Confused state of case law

2. ‘The statutory statement of directors’ duties contained in the CA 2006 does little to clarify or simplify the confused state of the case law’. Discuss.

The Companies Act 2006 s250, states that a ‘Director’ is any person occupying that position, whatever the name of that position is within the company.

All companies, whether public or private, will have a director or a position within the company that entails the same duties as a director. It is established in Ferguson v Wilson (1866) [1] that this is because a company can not act on its own as an individual or be represented by members and thus requires a director to act on behalf of it. A shareholder of a company can then and only act through the director. [2] 

The introduction of the Companies Act 2006 s154, now requires that every private company has at least one director and every public company has at least two, this is to ensure that every company is represented to deal with other individuals or indeed companies and also to fulfill the requirements of the Companies Act 2006.

Directors are not expected to manage the business but the model Articles of Association puts directors at the heart of ‘corporate governance,’ which in its most basic definition is the system by which companies are directed and controlled.

Directors are said to have a fiduciary relationship in that they must act on behalf of the company and also in way in which will benefit the company and not themselves. It is generally assumed and established in Multinational Gas and Petrochemical Services Ltd (1983) [3] that in common law the director has a duty to the company and not to the other.

Before the introduction of the Companies act 2006, courts used fiduciary equity principles and the common laws of negligence when dealing with the role of directors and their duties.

The first principle that was used was the duty of care and skill which is essentially the negligent act that the director may be guilty of.

This is demonstrated in Dorchester Finance co. Ltd v Stebbing (1989) [4] where it was held that a director, who regularly signed blank cheques without ensuring that they were being used appropriately, should have performed his duties with the skill which could be reasonably expected from his knowledge and experience.

The next was the duty to act ‘bona fide’ (in good faith) in the interests of the company, which was established in Re Smith and Fawcett Ltd (1942) [5] and is fundamental to the duties of the director.

In terms of acting bona fide, the courts generally can not be the judge of whether the director acted appropriately, in Regentcrest plc v Cohen and another (2000) [6] it is held that liability can only ensue if it can be shown that the director felt that they were not acting in good faith at the time.

As held in Hogg v Cramphorn (1967) the proper purpose rule was another principle used, which had the role of ensuring that the director acted for the right purposes as a fiduciary and did not act in a way that might lead to a substantial personal gain.

Conflicts of interests as a rule covered a range of elements and acted so as the director would not make a substantial personal interest due to his position without prior approval by the company. In Boston Deep Sea Fishing and Ice Co. v Ansell (1886) [7] a director awarded a contract to a company for the building of ships when they offered him secret profit, the courts held that this amounted to a conflict of interests and that he had only obtained the award as a result of his position in the company.

The Corporate opportunity Doctrine also acts as a means by which conflicting interests are prevented. This was seen in Industrial development Consultant v Colley (1972) [8] in which the director of a development company left his position in order to form a new company and agree to a large contract for himself. It was held that the director had embarked on a deliberate course of conduct which put his personal interests in direct conflict with his duty as director of the company and thus was in breach of his fiduciary duty.

Another example of resolving a conflict of interest is depriving a company of a maturing business interest. In CMS Dolphin ltd v Simonet and Another (2001) [9] the director of a company left his post to set up a competing business taking with him many of their clients and also much of its business.

It was held that although there is nothing preventing a director from doing this, the fact that the defendant had utilized information gained as a result of his previous post and by doing so had deprived the company of maturing business opportunities then it constituted a breach of his fiduciary duty.

The companies act 2006, s 170 (4) introduces statutory duties to replace these common law principles and also to provide a statutory basis. Although the legislation has the purpose of replacing the old common law duties, it is the intention that the common law rules and precedent will be used in the assistance of the interpretation of the new statutory provisions.

The new legislation in regard to the duties of a company director [10] is now codified which was recommended by the Law Commission and the Scottish Law Commission in Company Directors: ‘Regulating Conflicts of interest and Formulating a Statement of Duties [11] ’, with the primary intention to make the legislation more accessible, in particular to companies and their directors.

The Companies act 2006 was largely a piece of legislation which amalgamated pre-existing common law and statutes but with the codex system implemented it also separated and expanded upon them.

Section 171 of the act, refers to the duties that the director has to act within their powers, this section derives from the equitable principle that the director must exercise the companies powers for the purposes for which they were given to him and bears relevance to the principle mentioned previously relating to proper-purpose.

This section implies that the Director must act in accordance with the company constitution and only exercise powers for the purposes they are conferred.

The specific acts which may be regarded as outside the powers can sometimes be found in articles of association, however, is hard to specify as each particular case demands close scrutiny of its facts.

It was held in Hirsche v Sims (1894) [12] that The Court must find whether the act in question, lead to multiple purposes and whether the minor personal purposes were subject to the main company purpose. This means that even if a director does benefit then they may still be acting within their powers.

The directors’ power to allot shares has also been affected by this section and it is the case that most problems regarding a director acting outside of their power were and are due to allocation of shares. The Companies Act 2006 dealt with this problem and restricts the power of a director to allocate shares in sections 6.2.5. and 6.2.6. It is the case now that where a director acts outside their power and breaches section 171, then the act is deemed as void by the courts.

Section 172 is a bold attempt by the legislators to firstly ensure that directors are acting in the interests of the company and secondly to provide some detail on the factors which directors ought to take into account.

This section based on the equitable fiduciary duty that a director must act ‘bona fide’ [13] or in good faith in the interest of the company. In Regentcrest plc v Cohen (2001) [14] Justice Jonathan Parker said, ‘the question is whether the director honestly believed that his act or omission was in the interest of the company.’

Section 172 ss1 (a) refers to the likely consequences of any decisions in the long term.

This section appears to be somewhat of a gray area as it suggests that the director must act in a way so as the company benefits. However, it is often the case in business that a company needs to take risks to progress, this leaves the question as to whether the company should take risks and focus on best annual dividends or focus on stability that ensures a future. [15] 

Section 172 ss1 (b) refers to the interests of the company’s employees.

This section is subject to particular scrutiny as in recent times there has been a move towards a lesser regard of the employee and the law would tend to focus on the benefit of the member. This was discussed when the Company law review Steering Group requested the successful repeal of s309 of the Companies act 1985 on the grounds that it believed it could enable employees to have more interest than shareholders and would therefore threaten the concept of shareholding primacy.

In his article ‘Companies and Employees: Common Law or Social Dimension’ [16] , Charlton argues that the way in which company law is progressing there was a real shift from labor to capital, which sees employees as nothing more than a commodity.

Section 172 ss1 (c) refers to the need to foster the company’s business relationships with suppliers customers and others.

Section 172 ss1 (d) refers to the impact of the company’s operations on the community and the environment. This particular section is of interest to pension funds, which tend to be a big investor with shareholdings in many listed companies. The trustees of these pension schemes are expected under the Pensions Act 1995, s53 to produce a statement of all their investment principles. The law now states that those with interests in these pension schemes must show what social, environmental and ethical considerations are taken into account when making investments.

Section 172 ss1 (e) refers to the desirability of the company maintaining a reputation for high standards of business conduct.

In general this will ensure that the director ensures that trading standards are met and that regular supervisory measures are taken to ensure company is performing as it should. This section also implies the equitable principle that a Director must disclose a breach in conduct by themselves [17] , or by another [18] if a breach does occur.

Section 172 ss1 (F) refers to the need to act fairly as between members of the company.

It is usually the case that where there is a dispute between shareholders and no consensus can be made, the courts will favor the solution of one party buying out the other, or parties buying out members with conflicting interests.

Section 173 reflects the equitable principle that the director on agreeing to assume the position will act in a particular way as agreed prior to acceptance of the role. As held in Fulham Football F.C. v Cabra Estates plc [19] , it has to be established that the director believed that the required actions were in the best interests of the company at that time. The director will be held to the original agreement as to how to act even if interests change and he believes different methods are required.

However, it is established in Motherwell v Schoof (1949) [20] that if it is the case that the agreed act was not in the best interest of the company to begin with, then the courts will not consider it a duty.

Section 174 is the duty that the director will exercise reasonable care, skill and diligence.

There are no statutory implied terms of contract that a director must act using care, skill and diligence because this position is excepted by the Supply of Goods and Services Act 1982.

This section is based on both common law and equitable principles and due to the exemption mentioned it is established in Henderson v Merret Syndicates Ltd (1995) [21] by Lord Browne that the duty of care for the company on behalf of the director arises from the assumed acceptance of responsibility for the property and affairs of the company.

The director also has the burden under this section of having and continuing to have a basic knowledge of the company’s business.

This is established in re Brazilian rubber plantation and estates ltd (1911) [22] when Justice Jonathan Parker suggests that directors do this so they can properly carry out their duties.

It is however not the case the courts will burden the director to an unfair extent and it is accepted that directors are expected to rely on company officials to report to them and inform them accurately what is going on in the company. [23] 

Despite the need for referral, directors are still expected to carry out supervisory duties [24] , involve themselves with important aspects of the company and not to rely too heavily on other company officials. [25] 

In Lexi Holdings plc v Luqman (2009) [26] , it is established that if a director is responsible for carrying out an action for a company and they do not perform it, then they are liable for the consequences of that.

Section 175 is the duty to avoid conflicts of interest and is based on two main equitable principles, the no-conflict and no-profit rules.

These rules where established by Lord Herschell in Bray v Fird (1989) [27] and prevent a fiduciary individual, from putting themselves in a position where the primary benefit is their interest or a position in which there is a conflict of duties.

Section 175 ss(2) provides that a director must avoid conflicts in regard to exploitation of property, information and opportunity

As mentioned earlier the corporate opportunity Doctrine prevents a director from leaving a company and setting up another one with the assistance of information that could be regarded in equity as property of the previous company.

This principle is still not diminished even if the previous company had displayed no interest in the venture as held in Industrial Development Consultants v Cooley (1972). [28] 

Section 176, provides the duty not accept benefits from third parties. Third parties refer to any individual or person who is not involved with the running of the company who offers a benefit based on the fact that the individual in a company director.

This is essentially because this will most likely lead to a conflict of interests as discussed previously.

Section 177, provides the duty to declare interest in proposed transaction or arrangement:

The director must give a declaration to other directors of nature and the extent of the transaction or arrangement.

This section is backed up by s 182, which requires a declaration when the company itself has entered into a transaction. If there are no other directors then there is no need for a declaration.

Section 177 is based on the equitable principle established in Bentinck v Fenn (1887) [29] that when a company is carrying out a transaction then the director of the company must declare what interests he personally has in regards to the transaction.

This section essentially deals with all forms of transaction and so it covers everything from property transactions to loans and credit transactions.

In summary it is clear to see that

In summary it is clear that a statue-based law reduces the necessary flexibility so effective in case law. However on the other hand the codification provides clarity on what is expected of directors and makes the law more accessible.

It could be argued that the changes are not radical enough and there is little distinction between the new law and common law position.

However in the article… chuah, J (2005) believes that the new regime does require certain significant adjustment to current practice and it is important to consider the wider and more policy-orientated approach to the evaluation of director’s duties.

Although the Companies Act 2006 has brought about many changes to create a more efficient and clear approach to how companies operate, there are still some ‘loose ends’. It can be said the new act has brought about a complete upheaval, especially considering the amendments of the articles of association, but upon closer examination the decision making process is still long winded and over regulated in many respects, e.g. the aforementioned decision making process of directors who are members. Although the new act can be criticised it has brought a forward change in the running of companies. It presents a step in the right direction in removing the more archaic and regimented provisions, although there is still a long way to go in perfecting the way in which company decisions are made.

This act has however, brought with it under part 11 a derivative which means any shareholder can bring forward a claim on behalf of the company.

‘The Part 11 procedure broadens the circumstances in which derivative actions may be brought, extending to actions in respect of any ‘actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company’. In particular, the procedure will apply to derivative actions for alleged breaches of….the duty to exercise reasonable care, skill and diligence…in relation to an act, omission involving negligence, default, breach of trust or a breach of duty.’ [30]