to inspect the contracts free of charge and s 230 applies these rules to shadow directors as well as directors. Sections 228–230 replace section 318 of the 1985 Act.

Chapter 6: Contracts with sole members who are directors

Under s 231, such contracts must be recorded in writing unless they are those entered into in the normal course of the company’s business. Failure to comply results in the responsible company o cers’ liability for a fine not exceeding £5,000. This section replaces s 322B of the 1985 Act.

121Section 204.

122Sections 205 and 206 respectively.

123Section 207.

124Sections 228 and 227. Section 227 is new.

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Chapter 7: Directors’ liabilities

Under s 232 a company is prohibited from exempting a director from negligence, breach of duty or breach of trust and any provision in the company’s articles which attempts to do so is void. This replaces s 310 of the 1985 Act. Sections 233–238 set out various provisions in respect of a company’s provision of insurance or indemnification for its directors. Section 239 provides that any decision by a company to ratify an action which constitutes negligence, default, breach of duty or breach of trust must be taken without the votes of the director in question or any person connected to the director.125 Otherwise all existing rules on ratification remain.

Chapter 8: Directors’ residential addresses: protection from disclosure

The purpose of this chapter is to put into statutory form the recommendations of the CLR that a director may choose to either put his residential address on public record, as under the 1985 Act, or to provide a service address which would be on public record. Their residential address would be held on a separate secure register to which access would be restricted. Section 240 prohibits a company providing its directors’ home addresses without their consent. Section 243 allows the registrar to use or disclose a director’s address for certain limited ends such as when he needs to communicate with the director. Under s 244 anyone with su cient interest may apply to the court for an order to disclose the protected address. This may be because the service address is ine ective126 or to enforce a court order.127

Chapter 9: Supplementary provisions

Under this chapter a number of terms are closely defined. Under ss 252–256 persons that are connected with the company are defined, including members of the director’s family under s 253, a body corporate under s 254 and an associate body corporate under s 256.128 It also includes a company in which the director has a controlling interest, defined as more than 50 per cent of the shares.129 Section 248 sets out certain requirements in respect of records of directors’ meetings, including the requirement to keep the records for 10 years. Section 250 defines a director and s 251 defines a shadow director;

125Defined in s 252.

126Section 244(1).

127Section 244(2).

128A connected body corporate is one in which the director owns at least 20 per cent of the shares. Section 256 is new.

129Section 255.

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both reproduce the definitions under the 1985 Act. Finally, s 247 replaces s 719 of the 1985 Act and provides that directors may make provisions for employees including ex-employees but may not rely on this section to make payments for themselves or for former directors or to shadow directors. Subsection 6 provides that such payments may only be made following a resolution of the members unless the articles allow such authorisations to be made by the board. All such payments must be made out of profits and before the company commences winding up.

CONCLUSION

The reform process and the resulting legislation on directors’ duties have promoted the ideology of shareholder primacy. The provisions in s 172 mean that all the duties which a director owes to the company, be it a duty to be reasonably competent, honest or to act with discretion, are to be exercised in such a way that primarily pursues shareholder interest. The ideology of contractarianism has facilitated a modern and sophisticated justification for focusing ‘the best interests of the company’ in this way. But it is wrong, both methodologically and morally. The company is made of arrangements between people as the contractarians rightly assert, but this makes it a social as well as an economic actor, which must be reflected in giving it a broad public nature. Accordingly, directors’ duties should take proper account of the interests of all engaged persons and not simply privilege shareholders.

Chapter 6

Corporate governance III: minority shareholder protection

Minority shareholder protection is vital to corporate governance. In the words of La Porta et al, ‘corporate governance is, to a large extent, a set of mechanisms through which outside investors protect themselves against expropriation by the insiders’.1 The reform process in respect of the law on minority protection has attended to two key perspectives, the ‘law matters’ perspective and contractarianism. The first position posits the notion that minority shareholding will only be attractive and thus encourage the wide share dispersal which characterises Anglo-American corporations if there are su cient legal protections for shareholders without a majority holding. The second perspective asserts that unfettered minority rights are not economically e cient as ultimately the costs to the business from a minority action are costs that are borne by shareholders with the largest stake in the business. This position advocates strong controls over minority rights. The law matters thesis and contractarianism will be briefly examined in the first part of this chapter in so far as they relate to minority shareholder protection. The chapter will then examine the law on minority protection as it has developed, the aims and ideological influences of the reform process in respect of minority protection and its legislative expression in the 2006 Act.

THEORY AND MINORITY PROTECTION

Law matters

As we saw in Chapter 4, Mark Roe argued that the most important factors in creating an environment which encourages wide share dispersal is politics. A political environment that facilitates state control over business will discourage the sale of large, usually family stakes in businesses, where such

1La Porta et al, ‘Investor protection and corporate governance’ (2000) 58 Journal of Financial Economics, 3, p 4.