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Shareholder Issues- Director's Duties

Directors' Duties

Arguably the most significant change to company law made by the Companies Act 2006 is the placing of directors’ duties on a statutory footing. Whilst the new statutory duties are essentially a codification of the existing common law duties, there are some differences, and the statutory duties are not an exhaustive list.

The following have been in effect since 1st October 2007:

To act within the directorial powers afforded by the company’s constitution;
To promote the success of the company;
To exercise independent judgment;
To exercise reasonable care, skill and diligence.

The first duty, which is to be found at section 171 of the 2006 Act, does not differ much from existing law. A director must act only in accordance with the company’s constitution (which includes decisions taken by members in line with the articles of association) and must only exercise powers for the purpose for which they are intended.

The duty to promote the success of the company under section 172 of the 2006 Act broadly replaces the common law duty to act only in the best interests of the company. Section 172 however includes a non-exhaustive list of factors which directors need to consider when discharging this duty. These factors make up the “enlightened shareholder value” principle. The director must have regard of:

(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers, customers and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.

“Success of the company” in the context of a commercial company will usually mean long term increase in value, according to the Government.

The duty to exercise independent judgment, found at section 173, reflects previous law and is not infringed by a director who acts in accordance with an agreement entered into by the company that restricts the future exercise of discretion, nor is it infringed when acting in a way authorized by the company’s constitution.

The duty to exercise reasonable care, skill and diligence reflects the position that the common law duty of care and skill had shifted towards, which is to impose both an objective and subjective standard upon directors. A director must meet the objective standard of a reasonably diligent person, and a subjective test based on his own actual experience and skill.

The following have been in effect since 1st October 2008:

To avoid conflicts of interest;
Not to accept benefits from third parties; and
To declare interests in a proposed or existing transaction or arrangement with the company.

Duty of directors to avoid conflicts of interest- section 175

A 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 duty applies in particular to the exploitation of property, information or opportunities and will apply whether or not the company itself could take advantage of any such property, information or opportunity.

The section 175 duty will, for example, cause problems for directors who hold more than one directorship.

However, the Act allows for more flexibility than the old regime in that a director’s conflict of interest may be authorised by the other directors provided that the authorisation is given by non-conflicted directors who must also be able to form a quorum. Under the existing common law rule, such authorisation may only be given by the shareholders.

Thus, if a conflict arises, it can be authorised in advance in one of two ways:

1. By the shareholders, or

2. By the directors.

Shareholders can authorise an actual or potential conflict by an ordinary resolution (more than 50% support from those shareholders voting). This can be achieved by a vote at a general meeting or (in the case of a private company only) by getting agreement to a written resolution. A director who is also a shareholder can participate in the vote, even if he is one of the directors interested in the matter being authorised.

Directors can also authorise conflicts by a majority vote, provided there is nothing in the articles of association that prevents them from doing so and provided the matter is agreed to without the conflicted director voting or counting in the quorum.

It must be noted that directors can only authorise conflicts in advance, but conflicts can be ratified after the event by shareholders. When shareholders ratify a conflict the votes of any shareholder who is also an interested director won't be counted. Nor will the votes of any shareholder who is connected with an interested director. (Note that where the vote is to authorise a conflict in advance, the votes of interested shareholders are allowed.)

Public company – the directors can only authorise conflicts if the Articles contain a specific authority for them to do so. That means that, to avoid the need for shareholder approval of conflicts, a plc's Articles will have to be amended.

Private company incorporated prior to 1 October 2008 – is effectively in the same position as a public company. It either needs to amend its Articles to allow for director authorisation, or it can ask its shareholders to pass an ordinary resolution permitting the directors to authorise conflicts.

Private company incorporated on or after 1 October 2008 – only in this case is the directors' power to authorise a conflict implied without the need for specific wording in the Articles.

Steps to be taken as a consequence of the changes:

Private companies incorporated before 1 October 2008 must obtain shareholder consent (i.e. via a shareholder resolution) before the directors can authorise a conflict.

Private companies may also amend their articles to include provisions dealing with conflicts of interest, and must amend their articles to remove any provisions which would invalidate the authorisation of conflicts by directors.

Having passed a shareholder resolution (and, if necessary, removed from its articles anything which would invalidate such authorisation) a private company can rely on the provisions of the 2006 Act allowing the directors to authorise conflicts, provided that the conflicted director does not vote and is not counted in the quorum.

Private companies should therefore consider passing a special resolution to confer shareholder consent for the authorisation of conflicts and to amend the company’s articles by inserting conflicts management provisions into their articles before 1 October 2008. If for any reason it is considered difficult or undesirable to pass a special resolution at this time, the company may pass an ordinary resolution permitting the directors to authorise conflicts with effect from that date.

In preparation for the changes, private companies should also collate information on any existing directors’ conflict situations and consider what processes they wish to put in place for authorising and dealing with conflicts.

Companies incorporated on or after 1 October 2008 need not pass a shareholder resolution but may choose to amend their articles to include provisions dealing with conflicts of interest (and should remove from the articles any provisions which would prevent the directors from authorising conflicts).

All companies, whether public or private, should review their procedures for transactions between directors and the company and ensure that they comply with the 2006 Act and that board minutes and board papers refer to the correct provisions of the 2006 Act.


Duty not to accept benefits from third parties - section 176

Under section 176, a director must not accept any benefit from a third party conferred by reason of his directorship unless acceptance of the benefit cannot ‘reasonably be regarded as likely to give rise to a conflict of interest’.

Unlike section 175, there is no statutory provision giving boards the power to authorise directors to accept benefits from third parties.

However, companies may wish to include safe harbour provisions in their articles to provide that, where directors accept benefits below a specified value, they will not be in breach of duty.

Declarations of interest - section 177

Under section 177, a director must declare to the other directors the nature and extent of any interest, direct or indirect, which he has or will have in a proposed transaction or arrangement with the company.

Under section 182, a similar rule applies to existing transactions and arrangements, to the extent that the interest has not already been declared under section 177.

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