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New codification of directors duties
This paper discusses on whether the new codification of directors’ duties in the Companies Act 2006 gives a true reflection of the previous common law. It also considers whether the objective of codifying the directors’ duties has been achieved. The main reason for the codification was to make it much easier for directors to be aware of and understand their responsibilities and hence improving standard of governance.
Directors and their responsibilities prior to enactment of the Companies Act 2006
A director is not strictly a trustee in respect of the company’s property but he may come under the same liability as a trustee. In Re Lands Allotment Co, Lindley LJ said,
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…
It is well established that directors, as an individual or in group, are fiduciaries. The term fiduciary has no exact definition in itself but the characteristic of a fiduciary relationship can be identified and the principle duties stated. Per Millett LJ in Bristol and West Building Society v Mothew,
A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstance which give rise to a relationship of trust and confidence… A fiduciary must act in good faith, he must not place himself in a position where his duty and his interest may conflict, he may not act for his own benefit or for the benefit of a third person… This is not intended to be an exhaustive list, but is sufficient to indicate the nature of fiduciary obligations…
Since time immemorial, fiduciary duties have been expected from directors of companies. Before the Companies Act 2006 was enacted, directors’ duties were scattered in several of leading case law opinions and precedents. Judges have enforced a stringent, rigid and a widespread quantity of fiduciary duties against directors for the importance of the role of responsibility and trust entrusted in them. In contrast; common law duties of skill and due care have conventionally proved considerably more lenient when applied to incompetent directors.
Companies Act 2006 and the codified law on directors’ duties
The Companies Act 2006 is one of the biggest legal reforms ever to face businesses, involving eight years of consultation. One of the most significant changes in the new Companies Act purports to the codification of the equitable principle of fiduciary duty and the common law of negligence as they apply to directors. The list of codified duties is contained in section 170 to 181 of the new Act.
In the introduction, we were concerned whether the codified directors’ duties give a true reflection of the previous common law and preceding law cases. It is in fact stated in the Act, in section 170 (3) that;
“The general duties are based on certain common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director."
A system based on common law is often regarded as highly adaptable and adjustable whereas a system based on statute or codification tends to be less flexible and offers fewer opportunities to establish new elements in areas where law is not well settled. However, section 170 (4) of the Act, attempts to bind together the clarity, accessibility and comprehensibility that the codification brings and the adaptability and versatility of the common law. Section 170 (4) of the Act states the following;
“The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties."
It can thus be interpreted that the new Act somehow gives a true reflection of the common law. We will now examine section 171 to 177 and discuss on whether it mirrors the previous common law principle.
Section 171 stipulates;
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.
In Hogg v Cramphorn Ltd (1967), the directors of Cramphorn Ltd decided to issue new shares in order to block a takeover bid from Hogg. It was acknowledged in court that the directors were acting in good faith and not in self-interest since they believed that the takeover would be disadvantageous to the company. However, the court held that the issue of the new shares were invalid. The argument being; the power to issue share creates a fiduciary duty and must only be exercised in order to raise capital and not for any other purposes such as to prevent a takeover. It was therefore held that the directors were in breach of their fiduciary duty to the company since they did not exercise power for the purpose for which they were conferred.
The Hogg v Cramphorn Ltd (1967) principle was later applied in the case of Howard Smith Ltd v Ampol Petroleum Ltd (1974) and in various subsequent cases. In 2009, the ruling in the case of Eastford Ltd v Gilliespie and another, has clearly established that the statutory statement in section 171 has not superseded the common law and therefore is a reflection of the common law.
Section 172 of the Act relates to the duty of the directors to promote the success of the company, accompanied by a non-exhaustive list of interest and factors that the director must take into account when performing his duties. This duty was previously expressed in terms of a duty to act bona fide of in what the directors considered to be the interest of the company and not for any collateral purposes.
Section 173 states that a director of a company must exercise independent judgement. A director's ability to fulfil this duty is not impaired if he is required to observe contractual obligations under an agreement entered into by the company which restricts the future exercise of discretion by its directors, or he acts in a way authorised by the company's constitution. Under the common law rules and equitable principles that apply in relation to this particular duty, directors in their powers as fiduciary agents owe a duty to the company to exercise an independent judgement accordingly, Fulham Football Club Ltd v Cabra Estates plc (1994). Directors must not fetter their powers by contracts with or promises to other persons, Clark v Workman (1920). However it does not follow that directors can never make a contract by which they bind themselves to the future exercise of their powers in a particular manner, even though the contract taken as a whole is manifestly for the benefit of the company, High Court of Australia in Thorby v Goldberg (1964).
Section 175 (1) of the Companies Act 2006 provides that a company’s director
must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.
The rest of section 175 gives more details of when a conflict of interest is authorised.
At the common law, the Aberdeen Railway Co v Blaikie Brothers (1854) case laid down that no director is allowed to enter into engagements in which he has, or can have; a personal interest or which may possibly conflict, with the interest of those whom he is bound to protect. We can therefore perceive that the legislation set down in section 175 of the Companies Act 2006 does not depart from the previous common law principles.
The same conclusion can be drawn from section 176 of the Companies Act 2006 which prohibits a company’s director from accepting a benefit (commission, fee or gift) from a third party which has been conferred by reason of him being a director or doing or not doing anything as a director. The judgement from the case of Boardman v Phipps (1967) and Industrial Development Consultants Ltd v Cooley (1972) suggest that the section 176 does not depart from the common law principles.
As stated in section 177 of the Companies Act 2006, company directors are required to declare any personal interest in a proposed transaction or arrangements with the company. Likewise, this provision mirrors the well established common law principle on declaration of personal interest. The common law jurisprudence was previously scattered into different cases: Baker v Gibbons (1972), Newgate Stud Co v Penfold (2004). Scottish CWS v Meyer (1958). Section 177 is thus more accessible and easier to understand than the common law.
Section 174 – Rules on skill and care
Section 174 is one of the most ground-breaking parts of the new 2006 Act in terms of law relating to directors’ duties. Under the traditional common law, a director is under the duty to conduct the business of the company with the same care as an ordinary prudent man of business would extend to his own affairs, Bartlett v Barclays Bank Trust Co Ltd (No 1) (1980).
The main setback with the common law regarding directors’ duty to exercise reasonable care, skill and diligence is that it was dependent on subjective measures.
In Re City Equitable Fire Insurance Co (1925), the three fundamental duties were usefully summarised as follows;
a director need not exhibit in the performance of his duties a greater degree of skill than could reasonably be expected from a person of his knowledge and experience;
a director is not bound to give his whole time and attention to the affairs of the company, for instance by attending every board meeting;
a director may delegate duties in certain circumstances to others.
However, it became clear that the standard of care required at common law proved to be too lax when applied to comparatively recent cases. In Norman v Theodore Goddard (1991) and Re D'Jan of London Ltd (1993), Lord Hoffman argued that the court would required a director to reach a higher standard than that set in Re City Equitable Fire Insurance Co (1925). The test used by Lord Hoffman was derived from the Insolvency Act 1986 and is based on both subjectivity and objectivity.
In Bishopsgate Investment Management Ltd (in liquidation) v Maxwell (No 2) (1993), it was suggested that the law may be evolving in response to changes in public attitudes to corporate governance.
Section 174 of the Companies Act 2006 now states the following;
(1) A director of a company must exercise reasonable care, skill and diligence.
(2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with—
(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
(b) the general knowledge, skill and experience that the director has.
This above section of the new Act brings harmony between the traditional subjective common law and a new objective requirement in the legal regime. With the enactment of the Companies Act 2006, directors will not only be judged according to their competency and experience but will also be judged based on a minimum objective benchmark of performance expected from reasonable professional individual performing the same task.
Relationship between the new statutory framework and the previous common law principle
So far in this paper, the new codified directors’ duties has been examined and compared with the previous common law and common law cases. It can be concluded that there exist a mutually beneficial relationship between the new statutory framework set down in the Companies Act 2006 and the existing common law cases. This mutual relationship will gives assurance on the consistency and continuity of the law and will also allows the law become more powerful using the pre-2006 and post-2006 law regimes.
It is clear that the codification of directors’ duties recommended by the Law Commission and the Scottish Law Commission has brought with it many advantages. The Commissions most important objective for recommending a codification of directors’ duties was to make the law governing on directors more accessible and clear. The new 2006 act has in no doubt accomplished its prime objective of the Commissions.
It is unquestionable that directors will improve their performance if they can now more easily access and understand their legal obligations and are clearly aware of the standard of care and duty expected from them.
The Companies Act 2006 is in compliance with the policies and codes from the UK Corporate Governance Code. The codification of directors’ duties has not only helped to refocus the UK corporate governance regime but it has also facilitated to make it more distinct.
In conclusion, the Law Commission has certainly attained its objective. However the Companies Act 2006 should not be viewed as a universal remedy for the modern UK company law. The current codified statement on directors’ duties indeed gives a true reflection of the common law duties which has been established over 100 of years. Therefore, the court will still need to refer to pre-2006 case law when judging new cases.