Duties of Company Directors

The directors’ duties to the company were governed by the common law of negligence and the equitable principles of fiduciary duties before the CA 2006. The CA 2006 has brought an important change of codification. [1] This codification of the general duties of a director was brought forward by the law reforms bill as introduced to the parliament on November 1, 2005. The explanatory notes to the bill show the apprehension of the draftsmen that the exercise of the codification will serve as insulation to the development of the directors’ duties. The general duties will be interpreted in the same manner as the common law rules or equitable principles and in interpreting and applying these general duties regard shall be had to corresponding common law rules and equitable principles. [2] In this work an endeavour has been made to discuss the directors’ duties as conferred by the CA 2006 in a codified form. The directors have the duties to work within the powers, to exercise the reasonable skill and care, and to work for the success of the company. They also have important duties to the shareholders and owe certain duties to the creditors in case of the insolvency of the company. These duties of the directors have been discussed along with the relevant case law.

Directors Duties to the Shareholders

In general the directors do not have any contractual or fiduciary duty to the shareholders of the company. But if there is a bid situation the City panel would be concerned on takeovers and mergers and the stock exchange is beginning to look critically at the sort of insider dealing which took place in the Percival v Wright [3] where a listed company is concerned at least and has set up a dealing code for the directors. [4]

Lindley L.J. said in the Re Lands Allotment Company [5] regarding the position of directors towards shareholders,

“Although directors are not properly speaking trustees, yet they have always been considered and treated as trustees of money which comes to their hands or which is actually under their control; and ever since joint stock companies were invented directors have been held liable to make good moneys which they have misapplied upon the same footing as if they were trustees, and it has always been held that they are not entitled to the benefit of the old Statute of Limitations because they have committed breaches of trust, and are in respect of such moneys to be treated as trustees”. [6]

Swinfen-Eady J. held in the case of the Percival v Wright [7] regarding the directors’ duties towards the shareholders

“The directors of a company are not trustees for individual shareholders and may purchase their shares without disclosing pending negotiations for the sale of the company’s undertaking” [8] .

The decision in the case of the Percival v Wright [9] has been criticised a lot that it should not be deduce that the directors can never be placed in a fiduciary relationship to the members. If the shareholders authorise the directors to negotiate for them, then the directors owe a duty in the case of a takeover bidder. The establishment of an agency relationship may be sufficient in the case of a family company, which depends on the whole surrounding circumstances and the character of the responsibility which the directors have assumed in a real and practical sense. [10]

The family characteristic of the company is the most important reason to impose fiduciary duties on the directors towards the shareholder, this happened in the New Zealand in the case of Coleman v Myers [11] , in which Mahon J did not follow the decision of the Percival v Wright [12] , he stated the following:

“It seems an untenable argument to suggest that the shareholders on an offer to buy their shares are not perforce constrained to repose a special confidence in the directors that they will not be persuaded into a disadvantageous contract by non-disclosure of material facts. [T]here is inherent in the process of negotiation for sale a fiduciary duty owing by the director to disclose to the purchaser any fact … which might reasonably and objectively control or influence the judgment of the shareholder in forming the decision in relation to the offer.” [13]

As it has been discussed that the directors do not have any fiduciary duty to the shareholders, but some of the judges are of the view that directors have some discrete duties to the company’s shareholders and these duties are fiduciary in character. The directors have to fully inform and should avoid misleading the shareholder when their action or approval is required. The disclosure will relate to material considerations having an effect on the management of the company. [14]

According to Mr Flannigan the decision in the case of the Coleman v Myers [15] by the court of appeal of the New Zealand is based on the wrong analysis. The shareholders complaint was that the director had failed in disclosing about their financial plans to get all the share of the company, through non disclosure and misrepresentation. According to the court, failure was the breach of the fiduciary duty which arose on the basis of the facts. The court distinguished the Percival v Wright [16] that the directors do not have any fiduciary duty to the shareholders. Mr Cook said that Percival v Wright [17] ,

“would merely exclude any automatic fiduciary duty, leaving open the possibility of such a duty falling on a director in particular circumstances”.

There is no fiduciary obligation on the directors because the relationship between the members and the directors is not of a limited access in general but in some circumstances a limited access can exist. [18]

Duties to the Creditors

When the question of the directors’ duties arises in a solvent company the shareholders as a body is regarded a company. But in the case of the insolvency the creditors’ interests intervene. Through the insolvency procedure they have the power to secure the assets of the company and in fact these assets belong to them and not to the shareholder any more. [19] As the duty is owed to the creditor but the question is that the duty is owed to what kind of creditors and the debated issue is that the duty is owed to the future creditors. This problem arose because of the decision by Lord Templeman in the House of Lords in Winkworth v Edward Baron Development Ltd [20] . His Lordship said that the duty is owed by the company to the present and future creditors. The court following this decision in the cases of the Western Australian Supreme Court in Jeffree v NCSC [21] , and in the Court of Appeal decision in Fulham Football Club Ltd v Cabra Estates Plc [22] , said that it is the duty of the directors to give consideration to the interest of the creditors. But in fact there is a great amount of academic commentary, which has criticized this approach that there is no such duty to protect the interest of the future creditors. [23]

The other issue is that whether the duty owed by the directors is either direct duty to the creditors, or whether it is an indirect duty which the directors do not owe to the creditors but to the company to consider the interest of the creditors. In his saying in Winkworth v Edward Baron Development Ltd, [24] Lord Templeman seemed to advocate the fact that a direct duty exists. His Lordship said that:

“A duty is owed by the directors to the company and to the creditors of the company to ensure that the affairs of the company are properly administered and that its property is not dissipated or exploited for the benefit of the directors themselves to the prejudice of the creditors.” [25]

The duty of the directors to the creditors is not owed by the directors at all the times. But in fact there is no agreed judicial decision regarding the commencement of the duty which has led to some ambiguity. The directors have the duty to consider the creditors’ interest upon insolvency of the company. When the company is insolvent the concept of the corporate ownership and the creditors’ rights meets. The creditors in reality may be considered the owner of the company in such a case. When the creditors become the owner of the company then the shareholder loses the ownership and they have nothing to have a claim on. [26]

Directors’ Duties as conferred by the CA 2006

The general duties of the Directors

The principles of equitable justice and the common law of negligence were the two factors through which the directors’ duties were governed prior to the CA 2006. The CA 2006 brought a significant change by codifying these duties. The equitable principles of fiduciary duty and the common law of negligence apply to the directors. [27] The Company Act 2006 contains seven codified general duties which are owed not to the shareholders but to the company. More than one of these codified duties will be relevant in many circumstances. These duties are responsibilities of every director in personal, and the board of directors of a company as a whole are not responsible. [28] According to section 170 of the CA 2006 the directors owe a duty to the company and therefore only the company can bring an action against the director through its board of directors.

Duty to Act within the powers

According to section 171 of the CA 2006 the directors should (a) act within the constitution of the company and (b) only exercise power for the purpose for which they are conferred. “The exercise of a power for a purpose which is outside the purposes for which the power has been given is voidable. In older cases, such an exercise of power was called a fraud on the power”. [29] To use the power for such a purpose which is not in the ambit of the company’s object is using the power for an improper purpose. The powers exercised by the directors’ lead to one or possibly more of the effect, therefore the achieving of the one or more of the effect is a proper purpose and the remaining is an improper purpose. That is reason that the court is required to know whether the improper purpose achieved is the substantial purpose or the dominant purpose. [30] According to C.G Kilian, the proper purpose doctrine is very often confused with honesty. He says that honesty is an important requirement for an act to be a proper purpose. [31] But honesty is not clear in any of the legal system that is the reason that court tries to focus on the best interest rather than honesty. The reason is that directors are allowed in law to a great extent to take business risks or enterprises for the company because it is considered as a more flexible principle. [32]

Duty to promote the success of the company

Section 172 of the CA 2006 has provided the duties for the directors to promote the success of the company. According to Professor Sealy this section is one of the important and also controversial sections. Its approach declares to end the controversy over the meaning of the company and the interest of the company. [33] It has been stated in Mills v Mills [34] that the director must act for the interest of the company alone and never in their own interest. [35] Lord Green said in Re Smith v Fawcett that the company’s directors must:

“Exercise their discretion bona fide in what they consider – not what a court may consider – is in the interests of the company, and not for any collateral purpose.” [36]

The property of the company must not be used by the director but only for the interest of the company. [37] The director has the duty to promote the interest of the company by acting in good faith for the benefit of the company’s members. The director is obliged to consider the likely consequences of any of his decision in the long run; he should work for the interest of the company’s employees. The director should work to promote the business relationship with the people involved in the company’s business and has to take into consideration the effect of his company on the community at large, like the effect on the environment. He has to work effectively in order to promote the reputation of the company and maintain a high standard of business conduct and to act fairly amongst the members of the company. This is called the “enlightened shareholder value”. If the director is successful in this, it means the long term increase in value. [38]

Duty to exercise independent judgement

Section 173 of the CA 2006 provides for the duty that the directors should exercise independent judgment. Director must use independent judgment and it is not a breach of this duty if they take an advice or if the director act in compliance with the agreement entered into by the company that restricts the future exercise of discretion by its directors or permitted by the company’s constitution. [39] It has been stated in the explanatory note to the CA 2006 about this section as the following,

“This duty codifies the current principle of law under which directors must exercise their powers independently, without subordinating their powers to the will of others, whether by delegation or otherwise (unless authorised by or under the constitution to do so).” [40]

This duty was seen in the past in the case of the Re Englefield Colliery Co [41] , where a director was held liable to pay back the money to the company. [42] About the exercising of independent judgment recently in the case of the Crowther Group Plc v International Plc [43] , the court said that the directors has to decide what is in the interest of the company and should do what they think is good for the company. [44]

It is fettering the directors’ discretion to make him do his directorial job in a certain way by his job contract that he cannot changed those decisions which are contrary to the interest of the company. [45]

Duty to exercise reasonable skill and diligence

Romer J in the Re City Equitable Fire Insurance CO [46] said that in order to ascertain the directors’ duties it is necessary to take into consideration the nature of the business of the company. It is also important to know the manner in which the work of the company is distributed amongst the directors and the officials.

He said further

“In discharging those duties, a director (a) must act honestly, and (b) must exercise such degree of skill and diligence as would amount to the reasonable care which an ordinary man might be expected to take, in the circumstances, on his own behalf. But, (c) he need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience; in other words, he is not liable for mere errors of judgment; (d) he is not bound to give continuous attention to the affairs of his company; his duties are of an intermittent nature to be performed at periodical board meetings, and at meetings of any committee to which he is appointed, and though not bound to attend all such meetings he ought to attend them when reasonably able to do so; and (e) in respect of all duties which, having regard to the exigencies of business and the articles of association, may properly be left to some other official, he is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly.” [47]

In the case of Re D Jan of London [1993] B.C.C, the director was acting in honesty and signed the form given to him, but nevertheless he was in breach of his duty of care to his company. The question that how much care and skill the director must show was dealt by Hoffman J in the case of the Norman v Theodore Goddard [1991] BCLC 1028; he said that the amount of care which a director must show in executing his duties is the care that may reasonably be expected from a person carrying out those obligations. [48]

Duty to avoid conflict of interest

According to section 175 of the CA 2006, the directors must act in a manner to avoid the conflicts of his own interest to that of the company. This applies to such kind of situation like the exploitation of the property, information or available opportunity of the company and the way in which the company can or cannot take any benefit of such opportunity, information or property. [49] This duty of the director is based on two equitable principles, the non-conflict and the no profit rules and it treats the no profit rules as a part of the non conflict rule. In fact the most important situation in which the non conflict and the non profit rules applied in equity are excluded from s 175 by s 175(3). [50] Lord Herschell said regarding the conflict of interest in the case of Bray v Ford [51] as the following,

“It is an inflexible rule of a Court of Equity that a person in a fiduciary position, such as the respondent’s, is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict.” [52]

This section has replaced the well known rules of non conflict in the Aberdeen Railway Co v Blaikie Bros [53] , the rule applies where the director sells to the company, his own property. When a director makes profit from his position it can also leads to the conflict of interest. [54] The case of the Cooks v Deeks [55] is a good example in which the directors got an opportunity to make a personal profit by forming a new company. [56] In this case majority of the Directors without informing Deeks got a new contract with the Canadian Pacific Railway. The directors formed a new company and carry it out. The Privy Council order the new company and the majority of the directors to account to the Toronto construction company for the profit made from the contract. [57] This case Lord Buckmaster LC said that,

“It is quite right to point out the importance of avoiding the establishment of rules as to directors’ duties which would impose upon them burdens so heavy and responsibilities so great that men of good position would hesitate to accept the office. But, on the other hand, men who assume the complete control of a company’s business must remember that they are not at liberty to sacrifice the interests which they are bound to protect, and, while ostensibly acting for the company, divert in their own favour business which should properly belong to the company they represent.” [58]

The principle that a person having a fiduciary position should not make a profit out of it, applies to the directors in the same manner, despite the fact that the position of the director is not like that of a trustee. In the case of the Regal (Hasting) v Gulliver [59] the four directors made some incidental profit because of their position as being the directors. The court made them accountable for their profit although they worked in a bona fide manner. The reason was given that fraud and lack of good faith were immaterial to the directors’ liabilities. The new owner of the Regal would receive a windfall, and this would lead to the reduction of the shares’ price, paid by them for their share, as stated by Lord Porter. [60]

The Bhullar v Bhullar [61] is one of the important cases in which two brothers M and S were having company which was later on divided between their wives and sons. The family relations broke down and discussed to split the company. On the next door one of the properties was on sale and it was purchased on the name of a company controlled by them. The family brought an action on the basis of the breach of a fiduciary duty. The court held that it was a breach of the fiduciary duty and that the property held is on trust for the company and orders them to return the property to the company at cost and to be accountable for any profit. The same decision was upheld by the court of appeal. [62]

The rule of the corporate opportunity in Bhullar is neither based on the property misuse nor on the breach of the confidential information. The decision is based on the ordinary rule of the conflict of interest, because if the opportunity would have not used by the director for his personal gain, it would have been in the greater interest of the company. This decision also shows the general duty of the director to be loyal enough to the company to pass on the information he/she have, because it may be in the interest of the company to know. [63]

Duty not to accept benefit from third parties

This section has forbidden a director to exploit his position of being a director and has made illegal the acceptance of any benefits like bribes. The accepting of a benefit creates a conflict of interest scenario which comes under the ambit of the duty to avoid conflict of interest. The duty not to accept benefit from third party is not subject to be authorised by the board [64] , but accepting of benefit from third party can be authorised by the company. [65] This duty continues for a person who has ceased to be a director because as regards things done or omitted before his cease to be a director. [66]

Duty to declare an interest in proposed transaction or arrangement with the company

The directors with direct or indirect interest in the transaction planned by the company must declare the nature and extent of those interests to the other directors, save it is an interest, or involves a transaction regarding which the director do not have any knowledge. According to section 180, subject to the company constitution, if the director act in accordance with section 177, the transaction is not liable to be set aside by virtue of the usual equitable rules requiring the assent of the company’s members. If the director fails to act according to this rule then there is the remedy under section 178. If the company enters into impugned business deal then the director is obliged under section 182 to disclose in the expressed terms. [67] The equitable rule said by Lord Cranworth in Aberdeen Railway Co. v. Blaikie Brothers [68] that in a corporate transaction in which the director has an interest is voidable at the option of the company. This rule of equitable principles known as the self dealing transaction will still be avoided even if the directors act good faith in the interest of the company. [69]

Conclusion

The Company Act 2006 has introduced a codified set of duties for the directors of the company. As the directors has certain duties to the company and the shareholders as they form a company has got more powers in order to make the director accountable for their being undutiful and for the misuse of the power conferred on them by CA 2006. The directors have duty to work within their power and exercise reasonable care and skill as it is expected from them. The directors are also accountable to the creditors of the company in the case of the insolvency of the company. It is now expected more than ever from the directors of a company to act in good faith for the greater interest of the company.