The Companies Act 2006, which received the Royal Assent in early November, will shortly be published and will take a considerable amount of digesting. It has been described as the most substantial overhaul of company law for decades and is intended to simplify and improve company law to make it easier to understand.
Final comment must await formal publication of the Act, but the provisions of the Bill have given rise to much debate. It was originally intended that the Act would 'codify' the existing common law and statutory position, but it seems clear that it will go further and introduce some important changes to the scope and extent of the duties and liabilities of directors. While it is not anticipated that all parts of the Act will be in force before October 2008, it is very important that directors consider, understand and prepare for these important changes well in advance of their introduction.
Among the anticipated changes to director's duties are:
- A duty to act within the powers of the company
- A duty to promote the success of the company
- A duty to exercise independent judgment
- A duty to avoid conflicts of interest
- A duty not to accept benefits from third parties
- A duty to declare any interest in proposed transactions or arrangements with the company
- A duty to exercise reasonable care, skill and diligence.
All seem perfectly laudable at first sight. Clearly directors should act within their powers, should act independently and without conflict of interest and should use reasonable care, skill and diligence to promote the success of the company, but a closer examination of the practical effect of these changes is required.
An example of 'codification' of existing law is the duty on directors 'to exercise reasonable care, skill and diligence' which has largely been brought in line with the test provided for in s 214 of the Insolvency Act 1986, which has commonly been applied in the past as a convenient 'yardstick' by which to measure whether or not directors have been negligent when carrying out their duties. However, other duties are likely to be far more problematic for directors to interpret and apply. When considering their duty 'to promote the success of the company' directors must consider a number of factors, including:
- The interests of the company's employees
- The likely long term consequences of any decision
- The need to foster the company's business relationships with suppliers, customers and others
- The impact of the company's operations on the community and the environment
- The desirability of the company maintaining a reputation for high standards of business conduct
- The need to act fairly as between members of the company.
The list in the Bill, assuming that it survives to the Act, was not intended to be exhaustive, and prudent directors will ensure that they have considered not only these factors, but any other relevant factors when making decisions concerning the company's business. This looks likely to give rise to much further debate.
- Will directors be in breach of duty if they fail to consider these (or other) factors even where this would have had no material effect on the ultimate decision that they took?
- Can directors delegate their duty to another and, if so, how?
- What additional documentary records should directors now maintain to be able to show that they have duly considered these, and other, factors? How detailed must these records be?
It is this last point that directors will need to keep very much in the forefront of their minds. Duties that require directors to exercise 'independent judgment' and to act in accordance with the company's constitution and only exercise powers for the purposes for which they were conferred, mean that directors would be well advised to keep far better records of decision-making processes than they probably have in the past. These will enable them to justify the decisions that they have reached, and show how they have reached them.
Coupled with this, and perhaps of more concern to directors, will be the provisions enabling shareholders to pursue 'derivative actions' on behalf of the company if they believe that the directors have been negligent or failed in their duties to the company.
At the very least, directors should now undertake a thorough review of their liability insurance policies, as it is almost inevitable that the changes to the derivative action regime will lead to an increase in tactical litigation against directors by so-called activist shareholders. There may be cost implications for these insurance policies until it becomes clear how such derivative claims will be dealt with by the courts, and directors should take professional advice to ensure that they are fully protected from unwanted, time-consuming, damaging and expensive legal action.
- Craig Blakemore is commercial litigation partner, Mace & Jones, E-mail: email@example.com