A common law obligations of directors or whether

A company has its own legal personality, nevertheless
it is not a natural person. Hence, it needs someone to be in charge, on its
behalf, of taking strategic decisions and ensuring that the company’s
obligations under the Companies Acts are met. The Companies Act 2006
(hereafter, CA 2006) describes those individuals as ‘any person occupying the
position of director, by whatever name called’1 which means that as long
as those individuals perform the role of a director in the company, including
those who are not formally appointed as one,2 they are considered to be a
director according to the law. Moreover, the relationship between directors and
the company they represent is a fiduciary one, which derives from the
principles of the law and trusts and agency prior to the Joint Stock Companies
Act 1844 and reflects the common law and the equitable principles.3 Naturally, the fiduciary
relationship between the directors and the company creates duties imposed on
the directors. For that reason, directors have the duty of reasonable care,
skill and diligence in addition to their fiduciary duties. In effect, directors
are under the obligation to manage and promote the company in its best
interests.4 These directors’ duties are
owed to the company and are enshrined in sections 171-177 of the CA 2006. The
restatement of the duties were meant to clarify the obligations that the
director’s have to undertake on a daily basis and set a new commercial morality
which shareholders and others have a right to expect from those they place
their trust in. Nevertheless, the views are divided on whether the statutory
restatement was simply a codification reflecting on the existing common law
obligations of directors or whether section 172 has driven a wedge between the company
itself and the stakeholders that deal with the company. This essay will critically
analyse both positions.

 

Directors’
obligations

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

As mentioned previously, directors have fiduciary duties
conferred on them and this is for the purpose to limit the exercise of their
powers. These general duties are derived from the equitable principles and
common law rules and have now become statutory under Chapter 2 of the Companies
Act 2006 after the recommendations of the Law Commissions and the Common Law
Review.5 Section 171 states that
directors must (a) act in accordance with the companies’ constitution and (b) only
exercise the powers for the purposes which they are conferred. The first part
restates the common law principle that directors must act within their powers
and the latter reflects the ‘proper purpose doctrine’6 which limits the directors’
powers to only act in the best interests of the company. The ‘proper purpose
doctrine’ includes the element of ‘bona fide’ that is not mentioned in section
171, but in section 172 which reflects the duty to act in good faith and to
promote the success of the company. The aim pursued in this section is to raise
enlightened shareholders’ value but that is not that easy since it is dependent
on the management of the relationships with stakeholders of the company.7 Be that as it may, the
restatement of section 172 has raised some controversy which will be discussed
later on.

 

Directors also have the duty to exercise independent
judgment as set out in section 173. This codified the principle that ‘directors
must not fetter the future exercise of their discretion unless as laid out by
section 173(2)’8
which corresponds with promoting the success of the company as the duty
prevents directors from disregarding their fiduciary duties by following the discretion
of a third party instead of their own judgment.9 These fiduciary duties
derive from loyalty and these loyalties should be within the company. Therefore,
directors have the duty to avoid conflict of interests as enshrined in section
175 that reflects the equitable principles of ‘no conflicts’ and ‘no profits’
rules. In essence, this duty requires the director to avoid situations where
his personal interests and the interest of the company is or can be in conflict
and adds on that they can be held liable for any profits made personally under
such circumstances.10 Yet, there are situations
where these interests do cross, however these interests are not reasonably
expected to get in conflict. If that is the case, the director has the duty to
declare an interest in proposed or existing transaction or arrangement as laid
down in section 177 and 182. This reflects the common law rule where directors
had interests in conflict transactions, but were required to declare it to the
board. The final fiduciary duty is the duty to not accept benefits from third
parties in section 176. This means they should not get into the position where
they would owe any favours to a third party.

 

Another important duty is found in section 174 of the
CA 2006 which reflects the duty of reasonable care, skill and diligence. In the
early cases, director appointments were merely symbolic, notably in the Marquis of Bute’s11 case where a six-month
old was appointed to be a director of the bank. When the bank became insolvent,
the liquidator wanted him to be held liable for negligence. The court ruled
that the Marquis could not be held liable for the breach of this duty as he was
just six months old and only attended one meeting. Historically, the test for
this duty was subjective and had a very low threshold. The subjective test
looked at what the director could do in regards to his personal skill and knowledge,
but he was not expected to do more than that. On top of that, the duty was of
intermittent nature, meaning that the directors have to exercise care in the
meetings they attend, whereas they are not bound to attend any.12 As that test was deemed
insufficient in the majority of cases, a semi-subjective standard was adopted later
on, which was determined on the basis of the expertise by a particular
director.13
Nonetheless, professionalism was not expected until after the Donoghue v Stevenson14 case where reasonable
care was based on foresight. All in all, this resulted into the present
standards set out in section 174(2), which included both the subjective standard
under section 174(2)(a) and the objective test under section 174(2)(b),
resulting into a higher threshold.

 

The CA 2006 did not incorporate remedies in case a
director breaches his duty. It does mention that in case the director is in
breach of his duties and had made personal gain, he cannot keep the secret
profit he made unless he was authorized to do so.15 As shareholders and
others third parties place their trust in the directors and cannot monitor them
daily, it is important that the fiduciaries are encouraged in order to prevent
misconduct, and as a result the law has imposed standards for the fiduciaries
and an extensive liability. Where a director has made a profit personally by
breaching his fiduciary duties, he is considered to be a ‘constructive trustee’,16 and will be held
accountable for director’s liability. Furthermore, it should be noted that several
cases,17 such as Guinnes plc v Saunders, have led to the
conclusion that directors should not benefit from their breach of fiduciary
duty.

 

Section
172 CA 2006

These aforementioned fiduciary duties were meant to
bring stability and financial strength and eventually to benefit the society at
large. Stability and financial strength arises from good corporate governance,
and the corporate governance was failing at the time which can be deduced from
the financial crisis. Since the essential role of directors in corporate
governance cannot be denied, the codification of the fiduciary duties was not
unexpected. The aim of the codification according to the Law Commission was to
restate the law in pursuance to make the law clearer and accessible on director’s
duties and to bring about a change in directors’ behaviour.18 However, the duty has
been called ‘the most controversial and challenging duty that has been
introduced to the act’ and a lot of problems has arisen from this.19 Subsequently, a lot of debate
has been going on whether the codification of the duty of good faith and to
promote the success of the company, thus section 172, was fit for purpose. Some
have argued that cases which invoked section 172, such as Re West Coast Capital Ltd and the Cobden Investments case,20 declared that the
provision was just a codification of the previous existing common law
obligation, which was to act bona fide in the best interest of the company. Although
this may be true, the judges never went in detail to explain or discuss the
provision further.21 On the contrary, others
have argued that section 172 is different from the duty to act bona fide in the
best interest of the company.22

 

Section 172 does indeed not vary much from the
pre-existing duty if you look at the wording of it. Notwithstanding, those
wordings are rather vague on how they should be interpreted. In regards of ‘success’
the Law Society foresaw practical problems with this term. What the Government
intentionally tried to achieve, mentioned in the Explanatory Notes to the CA
2006,23 was that ‘success’ was
subjective and that different companies have different objectives so it is up to
the directors to determine what the term ‘success’ represented.24 The ‘success of the
company’ was regarded as something that shareholders are trying to achieve as a
collective body which is also mostly what the company is trying to achieve on a
long term basis.25
From this, it can be assumed that the interests of the company cannot be
distinguished from the interests of a specific group of individuals behind it,
meaning the present and future shareholders, and that the directors’ duties are
in reality owed to them.26 This is also reflected in
common law, where the interests of the company are in essence the same with
that of its shareholders wants as a whole.27 It can be deduced from this
that the success of the company is for the members as a collective body and thus
‘for the benefit of the members as whole’ and not only for majority
shareholders or special stakeholders.28 Having established that,
to come back on whether the codification of this duty was fit for purpose, the
answer is no. However, it does end up introducing the ‘enlightened shareholder’s
value’ in section 172(1)(a)-(f), which derives from the duty of good faith and
constitutes to ‘acting in the best interest of the company’, to maximise the
value of the corporation and thus adopting a new way of decision-making and
management by directors. The duty imposed in section 172 is subjective,29 as it leaves the bona
fide requirement open to the director. Even though his decision might have
injured the company in a way, as long as he had acted in his own judgment that
it would have been for the benefit of the company, he would not be held
responsible.30
As a result, there is no new or clearer interpretation on this duty compared to
the existing common law and the situation is as it was before the codification.
Problems still arise where, for example, the director has to balance the
interests of stakeholders in order to find out what is best for the company. The
provision does not say which is more important and leaves that decision for the
director. Ultimately, directors have more discretion in their decision which
could eventually lead to cases where the director seizes the opportunity to
fill his own pockets. In any case, where a case like this would go to court,
the court will be reluctant on its decision when the director claims to have
acted in good faith. It would be difficult for the courts to assess whether or
not the director has actually considered and balanced the stakeholders’
interests set out in section 172(1)(a)-(f) or is merely saying it for the sake to
be in compliance with the provision.31

 

Having that in mind, in reality, the directors do take
stakeholder’s interest in account to ‘promote the success of the company’, but
will not exceed to do more as to what will be beneficial for the shareholders. This
is because in practice, the director’s position will eventually depend on the vote
of the shareholders and by keeping them happy means keeping their position. Nevertheless,
most companies have always already considered the factors set out in
172(1)(a)-(f) in their decision-makings for the purpose of fostering the
benefits of the shareholders. Therefore, even though the enlightened
shareholders’ values were introduced, it is probably true to say that little
has changed from the situation as it was before the codification. Nevertheless,
the codification did induce directors to take these factors more seriously and
has given a better understanding on the scope of this duty.32 What is noteworthy is
that some may argue that directors are given the discretion to abuse their
power in section 172 with regard to the stakeholder theory, because directors will
not be held accountable for the management of the company’s resources as long
as they say they have acted in the best interest of the company.33 As said before, section
172 leaves that open for directors. Since this is subjective, prosecuting
derivative actions are quite hard for stakeholders of the company. If
stakeholders cannot prove that directors have failed to take their interests
into regard in their decision, they will not have the right to bring
proceedings against them (no locus standi). Since the state of mind is hard to
prove, directors will not be held accountable for their actions. What most
stakeholders resort to do if they cannot bring a derivative claim, is to break
off their relationship with the company which will eventually lead to a wedge
between the stakeholders and the company.

Having this said, the government has acknowledged the issue
and one of the three current key proposals is to introduce a secondary
legislation where companies are required to explain on how they would comply with
all the requirements set out in section 172, with the means to tackle the
abovementioned problem and therefore strengthen the position of company
stakeholders.34

 

Conclusion

Directors have a fiduciary relationship to the company
they owe duties to companies. These duties are in place to limit the exercise
of the powers that directors have and are derived from the equitable principles
and common law obligations. The government saw for the restatement of those
duties into a codification for the reason to offer better guidance for
directors. As a result, the Companies Act 2006 has introduced these directors’
fiduciary duties enshrined in sections 171-177 for the reason to clarify their
daily obligations.

 

The aim of codifying these fiduciaries was to change
directors’ behaviour and improve corporate governance which will eventually be
beneficial for society and therefore aligning what is good for the company with
what is good for society at large.

 

Even so, with the enactment of the fiduciaries,
controversy over section 172 of the CA 2006 arose. The question was whether the
statutory restatement was simply a codification of its pre-existing common law
obligations or whether it has marked a radical departure of the joint
connection between the company and stakeholders that deal with the company. It
can be concluded that, both views on the provision are essentially correct. The
codification of the duty of good faith and to act in the best interest of the
company has not changed much for company’s decision-making compared to earlier
practices. Nevertheless, by making it codified law, it provided more guidance
on how the duties should be interpreted. Albeit, it rendered more difficult for
company stakeholders to bring a derivative claim against the director at the
same time, provided that he has locus standi which can only be achieved by
proving that the director has breached good faith by failing to take their
interests into account in the decision-making process. Since the government has
noticed this issue and acknowledged that directors have certain statutory duties in relation to stakeholders, they have already undertaken
steps in order to address this problem. Whether these will be effective is an
answer that the future holds.

1 Companies Act
2006, section 250.

2 Re Kay-Tech international plc; Secretary of
State for Trade and Industry v Kaczer and others 1999. 2 BCLC 351.

3 Alan Dignam and
John Lowry, Company Law (9th
edn, OUP 2016) 282.

4 Towers v Premier Waste Management Ltd
2011 EWCA Civ 923.

5 Alan Dignam and
John Lowry (n 3) 317.

6 Re Smith and Fawcett Ltd v Maxwell 1942
Ch 304.

7 Alan Dignam and
John Lowry (n 3) 329.

8 Alan Dignam and
John Lowry (n 3) 338.

9 Boulting v Association of Cinematograph,
Television and Allied Technicians 1963 2 QB 606.

10 Kak Loui Chan v Zacharia 1984 HCA 36.

11 Re Cardiff Savings Bank 1892 2 Ch 100.

12 ibid.

13 Re Brazilian Rubber Plantations and Estates
Ltd 1911 1 Ch 425.

14 Donoghue v Stevenson 1932 UKHL 100.

15 Companies Act
2006, section 178.

16 Paragon Finance plc v DB Thakerar and Co
1999 1 All ER 400.

17 Guinness plc v Saunders 1990 2 AC 663;
Quarter Master UK Ltd v Pyke 2005 1
BCLC 245.

18 The Law
Commission and The Scottish Law Commission, Company
Directors: Regulating Conflicts of Interest and Formulating a Statement of
Duties, Law Reform Commission (Law Com No 261, Scot Law Com No 173, 1999).

19 Andrew Keay, The duty to promote the success of the
company: is it fit for purpose? (August 20, 2010)
accessed 6 January 2018.

20 Re West Coast Capital (LIOS) Ltd 2008
CSOH 72; Cobden Investments Ltd v RWM
Langport Ltd 2008 EWHC 2810 (Ch).

21 Keay (n 19) 12.

22 Keay (n 19) 29.

23 Explanatory
Notes on Companies Act 2006 327.

24 Anna
Hadjimarkou, ‘Would a failure to pursue lawful tax planning strategies that
would ordinarily lead to a significant increase in shareholder funds expose a
director to liability for breach of duty under section 172 of the Companies Act
2006?’ (Jordon Publishing, 4 March
2015)
accessed on 9 January 2018.

25 Department of
Trade and Industry, Ministerial
Statements, Companies Act 2006, Duties of Company Directors (October 1, 2007)
7-8.

26 Brady v Brady 1998 BCLC 20 40.

27 Gaiman v National Association for Mental
Health 1971 Ch 317 330.

28 Lord Goldsmith,
Lords Grand Committee, 6 February 2006, column 256.

29 Cobden Investments Ltd v RWM Langport Ltd
2008 EWHC 2810 (Ch).

30 Keay (n 19) 14.

31 Keay (n 19) 18.

32 Alan Dignam and
John Lowry (n 3) 334.

33 Michael Jensen,
Value Maximisation, Stakeholder Theory
and the Corporate Objective Function (2001) vol 7(3) European Financial
Management 297-317, 305.

34 Department for
Business, Energy & Industrial Strategy, Corporate
Governance Reform: the Government response to the green paper consultation (August,
2017)
accessed 10 January 2018.

x

Hi!
I'm Barry!

Would you like to get a custom essay? How about receiving a customized one?

Check it out