Company Law

Directors, being the principal management organ of the company, must act for its benefit and they therefore occupy a fiduciary position. Their fiduciary status can be traced to the origins of the modern company when companies were established by a deed of settlement that generally declared the Directors to be trustees of the funds and assets of the business venture. The courts thus had a ready-made template in the form of trustee liability that was harnessed in order to frame fiduciary duties of Directors.[1] However, In order to answer this question it is necessary to discuss the changes, which displaces the common law principles. The Companies Act 2006, ss170 to 177 Provides wider provisions of director’s duties. Only sections 171 to 174 come into operation on 1st October 2007. However, before attempt to answer this question it needs to discuss director’s duty at common law.

The fiduciary duties of directors:
In broad terms the duties can be distilled into three propositions: Firstly, directors are under a duty to act bona fide in the interests of the company. Secondly, to exercise their powers under company’s constitution for the proper purpose. Finally, to avoid conflict of interests and to profit from their position.

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i) To act bona fide in the interest of the company:
The pivotal duty of a director is to act and in good faith in the best interest of the company. Directors are therefore precluded from exercising their powers to further their own interests or interests of the third party. The classic formulation was made by Lord Greene MR in Re Smith & Fawcett Ltd[2], who said that ‘directors must exercise their discretion bona fide in which they consider – not what a court may consider – is in the interests if the company…’ As in apparent from this statement, the court will not substitute its own view about which course of action the directors should have taken in place of the boards own judgment – to this extent the duty is subjective.[3]

Over-arching nature of duty is illustrated by the decision of the Supreme Court of Canada in Sun Trust co. v Begin[4]. The court stated that self-dealing on the part of directors and giving preference to one shareholder group over and above the shareholders as a whole are types of motivation which could lead a court to conclude that the directors had not acted in good faith for the benefit of the company.

The duty of good faith operates to prevent directors fettering their discretion by, for example, contracting with a third party as to how a particular discretion conferred by the article will be exercised. However, where the board is able to establish that it was in the best interests of the company to enter into such an agreement, the duty would not be broken. For example, the directors may be able to point to some commercial benefit accruing to the company as a result of their undertaking to the third party.

Provided director’s act in good faith and in the interest of the company and are not willfully  Blind to the company’s interests they will not be liable for breach of fiduciary duty if they make a mistake and act unreasonably, but may be liable for breach of their duty of care (Colin Gwyer & Associates Ltd v London Wharf  (Limehouse) Ltd (above), per Leslie Kosmin QC, sitting as a deputy judge in the High Court).

ii) Secondly, to exercise their powers under company’s constitution for the proper purpose:

In Re Smith & Fawcett Ltd Lord Greene MR went to add that Directors must not exercise their powers for any “collateral purpose”. This is called the proper purpose doctrine. The facts of Extrasure Travel Insurances Ltd v Cohen[5], afford a clear illustration of a power being exercised for an improper purpose. More generally, however, the issue of whether Directors have used a power for a proper purpose arises in relation to their authority to issue shares. If shares are allotted in exchange for cash where the company is in need of additional capital the duty will not be broken. But where Directors issue shares in order to dilute the voting rights of an existing majority shareholder because he or she is blocking a resolution supporting, for example a takeover bid, then the duty will be breached.

The Privy Council in Howard Smith Ltd v Ampol Petroleum Ltd[6], subjected the content of the duty to through scrutiny. The Directors allotted shares to a company, which had made a takeover bid. The effect of the shares was to reduce the majority holding of two other shareholders who had made a rival bid from 55 percent to 36 percent. The two shareholders sought declaration that the share allotment was invalid as being an improper exercise of power. The directors argued, however, that the allotment was made primarily in order to obtain much needed capital for the company. The court held that it must be unconstitutional for Directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority, or creating a new majority, which did not previously exist.

To avoid conflict of interests and to profit from their position:

Directors must not place themselves in a position whereby their personal interests conflict with their duties to the company. Breach of this renders the Director liable to account for any profit he obtains in circumstances where his interests may conflict with his duty to the company. In Re Lands Allotment[7]; and JJ Harrison (Properties) Ltd v Harrision[8], confirming that a Director holds the proceeds made from a breach of fiduciary duty as constructive trustee. A ‘conflict transaction’ entered into by a Director is void able at the company.

Now it needs to discuss Companies Act 2006.  One of the core objectives of the Companies Act 2006 was the change of the rights of minority shareholders and to make directors more liable to the shareholders they represent. However, if they fail in their duties, the introduction of enhanced rights for a shareholder at present means that they can take definite action against them. The Act makes a range of significant changes to shareholder rights, which thread through the different areas that the Act covers.[9] Now the Companies will be allowed to check on whether or not the beneficial owner wishes to retain information rights on an annual basis. Any failure to respond to such a check within 28 days will mean that the company can assume that the rights have lapsed.

For the first time, all the duties owed by directors to their company have been set out in statute, in Part 10 (ss.170–177) of the new Act. The general duties are duty to act within powers, duty to promote the success of the company, duty to exercise reasonable care, skill and diligence, duty to exercise independent judgment, duty to avoid conflicts of interest, duty to declare interest in proposed transaction or agreement, and duty not to accept benefits from third benefits etc. if they do not follow this section minority shareholders can take action against directors. So it can be said, that the rights of minority shareholders have been improved by the enactment of the Companies Act 2006.

Before attempt to discuss Directors Duty it need to say that CA2006 does not contain a specific definition of the term “director”.[10] However, there is a general provision in section 250 of CA 2006, which states that the expression “director” includes “any person occupying the position of director, by whatever name called”, which includes a person who is treated by the board as such despite not having been validly appointed[11]. The law also recognises the concept of shadow director, which is defined by section 251. They may be held liable for his acts, particularly in cases of insolvency or where wrongful or illegal trading is alleged.

Section 171 of Companies Act 2006 states that 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.

The constitution of the company is one or more documents setting out the rules by which the company is to be operated (generally the memorandum and articles of association, although under the Act now simply the “constitution”). While the constitution is subject to the Act, it sets out what powers directors have and how they are to exercise them. Directors must abide by these rules. If this power is given for one purpose, they cannot exercise it for a different proper purpose, even if they think that to do so would be in the best interests of the company.[12]

Section 172 of Companies Act 2006 introduces significant change in common law. This Act states that duty to promote the success of the company. Section 172(1) 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.

Previously it was described that the director had to act bona fide in the best interests of the company. By this Act, the obligation of good faith remains and it is the interests of the company, defined as the benefit of its members as a whole, which must be advanced.[13] The director must now have regard to the definite matters set out in section 172(1)(a)-(f). While competent directors have previously had regard to these specific matters, that process is now part of the directors’ statutory obligation. It is important to note that Section 172(3) makes it clear that the statutory duties set subject to certain obligations of directors to act in the interests of creditors when the circumstances arise. The Act does not expressly require directors to have considered to the interests of creditors. Under CA 2006, directors remain responsible for the company’s relationship with its creditors. Where necessary they take reasonable steps and professional advice should be taken.

According to this act a director who gives proper consideration to the statutory matters will not be in breach of the duty to have regard to them.[14] If a director who pays lip service to the list of matters, but gives no proper consideration to them will be in breach of duty.

Section 173 of Companies Act 2006 states that duty to exercise independent judgment[15]

Section 173 CA 2006 does not represent a significant change in the law. Under this act a director must act in the interests of the company. If a director to act in accordance with the instructions of some other person, it will usually be a breach of duty. Usually Director is allowed to look after the interests of their appointer, but only in so far as that is compatible with the interests of the company.[16]

Section 174 of Companies Act 2006 states that duty to exercise reasonable care, skill and Diligence. Section 174(1) provides a director of a company must exercise reasonable care, skill and diligence.

However, this section does not represent a significant change in the common law. Directors must continue to act with reasonable skill and care. The duty also imposes that if they have special skills or knowledge then they will be expected to exercise them. Hence or otherwise they will be measured against the standard of a reasonable person occupying their position.[17] It is necessary to say that non-executive directors are expected to have a reasonable degree of knowledge and competence. All directors should give the company the full benefit of their knowledge and actual experience. The remedy for a breach of section 174, (duty to exercise reasonable care, skill and diligence) which states under section 178, usually be damages. Remedies for breaches of other general duties may include- setting aside of the transaction, restitution an injunction, and account of profits, restoration of company property held by the director, damages, and/or termination of the director’s service contract.

Section 175 of Companies Act 2006 states that duty to avoid conflicts of interest. The Act generates a new, positive duty to avoid unauthorised conflicts of interest. The Act also allows conflicts of interest to be authorised by directors instead of by shareholders. The most important think is that where directors may face a conflict of interest until 1 October 2008,[18] it will continue to be possible for them to place themselves in a position. However, in such a case, directors must be specifically authorised by the board to allow them to continue to act after passing that date. Consequently, from 1 October 2008, all directors who face actual or possible conflicts of interest by virtue of their position must either or remove the possibility of the conflict, obtain authority to act, or resign as directors. In every case, they should, disclose full details of any interest they have in a proposed transaction by the company. Directors are allowed to take part in decisions in which they are interested or to enter into contracts with the company, so they should understand the constitution of the company. However, where a director proposes to enter into some transaction with the company itself, s.175 does not deal with cases other than if permitted under the constitution of the company and also subject to making proper disclosure to the board under section 177.

Section 176 of Companies Act 2006[19] introduces The “No Bribe” Rule that means duty not to accept benefits from third parties.

For the first time, the Act sets out a statutory rule against directors accepting benefits from third parties. However, directors have always been required to account for benefits received by them so this rule makes little difference to the law. For example, the procurement director is taken by a prospective supplier on an all expenses paid holiday. This would be a breach of duty. However, gift could not reasonably be thought breach of the section. They should ensure that under the constitution of the company, they do not receive any benefits not provided for, or allowed. The only exceptions will be benefits that are so minor such as gift. It is fundamental that directors have to be completely transparent with their shareholders as well as with their boards as to the benefits that are received. Corporate hospitality should be scrutinized critically in the light of s. 176.

Section 177 of CA 2006[20] states that the duty to declare interest in proposed transaction or arrangement if a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors. This Section will replace the equitable rule that directors may not have an interest in a transaction with the company unless the interest has been authorised by the members. The director need not be a party to the transaction for the duty to apply. Before the company enters into the transaction or arrangement, the declaration must be made. However, until 1 October 2008 the equitable rule will continue to apply.

If directors are shown to be unfit to be a director of a company, they may be disqualified. Under the Company Directors Disqualification Act 1986, Directors should be aware that they might in certain circumstances be liable to disqualification.[21] This Act also deals with Non-executive directors.

Conclusion:

Section 171 of CA 2006 states that Directors has to be exercised their powers for appropriate purposes. Section 172 of Companies Act 2006 states that Duty to promote the success of the company. Directors may be subject to criticism if the directors do close the plant, by factory employees, politicians, unions, environmental and human rights groups. On the other hand, they may be subject to criticism by shareholders and other groups if they do not close down the plant. Section 172(3) makes it clear that the statutory duties set subject to certain obligations of directors to act in the interests of creditors when the circumstances arise. Section 173 and 174of CA 2006 does not represent a significant change in the law. Section 175 of CA 2006 deals with conflict interest, which is particularly complicated. By this Act directors should take legal advice where necessary. Section 176 sets out for the first time a statutory rule against directors for benefits from third parties. From the above discussion it can be said that CA 2006 enhance the common law as specific statutory format.

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