Duties of company directors - Companies Act 2006
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Introduction
Rt. Hon Margaret Hodge MP MBE,
Minister of State for Industry and the Regions
I know that the new statutory duties of directors set out in Part 10 of the
Companies Act 2006 were keenly debated while the Bill was going through
Parliament, and I am sure they will continue to be seen as one of the most
significant parts of the Act.
During those debates, I and the other Ministers were questioned about the
meaning of the provisions. Some of our responses and statements may be helpful
to people interested in what the provisions mean, and I am pleased to be
publishing this structured collection of what we believe are the most useful of
them.
There are two ways of looking at the statutory statement of directors’
duties: on the one the hand it simply codifies the existing common law
obligations of company directors; on the other – especially in section 172: the
duty to act in the interests of the company – it marks a radical departure in
articulating the connection between what is good for a company and what is good
for society at large.
Continuity
The statutory expression of the duties is essentially the same as the
existing duties established by case law, the only major exception being the new
procedures for dealing with conflicts of interest.
The simple high-level guidance for directors in the box on the following page
illustrates the way in which the codification maintains continuity with the
existing law: this advice on how a director has to live up to his position of
trust is applicable to the pre-existing common law as well as to the new
codification. For most directors, who are working hard and put the interests of
their company before their own, there will be no need to change their behaviour.
Guidance for company directors–
1) Act in the company's best interests, taking everything you think relevant
into account
2) Obey the company’s constitution and decisions taken under it
3) Be honest, and remember that the company's property belongs to it and not
to you or to its shareholders
4) Be diligent, careful and well informed about the company's affairs. If you
have any special skills or experience, use them
5) Make sure the company keeps records of your decisions
6) Remember that you remain responsible for the work you give to others.
7) Avoid situations where your interests conflict with those of the company.
When in doubt disclose potential conflicts quickly
8) Seek external advice where necessary, particularly if the company is in
financial difficulty
Change
But compared with most text-book definitions of the common law duties of
directors, the new statutory statement captures a cultural change in the way in
which companies conduct their business. There was a time when business success
in the interests of shareholders was thought to be in conflict with society’s
aspirations for people who work in the company or in supply chain companies, for
the long-term well-being of the community and for the protection of the
environment. The law is now based on a new approach. Pursuing the interests of
shareholders and embracing wider responsibilities are complementary purposes,
not contradictory ones.
I strongly believe that businesses perform better, and are more sustainable
in the long term, when they have regard to a wider group of issues in pursuing
success. That is a common-sense approach that reflects a modern view of the way
in which businesses operate in their community: they interact with customers and
suppliers; they make sure that employees are motivated and properly rewarded;
and they think about their impact on communities and the environment. They do so
at least partly because it makes good business sense.
The new expression of the duties is part of the wider recognition and
encouragement of change in the Act. The enhanced business review, which for
quoted companies must now include information on environmental, employee, social
and community issues, is another key example that builds on the growing
consensus that it is good business sense for companies to embrace wider social
responsibilities.
I am sure that directors’ duties will continue to evolve as times change and
as societal norms are transformed. Corporate social responsibility has developed
and evolved over time. The relationship between business interests and the wider
world is changing all the time. The best way of achieving lasting cultural
change is to go with the tide and the broad consensus of opinion.
Margaret Hodge
Notes on the ministerial statements
The quotations should be read in conjunction with the Act itself (available
in hard copy at www.tshop.co.uk or online at www.opsi.gov.uk) and should not be
regarded as a substitute for reading that Act or seeking legal advice. Full
explanatory notes on the provisions of the Act are also available at
www.tsoshop.co.uk and at www.opsi.gov.uk together with tables of origins and
destinations for the Act’s provisions.
It should be noted that on occasion the Parliamentary quotes have been edited
in order to make it easier to read them. References to Hansard have been given
so the full discussion can be seen if so desired.
Companies Act 2006 – duties of directors
Collated Hansard extracts from debates on Companies Bill (originally
Company Law Reform Bill)
Background
“The law commissions and the Company Law Review concluded that a statutory
statement of duties would be helpful…it is important that…flexibility and
ability to note changing circumstances are not lost”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 242
“First….the origins of the general duties [is] …that they are based in
certain common law rules and equitable principles…the statutory statement
replaces the common rule equitable principle…once the Act is passed, one will go
to the statutory statement of duties to identify the duties to identify the duty
the director owed”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 243
“…the main purpose in codifying the general duties of directors is to make
what is expected of directors clearer and to make the law more accessible to
them and to others”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 254
“We should remind ourselves that being a company director is a wonderful
thing for the person who is a company director. But it is a position of great
responsibility which involves running the affairs of a company for the benefit
of other people. It is a heavy responsibility we should not water down”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 291
Interpretation by the courts
“The courts should be left to interpret the words Parliament passes”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 243
“Although the duties in relation to directors have developed in a distinctive
way, they are often manifestations of more general principles…[it] is intended
to enable the courts to continue to have regard to development in the common law
rules and equitable principles applying to these other types of fiduciary
relationships.
The advantage of that is it will enable the statutory duties to develop in
line with relevant developments in the law as it applies elsewhere.”
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 244
Effect of codification
“One proposition [is] that the result of this codification will be increased
litigation. That is not how we see it…as in existing law, the general duties are
owed by the director to the company. It follows that, as now, only the company
can enforce them. Directors are liable to the company for loss to the company,
and not more widely. It is quite rare for companies to sue their directors for
breach of duty. That may well continue to be the position.”
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 242
Effect of the provision of new duties
“[On] the provision of new duties, we do not see why that should lead to
increased litigation either. For example…the need to have regard to the
interests of employees as part of the main duty to promote the success of the
company…was part of case law before becoming statute. It is an important
principle, and plays a crucial part in business decisions …however…there is not
evidence of which we are aware that it has led to legalistic decision making by
companies, or people turning away from bringing their talent to the world of
enterprise. We have no reason to expect that there will be a greater degree of
litigation on those duties than there is now”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 243
Statement of general duties
“The statement of general duties…is not intended to be an exhaustive list of
all the duties owed by a director to his company. The directors may owe a wide
range of duties to their companies in addition to the general duties listed.
Those are general, basic duties which it is seen as right and important to set
out in this way. The statement that these are the general duties does not allow
a director to escape any other obligation he has, including obligations under
the Insolvency Act 1986.”
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 249
Enlightened shareholder value
“The Company Law Review considered and consulted on two main options. The
first was “enlightened shareholder value”, under which a director must first act
in the way that he or she considers, in good faith, would be most likely to
promote the success of the company for its members…The Government agrees this is
the right approach. It resolves any confusion in the mind of directors as to
what that the interests of the company are, and prevents any inclination to
identify those interests with their own. It also prevents confusion between the
interests of those who depend on the company and those of the members”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255
“For the first time, the Bill includes a statutory statement of directors’
general duties. It provides a code of conduct that sets out how directors are
expected to behave. That enshrines in statue what the law review called
“enlightened shareholder value”. It recognises that directors will be more
likely to achieve long term sustainable success for the benefit of their
shareholders if their companies pay attention to a wider range of
matters…Directors will be required to promote the success of the company in the
collective best interest of the shareholders, but in doing so they will have to
have regard to a wider range of factors, including the interests of employees
and the environment”.
Alistair Darling, Commons Second Reading, 6 June 2006, column 125
Duty to promote the success of the company
“What is success? The starting point is that it is essentially for the
members of the company to define the objective they wish to achieve. Success
means what the members collectively want the company to achieve. For a
commercial company, success will usually mean long-term increase in value. For
certain companies, such as charities and community interest companies, it will
mean the attainment of the objectives for which the company has been
established”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255
“…for a commercial company, success will normally mean long-term increase in
value, but the company's constitution and decisions made under it may also lay
down the appropriate success model for the company. … it is essentially for the
members of a company to define the objectives they wish to
achieve. The normal way for that to be done—the traditional way—is that the
members do it at the time the company is established. In the old style, it would
have been set down in the company's memorandum. That is changing … but the
principle does not change that those who establish the company will start off by
setting out what they hope to achieve. For most people who invest in companies,
there is never any doubt about it—money. That is what they want. They want a
long-term increase in the company. It is not a snap poll to be taken at any
point in time.”
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 258
“…it is for the directors, by reference to those things we are talking about
– the objective of the company – to judge and form a good faith judgment about
what is to be regarded as success for the members as a whole….they will need to
look at the company’s constitution, shareholder decisions and anything else that
they consider relevant in helping them to reach that judgement…the duty is to
promote the success for the benefit of the members as a whole – that is, for the
members as a collective body – not only to benefit the majority shareholders, or
any particular shareholder or section of shareholders, still less the interests
of directors who might happen to be shareholders themselves. That is an
important statement of the way in which directors need to look at this judgement
they have to make”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 256
“…we have included the words “amongst other matters”. We want to be clear
that the list of factors [for a director to have regard to] is not exhaustive”.
Lord Goldsmith, Lords Grand Committee, 9 May 2006, column 846
“The clause does not impose a requirement on directors to keep records, as
some people have suggested, in any circumstances in which they would not have to
do so now.”
Margaret Hodge, Commons Committee, 11 July 2006, column 592
“The Government believe that our enlightened shareholder value approach will
be mutually beneficial to business and society. We do not, however, claim that
the interests of the company and of its employees will always be identical;
regrettably, it will sometimes be necessary, for example, to lay off staff. The
drafting … must therefore clearly point directors towards their overarching
objective. We have made it clear that [the clause] will make a difference, and a
very important difference.
The words “have regard to” mean “think about”; they are absolutely not about
just ticking boxes. If “thinking about” leads to the conclusion, as we believe
it will in many cases, that the proper course is to act positively to achieve
the objectives in the clause, that will be what the director’s duty is. In other
words “have regard to” means “give proper consideration to”…
Consideration of the factors will be an integral part of the duty to promote
the success of the company for the benefit of its members as a whole. The clause
makes it clear that a director is to have regard to the factors in fulfilling
that duty. The decisions taken by a director and the weight given to the factors
will continue to be a matter for his good faith judgment.
Margaret Hodge, Commons Report, 17 October 2006, column 789
Duty to exercise independent judgement
“…the clause does not mean that a director has to form his judgement totally
independently from anyone or anything. It does not actually mean that the
director has to be independent himself. He can have an interest in the matter…It
is the exercise of the judgement of a director that must be independent in the
sense of it being his own judgement…The duty does not prevent a director from
relying on the advice or work of others, but the final judgement must be his
responsibility. He clearly cannot be expected to do everything himself. Indeed,
in certain circumstances directors may be in breach of duty if they fail to take
appropriate advice – for example, legal advice. As with all advice, slavish
reliance is not acceptable, and the obtaining of outside advice does not absolve
directors from exercising their judgement on the basis of such advice”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 282
Standard of care owed by a director
“…the standard of care which a director owes is enormously important…it is
now accepted that the duty of care…is accurately stated in Section 214(4) of the
Insolvency Act 1986….Under the clause you take account both of the general
knowledge, skills and experience that may be reasonably expected of a person
carrying out those functions and the general knowledge, skills and experience
that that director has. It is a cumulative requirement…I want to emphasise the
point that it is not making a change from what is already the common law”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 284
Duty to avoid conflicts of interest
“…the law already recognises that potential conflicts in certain
circumstances are to be avoided…there is currently no absolute rule prohibiting
directors from holding multiple directorships or even from engaging in business
that competes with the company of which they are a director, but obviously a
tension results from that degree of tolerance and the fiduciary duties which the
director owes. The solution to it is…there is no prohibition of a conflict or
potential conflict as long as it is has been authorised by the directors in
accordance with the requirements set out in [the Act]”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 288
“…we do not say that this should happen just because in the mind of a
director it is all right; there should be a process for the company, through its
members or directors, to make that decision, and that is what these new
regulations permit”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 289
“Following consultation, the Government have already adjusted the
provision…to use instead the expression “if the situation cannot reasonably be
regarded as likely to give rise to a conflict of interest”. This introduces the
concept of reasonableness which makes the situation easier from the point of
view of a director and avoids a very harsh test, although it is still a heavy
duty and intended to be so.”
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 293
“So far as private companies are concerned, the default position is that the
directors may authorise the matter unless there is a provision in the company’s
constitution saying otherwise. In the case of a public company…[d]irectors may
authorise the matter only if the company’s constitution includes provisions
saying they can do so. It must follow that if the constitution does not do so,
steps will have to be taken to amend it to that effect and the members of the
company will be able to take a view about whether they think that is a good
move”.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 294
“…the authorisation has to be given without relying on the votes of directors
seeking the authorisation or any other director with an interest in it….Those
directors cannot count towards the quorum either….[and] any requirements under
the common law for what is necessary for a valid authorisation remain in
force…Finally, in general terms, the directors who are giving the authorisation
will need to comply with the general duties imposed on them. Those will include,
specifically, the general duty…to act in such a way that in good faith they
consider that authorisation is the course of action most likely to promote the
success of the company”.
Lord Goldsmith, Lords Grand Committee, 9 February 2006, column 327
“…the duty does not apply if the situation cannot reasonably be regarded as
being likely to give rise to a conflict of interest. If the matter falls outside
the ambit of the company’s business, a real conflict of interest is unlikely”.
Lord Goldsmith, Lords Grand Committee, 9 May 2006, column 864
“…the company’s articles may contain provisions for dealing with conflicts of
interests, and directors will not be in breach of duty if they act in accordance
with those provisions. Examples might include arrangements whereby the directors
withdraw from any board meeting at which the matters relating to conflicts of
interest are discussed…our amendments will allow all the normal, perfectly
acceptable, lawful ways in which companies and their directors deal with
conflicts of interest to continue.”
Lord Sainsbury of Turville, Lords Report, 23 May 2006, column 722
Duty not to accept benefits from third parties
“…the purpose of the clause…is to impose on a director a duty not to accept
benefits from third parties. It applies only to benefits conferred because the
director is a director of the company or
because of something that the director does or doesn’t do as director. The
word “benefit”…includes benefits of any description, including non-financial
benefits.
The clause codifies…[the] long-standing rule, prohibiting the exploitation of
the position of director for personal benefit. It does not apply to benefits
that the director receives from the company, or from any associated company, or
from any person acting on behalf of any of those companies….I…draw attention to
the fact that benefits are prohibited by the duty only if their acceptance is
likely to give rise to a conflict of interest”.
Lord Goldsmith, Lords Grand Committee, 9 February 2006, column 330
Duty to declare interest in proposed transaction or arrangement
“[This] clause…is deliberately intended to apply only to proposed
transactions…if a company is told that a director has an interest in a proposed
transaction, it can decide whether to enter into the transaction, on what terms
and with what safeguards.
[As for] “a director is treated as being aware of matters he ought reasonably
to be aware”...I believe that the test is objective – that is, one judges
objectively whether this is a matter of which the director ought to be aware
reasonably”.
Lord Goldsmith, Lords Grand Committee, 9 February 2006, column 334
Civil consequences of breach of general duties
“…we take the view that the “duty to exercise reasonable care, skill and
diligence” is not a fiduciary duty. It may be owed by someone who is a
fiduciary. But that is not the same thing. ..It is important to keep to the
principle that these are enforceable in the same way as any other fiduciary duty
owed to the company by its directors.”
Lord Goldsmith, Lords Grand Committee, 9 February 2006, column 336
Consent, approval or authorisation by members
“[The Bill] permitted director authorisation of what would otherwise be
impermissible conflicts of interests [and]…required declarations of interest in
proposed company transactions. In both those cases, the general duty no longer
requires the consent of the members. The common law rules or principles that
refer to the failure to have had a conflict of interest approved by the member
of a company under certain circumstances need to be set aside….However…the
company’s constitution can reverse the change and can insist on certain steps
being taken requiring the consent of the members in certain circumstances”.
Lord Goldsmith, Lords Grand Committee, 9 February 2006, column 337
Indemnifying directors
“…the starting point for our reform package was a principle…that companies
should be prohibited from exempting directors from, or indemnifying them
against, liability for negligence, default, breach of duty or breach of trust in
relation to the company. However the reform package also recognised that
companies should be permitted to indemnify directors in respect of third-party
claims in most circumstances…There are four main possible exceptions to
indemnification: criminal penalties; penalties imposed by regulatory bodies:
costs incurred by the director in defending criminal proceedings in which he is
convicted; and costs incurred by the director in defending civil proceedings
brought by the company in which final judgement is given against him”.
Lord Goldsmith, Lords Grand Committee, 9 February 2006, column 364
”[The Companies (Audit, Investigations and Community Enterprise) Act
2004]…closed an important loophole concerning the indemnification of directors
by third parties. It used to be the practice in some groups that one group
company would indemnify the director of another group company...in effect to
circumvent the rule that the company could not indemnify its own directors. We
take the view that… continu[ing] to make directors properly accountable for what
they do in relation to the company…should stand”.
Lord Goldsmith, Lords Grand Committee, 9 February 2006, column 366
“It is also important to remember that at the same time as the loophole was
closed, important reforms were introduced that permit all companies to indemnify
directors against third-party claims, subject to… [certain] requirements.
Although we agree that indemnification by a parent company of the directors is
less likely to result in attempts at circumvention of the prohibition than
indemnification by a wholly owned subsidiary company of the director of a
holding company, we still believe there is scope for mischief. We cannot…accept
[any] amendment”.
Lord Sainsbury of Turville, Lords Report, 23 May 2006, column 724
Shadow directors
“The law is still developing. It would not be right for the general duties
not to apply at all to a shadow directors, but the law may develop in such a way
that some do and some don’t. It is right to leave those areas, as now, to the
courts…”
Lord Goldsmith, Lords Grand Committee, 9 May 2006, column 828
About the Author
© Crown Copyright. Material taken from the BERR- Department for Business, Enterprise and Regulatory Reform replacing DTI - Department for Trade and Industry. Reproduced under the terms and conditions of the Click-Use Licence.
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Article Published/Sorted/Amended on Scopulus 2007-10-11 16:26:39 in Business Articles
