Directors’ duties

all’.4 These are proud words perhaps, but fundamental to how directors see their responsibilities in the overall context.

Core duties

There was no comprehensive statement in statute of what are the duties of a director. Indeed, the duties vary according to the nature of the position or office that a director is regarded as holding. Legally, it was a very peculiar position. One judge said almost as much: ‘Directors of a limited company . . . occupy a position peculiar to themselves. In some respects they resemble trustees, in others they do not. In some respects they resemble agents, in others they do not. In some respects they resemble managing partners, in others they do not.’5 And the law on directors’ duties was derived from voluminous and historical case law. There was a lot of law, a lot of it was old law and too much of it was inaccessible. The Companies Act 2006 attempts to codify existing directors’ duties and so increase accessibility to the law. Whether it does so successfully has been a matter of considerable and continuing debate. What tends to get forgotten, in the heat of the debate, is that codification is being done for a very good reason: to make the law more modern and more accessible, thereby more useful and relevant to business needs.

The codification of directors’ duties is not, however, a complete statement of all the duties of a director. For example, it does not include the duty to consider the interests of creditors. The statutory statement is also not intended to change existing common law and equitable principles. So, the Act specifies that ‘regard should be had to the corresponding common law rules and equitable principles in interpreting applying of the general duties’. And the statutory statement also includes some deliberate changes of policy to the existing law. This means that there will be some uncertainty as to whether the new wording will have the same effect as the previous case law.

The duty to act within powers

A director of a company must –

(a)act in accordance with the company’s constitution, and

(b)only exercise powers for the purposes for which they are conferred.

Section 171

The requirement for a director to act in accordance with the constitution is not new. Currently the overriding duty of a director is to act in the best interests of the company. But there is a separate, objective duty to act within the purposes for

4Companies Bill – White Paper, Ch. 3, Enhancing Shareholder Engagement and a Long-Term Investment Culture, p. 20.

5Regal (Hastings) Ltd. v. Gulliver and others [1942] 1 All ER 378; [1967] 2 AC 134 at p. 147.

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which powers have been conferred. Mr Justice Jonathan Parker in Regentcrest plc (in liquidation) v. Cohen6 decided:

The position is different where a power conferred on a director is used for a collateral purpose. In such circumstances it matters not whether the director honestly believed that in exercising the power as he did he was acting in the interests of the company; the power having been exercised for an improper purpose, its exercise will be liable to be set aside.

Thus, under the old law, it could be said that directors had a duty to exercise their powers for a proper purpose. Under existing case law, a proper purpose is determined according to the construction of the particular power (either express or implied by the articles of association of the company). Typically, powers are drafted in general terms without express statements of the purposes for which they can be exercised. In the leading case7 on the purposes for which a power can be exercised it was decided that if the exercise of a power is challenged, the court will ‘examine the substantial purpose for which it was exercised . . .

to reach a conclusion as to whether that purpose was proper or not. In doing so it will necessarily give credit to the bona fide opinion of the directors.’ Despite the codification of directors’ duties, there remains a lack of a defined scope for this duty. One is left to decide, as Lord Wilberforce described it, ‘as to the side of a fairly broad line on which the case falls’. It will still involve issues such as how willing the court is to intervene in business decisions, and whether the directors acted to promote the success of the company, for the members as a whole, which in itself may require discussion of whether they have considered the statutory factors. Nonetheless, the duty is a separate one and requires the exercise of powers to be both in compliance with the company’s constitution and for the purpose for which they were conferred.

The words ‘for the purpose’ for which they were conferred arguably suggests some lower standard than that which might apply if the standard were an objective one based on what is ‘proper’. In fact, when this duty is read in conjunction with the duty to promote the success of the company and of the standards of skill and care, no lower standard should be presumed in relation to the duty of directors to act within their powers. While the duty is expressed as an individual one, a board of directors which authorised the exercise of a power which is clearly not in accordance with the company’s constitution (for example, breach of a borrowing limit) could be vulnerable to liability.

From the board’s point of view it is therefore important to focus not only on what considerations are important to a board’s decision, but also on the purposes for which they are exercising their powers in making that decision. Good faith alone is not sufficient, nor are reasonable care, skill and diligence. Where the

6[2001] 2 BCLC 80 at p. 105.

7Howard Smith Ltd. v. Ampol Petroleum Ltd. and others [1974] AC 821 at p. 835, per Lord Wilberforce.

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constitution contains an express statement of purpose for which a power can be used, this must be observed. Where there is no such express statement, the power must still be exercised properly and the board must always act within the company’s constitution.

The duty to promote the success of the company

A director of a company must act in the way he considers, 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:

(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.

(Where, or to the extent that, the purposes of the company consist of, or include, purposes other than the benefit of its members, the reference to promoting the success of the company for the benefit of its members should be treated as if it were to achieving those purposes.) Section 172

So far as the old law was concerned, Mr Justice Jonathan Parker in

Regentcrest plc (in liquidation) v. Cohen said:8

The duty imposed on directors to act bona fide in the interests of the company is a subjective one. The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind. No doubt, where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.

Section 172 codifies this primary duty while enshrining the enlightened shareholder value approach. The Government has therefore suggested that success will normally mean ‘long-term increase in value’.9

8[2001] 2 BCLC 80 at p. 105.

9Lord Sainsbury of Turville, Second Reading debate, Hansard Col. 245, 11 January 2006.

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It is important to appreciate that key elements remain in this new statement, such as:

the word success replaces the former word ‘interests’ and is a more modern, plainer term

the subjective test in meeting the duty ‘he considers’ has been retained

‘in good faith’ has been retained

‘for the benefit of members as a whole’ has long been the old but rather inelegant and imprecise definition of the company.

The new statutory factors are ones which large private companies and public companies would commonly consider when reaching a decision, as well as considering other factors relevant to their deliberations which are not referred to in the new Act. Even under the old law, if these factors were not being considered, then it is likely that directors would have been in breach of their duties as they applied before the Act came into force. What the new Act does is to make much clearer the necessity of considering these factors (among others).

For smaller, private, owner-managed companies, the new law will have an impact where board procedures are, understandably, less formal and there is a less obvious distinction between the views of directors and shareholders. Directors of smaller and other companies who cannot demonstrate awareness of the need to consider these factors may find that any defence to a claim that they have breached their directors’ duties is severely compromised.

The explanatory notes10 to the Act make it clear that, in having regard to the factors listed in section 172, the duty to exercise reasonable care, skill and diligence (see below) will also apply. This means that, while directors must have regard to the relevant factors listed in section 172 in promoting the success of the company, it does not require a director to do more than act in good faith and to exercise reasonable care, skill and diligence.

Some argue that the introduction of the reference to the ‘community and the environment’ in section 172(1)(d) has increased the scope of directors’ duties. The suggestion has been made that an activist could acquire shares and then through the new statutory derivative action procedures bring an action against a director claiming that they failed to ‘have regard’ to the impact of the company’s operations on the community and the environment. However, section 170(1) of the Act confirms that directors’ duties remain owed to the company and to no other person. The law has not changed in this regard. It is the company which must suffer loss as a consequence of the directors’ failing to have regard to a particular matter (not a shareholder or even a group of shareholders). Shareholders may still only bring a derivative action for a breach of directors’ duties in their capacity as shareholders and in no other capacity (for instance as the representative of a lobby group).

10 See paragraph 328 of the Explanatory Notes to the Act.

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It was a hot topic as to whether, within the codification, there is a single duty to promote the success of the company (and in promoting that success to have regard to the statutory factors) or whether there are in effect two distinct duties, namely to promote the success of the company and to have regard to the statutory factors (among others). The Government was adamant in Parliament that a single duty – an overriding duty to promote the success of the company – is intended and is the result of the wording. The Government went to considerable lengths to tailor the wording to achieve the effect it intended. Some might have preferred Government to have gone even further to have made this clearer and take the view that there will only be absolute certainty once there is a court decision. There seems, however, room for little doubt as to the approach a court would take and, from the director’s point of view, it seems appropriate to proceed, as the Government intends, as if there is a single duty.

What is clear is that the Government intends directors to have regard to at least the six statutory factors. A director who gives no consideration at all to any of these factors will be vulnerable to claims for failing to meet the standard of skill, care and diligence required of that director. This is deliberate on the part of the Government and, viewed in the context of the approach in favour of enlightened shareholder value, not surprising. Nor should there be undue concern that this is some inherently new obligation on directors. It is not. It formalises what was perhaps latent or less obviously developing in the law. One may debate whether the degree of formality arising under the Companies Act 2006 inhibits business decisions, creates a duty of due process or necessitates directors to keep additional records to prove that they did consider these factors.

Where the Companies Act 2006 missed an opportunity was to make absolutely explicit that the weight and relevance of the factors to be considered by the directors in fulfilling their duty to promote the success of the company is a matter for their good-faith business judgement. Under current law, where a director is exercising what can properly be described as his or her business judgement, the courts are reluctant to intervene. It has been stated:

No matter what profession it may be, the common law does not impose on those who practise it any liability for damage resulting from what in the result turn out to have been errors of judgement, unless the error was such as no reasonably well-informed and competent member of that profession could have made.11

The courts will intervene only where that business judgement can be shown to be one which no other director, in like circumstances, could properly have reached. There is frequently a range of business judgements that can properly be reached in any given situation. Only when a director takes a decision that is not within that range may he or she be liable for negligence.

11 Saif Ali v. Sydney Mitchell & Co. [1980] AC 198 at p. 220, per Lord Diplock.

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The principle that courts should be slow to substitute their own decision for that of the directors was expressed by Lord Wilberforce (giving the judgment of the Privy Council), in the following terms:

Their Lordships accept that such a matter as the raising of finance is one of management, within the responsibility of the directors: they accept that it would be wrong for the court to substitute its opinion for that of the management, or indeed to question the correctness of the management’s decision, on such a question, if bona fide arrived at. There is no appeal on merits from management decisions to courts of law: nor will courts of law assume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at.12

The Company Law Review steering group itself concluded:

The law recognises that it is essential for directors to have a discretion in the way they manage, and legal actions will not interfere with proper exercise of such business judgement.13

The Government was adamant that it is now implicit in the Companies Act 2006 that the weight and relevance of the various factors in a decision is for directors to decide (in other words directors meeting the minimum standards of skill, care and diligence can subjectively decide what is relevant – so called ‘subjective relevance’). The Solicitor General said as much in Parliament:

Under the duty to promote the success of the company, the weight to be given to any factor is a matter for the good faith judgement of the director. Importantly, his decision is not subject to a reasonableness test, and, as now, the courts will not be able to apply a reasonableness test to directors’ business decisions.

From a business point of view, it seems a shame not to take the opportunity to make absolutely explicit what the Government regards as implicit. From a legal perspective, the certainty would have been better although, even without it, it seems clear that a court would interpret the law in this way. The codification and the wording that require the courts to give effect to the existing law give them, as at present, a broad flexibility and, in the future, the power to modernise and increase further the standards expected of directors in specific circumstances.

From the board’s point of view, the new duty possibly results in a greater mutual reliance by one director on another. The reason is that the statutory factors highlight the need for a board to have directors, supported by management and advice, with sufficient knowledge, skill and experience to assess each of the statutory factors. While one director cannot abdicate his own responsibility for considering the statutory factors, it seems legitimate for a board to draw on

12Howard Smith Ltd. v. Ampol Petroleum Ltd. and others [1974] AC 821 at p. 832.

13Company Law Review Steering Group, Modern Company Law, p. 35.

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