Corporate Governance: Directors Duties - Dissertation Example

Corporate Governance: Directors’ Duties Introduction: The Companies Act has been in use for over a hundred and fifty years. This has been designed to provide companies with a framework within which companies with limited liability are required to work within. The Companies Act was replaced on 8th November 2006, which was updated, modernized and rewritten version of the company law. The changes in the act however are to be implemented in the number of different phases and this would end by October 2009. However before moving onto the duties of directors of listed companies it is essential to understand what listed companies are. Listed companies are companies whose shares are quoted on the stock exchange for public trading. Thus duties of directors in these companies are very important and it is essential that these are well understood and followed as well. Background of the Act: “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”1. “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”2. The Companies Act of 2006 is an Act of the parliament of the United Kingdom of Great Britain and Northern Ireland. This is an Act to regulate the companies within the jurisdiction that have been set down by the Act. This act has been known to be the longest in the British Parliamentary history and has almost 1300 sections and covers over 700 pages, which contains lesser then 15 schedules3. The list of the contents is a number of almost 59 pages. The Companies Act of 2006 has been created to override the Companies act of 1985. The old act however does have a number of parts that remain in force until first of October 2009, when the Act of 2006 would be in full swing4. There have however been a number of parts of the act that have been put into force currently. These include important aspect like the meetings, resolutions and also the company directors and secretaries. The Companies Act that has been put into action a comprehensive code of the company law for the UK and this has made a number of changes to almost every feature of the law in relation to the companies. Some of the important provisions are the common law principles which relate to the directors duties. Also the European Union’s Takeover and the Transparency Obligations Directives. There have been a number of new provisions that have been introduced for the private as well as public companies. The new Companies Act of 2006 also to a great extent almost amends and restates all of the Companies Act of 1985. The Bill for the Act has been introduces to the parliament and this was known as the ‘the Company Law Reform Bill’. This was introduced with the intension of making a number of wide ranging changes to the existing statutes. The lobbying from the directors and the legal professions tried to make sure that this was changed to a consolidating Act. This was to ensure that the need for cross referencing would be reduced between a numbers of different statutes. This however has not been well received by the legal professions in the UK5. There have been a number of issues as it is said to have included a number of details to ensure that every eventuality is covered. Although a number of promises for the entire law were promised, it has been noted that a lot of the current structure is still the same, mainly to simplify the job and keep things as simple as possible. However the companies Act in a number of places has shown and caused a number of issues and complications6. This includes even the previously settled law by making them complicated and obfuscated. The next section will deal with an important aspect of the Companies Act which has already been put into action, i.e. the duties of the directors. Evaluation of Directors 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.”7 The companies Act of 2006, has made a number of changes and codified the principal common law and also equitable duties of the directors. However it does not serve the purpose of providing an exhaustive statement of the duties of the directors. This would mean that common law duties that have been followed over the years in a number of terms still hold good for the act. The traditional common law presents a number of corporate benefits which have been swept away due to the introduction an emphasis that has been place on the corporate social responsibility. The duties of the directors as have been codified in the Act are discussed and evaluated below. As per the Freshfields Bruckhaus Deringer, the Directors duties are as discussed below. 1. A duty to act in accordance with the company’s constitution, and to use powers only for the purposes for which they were conferred. This replaces existing, similar duties.8 2. A duty to promote the success of the company for the benefit of its members. This replaces the common law duty to act in good faith in the company’s interests.9 3. A duty to exercise independent judgment. There is no exactly equivalent duty at common law. However, directors are currently under an obligation not to fetter their discretion to act or to take decisions – this aspect of the general duty replaces this obligation.10 4. A duty to exercise reasonable care, skill and diligence. This replaces the existing duty of care and skill.11 5. A duty to avoid conflicts of interest (except where they arise out of a proposed transaction or arrangement with the company – see below). At present, if a director allows his personal interests, or his duties to another person, to conflict with his duty to the company then, unless shareholders consent to the conflict: (i) the company can avoid any relevant contract and (ii) he must account to the company for any ‘secret profit’ he has made out of the arrangement. The new duty replaces this old rule.12 6. A duty not to accept benefits from third parties. There is no express duty to this effect at common law. It appears to derive from the current duties to act in the company’s interests and the rule dealing with conflicts of interest.13 7. A duty to declare to the company’s other directors any interest a director has in a proposed transaction or arrangement with the company. At present, a conflict of interest arising out of a transaction or arrangement with the company is dealt with by the general rule on conflicts of interest, described above. In future, such a conflict will be covered by this new duty of disclosure”14 The duties of the directors are gained from a number of different sources. The general duties that the directors are expected to complete and which they owe the company are got from the common law which has been in practice for a number of years and has been developed over a number of years with the assistance of the case laws. Also the additional rules and the additional duties have also been spelt out in the Companies Act of 1985. This included the various rules majorly in the Part X15. The directors and their behaviour have also been specified in a number of other statutes. These include behaviour in terms of health and safety and many other specific circumstances. However the Companies Act of 2006, now also sets out the new statutory statement which lists out the directors’ duties, which is also referred to as their general duties. It is also seen that this statement to a great extent has replaced the common law and to a great extent has also replaced and rewritten the Part X of Companies Act 198516. The common law that has been followed over the years was expressed to be the codification, however in the existing law this has not been the same. In the notes that have been provided with the original version of the Act, there have been two very essential and deliberate changes that have been included on the rules on the director’s conflicts. This has been included in the points that have been mentioned above. It is also essential to note that the language that has been used in the Act is different from that which has been used in the common law. This could to a great extent lead to confusions and differences in the approaches when the rules are being applied in real case scenarios. In short the seven duties can be explained as below. a. S171: requires the directors to act within their powers, i.e. abide by the terms of the organisation, the memorandum of association and the articles of association. Also it is important that the directors consider and keep in mind the decisions made by the shareholders while using their powers17. The best case for this section is that of Hogg Vs Cramphorn 1967, where Hogg was an investor who tried to get a takeover of the company – Cramphorn. This was a decision made within the powers of the directors since they believed that the takeover would not be beneficial to for the company. In this case the court could not prove the company directors to be wrong for issue of the shares as a mode of preventing the takeover, as they directors acted within their power for the goodwill of the company. Other cases like the Howard smith vs Atmmol Petroleum, 1974,AC 821-835p and Harlove nominee pty vs woodside 1968 121 C.L.R 483 Aust xc, also provide for some excellent examples where the directors have acted within their powers to make decisions which might bring ssucess to the company. b. S172: Directors are needed to promote the success of the company, i.e., the first preference for the directors should always be the best interest of the company. This includes any and all factors that might benefit the shareholders. This however has now got a new list of non – exhaustive factors to which the directors need to pay heed18. This had caused a number of issues for the new legislation in a number of different aspects mainly during the drafting stage. These included a number of aspects like the long term consequences of the decisions, the interest of employees, need to foster the relationships of the business with the suppliers and the customers and other business partners. Cases like the Re West coast capital (Lios)Ltd 2008,C.S.O.H 72, provide for examples as to how directors work towards the success of the company. This is a very important duty of the directors as it involves the decision making where directors need to ensure that the name and success of the company are not put to stake and neither is affected by incorrect decisions made by the directors. Also other factors like the impact on the community, environment and also the maintenance of high standards for the business and its conduct. Also the rules for the directors and how they act within the members has also been included in the Act. c. S173: Inclusion of right to independent judgement, i.e., the directors are needed to exercise an independent judgement and this however will not categorise as a infringement if the agreement that the company has entered into is different and requires the directors to follow a non independent judgement19. The case of RE englefield colliery 1878 LR 8 C.C.H.B 388, CA, where the directors have taken the decision on independent decisions to ensure that the best decision to the benefit of the company is made. However there is always a set fear that the directors right to take the independent decision might lead to the directors not taking the judgement of experts in the field. The only solution to however is if the work is delegated to the experts and the directors take advice from the experts but make the final decision themselves. The above mentioned case is an ideal example for the same.20 d. S174: Excise of reasonable care, skill and diligence, i.e. it is important for the directors to have a clear careful, responsible, skilful and diligent approach to be able to carry out the duties of the position and also to allow the directors to keep in good relations with the other associates of the company21. This has been well displayed when the directors have acted in good faith however have still been cheated like in the case of Dorchester finance com. Ltd vs Stebbing 1989 B.C.L.C 498. However along with the good faith it is essential that directors do not let themselves or the company be cheated of the money due to negligence. e. S175: Duty to avoid conflict of interest, i.e. there should be conscious effort to ensure and try to avoid any kind of possible conflict that could arise22. This is majorly in terms of the properties of the firm, information or even opportunities. This will apply to the directors’ even post leaving the company, and is needed by law for the directors to try and avoid the conflicts of interest mainly in regards to the property and even any possible opportunity for the company. J.J. Harrison properties Ltd vs Harrison 2002 1 B.L.L.C 162 case provides for a very essential questions to be put forth regarding this duty of the director. There are four essential provisions which deal with the conflicts of interest. These mainly include which transactions and arrangements that are in the interest of the company however need to be disclosed but not approved and secondly, about the other conflicts which normally arise and need to have some kind of approval23. f. S176: Duty to accept benefits from third parties, i.e. it is important that a director of a company should not use the help of a third party. This duty again is not infringed if the offer of the help might lead to an issue of conflict for interests. The case of Regal (Hastings)Ltd vs Gulliver 1942, 1 all ER 378, is a classic example for this duty. This case provides a better view of how directors need to be able to make decisions without taking advantage of their position and this duty continues to be on even once the directors cease to be directors in the company. g. S177: Duty to declare an interest in a proposed transaction with the company. If the directors in any mode wish to directly or indirectly have a transaction with the company, it is essential that the directors declare all the information of the transaction and this is in the interest of the other directors as well. I.D.C. vs Cooley 1972 1 WLR 443, provides for the understanding of whether the directors need to disclose the interest in regards to the general duties and also whether they need to consider in a case where the directors interest has already been recorded or entered. Both these provisions have a great deal of importance in the companies and require to be considered to ensure that the directors are not wrongly accused for something which is not committed by them24. The changes that have been made to the director’s duties have been faced with a number of issues and controversies. It is important to understand that although there are a number of changes to the duties of the directors, these have been most widely published and also have been the most controversial of all the features of the legislation. There is also a number of other effects that the Act has on the directors. Firstly, S239, which deals with the ability of the shareholders to ratify any conduct of a director. This includes a number of breaches like duty, negligence, default or even breach of trust25. Each of these is regulated by the statue. This section however does leave a loop hole for the common law principles. This was the only guide for the director duties in the past. “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.”26 Under the act the directors who also in a number of cases are the shareholders of the company, or even the people who are connected to them, and are not allowed to vote for the ratification resolution in regards to the actions27. There are also a number of existing restrictions on companies which indemnify the directors for a few of the liabilities and have been relaxed to allow for the indemnities by group companies for the directors of the corporate trustees and also occupational pension schemes. Also, the SS261 – 3, of the Act provides for the shareholders a statutory right to raise claims against the directors for misfeasance on behalf of the company. However it is important and necessary for the shareholders to gain consent from the courts to go ahead with the claims. There are a number of cases of transactions between the company and the directors where they have been prohibited by the law28. These are subject to the approval of the shareholders. Best examples of these transactions are loans from the company to the directors and many more. There is a requirement for the company to have corporate directors as a part of the company however it is also essential that the company has at least one natural person as a part of the board apart from the corporate directors29. The following also form important duties of the directors for the success of the company. According to Lord Goldsmith, “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”30. According to Lord Goldsmith, there are a number of different duties that are expected to be followed and “…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.”31. It is also important to understand that the lists of duties that are listed in the act are not exhaustive and the duties of the managers are very vast32. These duties that have been mentioned here are just as a handle which provide for the most essential duties that the directors need to perform. As expressed by Lord Goldsmith, “…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”.33 According to the S157, some of the other factors listed in the Act that effect the duties of the directors is the current age restriction of 70 years, which was prevalent in the previous laws, is now been removed34. This along with the acceptance of inclusion of directors at a minimum age of 16 years provides for the company to have a longer period of time to serve as directors in the company. The Act also allows for the directors to provide the companies house, with the use of the address for service. This is like a provision of a guest house for the directors which can be used for living. These houses will be kept in separate registers where the access to others will be limited and restricted35. This falls into a benefit for the directors and this is another one of the amendments which have been made to the act and one of the few provisions that have been made. “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”36. Conclusion: The new changes in the duties of the directors have raised a number of issues and questions. These questions that have arisen due to the changes require to be answered by the government. There is confusion about whether the companies will be treated as separate entity by itself or whether the present members of the company will have a say in the working of the company and if they will remain to be dominant in the company. Based on all the cases that have been studied to gain complete knowledge of the duties, it is clear that there are a number of aspects which still require to be cleared out and by law. This includes the fact that the duties in some terms cause confusion for the directors and the cases need to be referred to be able to analyse the actual issue. There has been a thorough analysis of the various statements provided by the government spokesmen in the Lords and the Commons37. However there are still a number of discrepancies based on the knowledge gained from the cases which require to be dealt with by the Companies Act of 2006 and the Combined Act of 2008. References Financial reporting council, 2009, ‘The Combined Code & Associated Guides’, Accessed on 15th May 2009, Retrieved from http://www.frc.org.uk/CORPORATE/COMBINEDCODE.CFM FRC, 2008, ‘The Combined Code on Corporate Governance’, June 2008, Accessed on 17th May 2009, Retrieved from http://www.frc.org.uk/documents/pagemanager/frc/Combined_Code_June_2008/Combined%20Code%20Web%20Optimized%20June%202008(2).pdf Freshfields Bruckhaus Deringer, 2006, ‘Companies Act 2006: Director’s Duties’, November 2006, Accessed on 17th May 2009, Retrieved from http://www.freshfields.com/publications/pdfs/2006/17062.pdf GLG, 2008, ‘Corporate Governance 2008’, Accessed on 16th May 2009, Retrieved from http://www.mannheimerswartling.se/Publikationer/Corporate%20Governance%202008.pdf Hodge, M., 2006, ‘Companies Act 2006: Duties of company directors’, June 2007, Accessed on 17th May 2009, Retrieved from http://www.berr.gov.uk/files/file40139.pdf ICAEW, 2009, ‘UK Corporate Government Codes and Reports’, Accessed on 15th May 2009, Retrieved from http://www.icaew.com/index.cfm/route/159058/icaew_ga/en/Library/Links/Corporate_governance/Corporate_governance_codes/UK_Corporate_Governance_Codes_and_Reports Lowy, M., 2003, ‘Corporate Governance for Public Company Directors’, 1 February 2003, Aspen Publishers Rooks Riders, 2009, ‘Companies Act 2006: Note on Director’s Duties’, Accessed on 16th May 2009, Retrieved from http://www.rooksrider.co.uk/uploads/public/documents/News/Business%20Articles/Note%20-%20Directors%20Duties.pdf Russell, J., 2008, ‘The Companies Act 2006: A Directors Handbook’, April 2008, 2nd Edition, Caspian Publishing Ltd. Sheikh, S., 2008, ‘A Practical Guide to companies Act 2006’, 1st edition, 12 March 2008, Routledge Cavendish Publishers Sykes Anderson, 2007, ‘Companies Act 2006 and Directors Duties’, 19th January 2007, Accessed on 17th May 2009, Retrieved from http://www.bytestart.co.uk/content/legal/35_2/companies-act-directors-duties.shtml Read More