Country Comparative Directors Duties Analysis

Select at least two and no more than three countries and do a comparative analysis of directors’ duties

Introduction

The aim of this assignment is to showcase a cumulative research drawn from the literature provided to examine, define, differentiate, compare and describe the duties that the directors owe to the companies. To justify this, the work below takes in specific the duties of the directors of companies within the United Kingdom and United States of America. This essay navigates the reader through two noticeable sections. The first portion discusses the various definitions, significance of the directors’ role within the two countries. The second section deals with the actual duties, the differences and also the similarities and a brief on the rights and powers of the directors in different jurisdictions. The second half of this assignment also addresses certain key duties out of the many available, to do justice to the limited scope of this assignment. This section in brief discusses the duties of a director towards the corporation, towards employees and duties of care and diligence. Furthermore, the directors’ duties at common law when a company is solvent have been discussed also in contrast to the duties when the company is insolvent. To compliment the duties mentioned it is necessary to highlight the duties with regard to conflict of interest as the reader is given a critical view towards these duties in the two areas of jurisdiction mentioned earlier. This piece of work would be incomplete without the mention of corporate governance to instil a feeling of “fair dealing” by directors. Hence, a general overview of the duties that the directors owe to the companies is covered with in the United Kingdom and the United States of America.

Company

There have been various meanings given, as to what a company is and the most common observation made is that a company is an association of a certain number of persons with a common objective. Though a company is an artificial person yet it cannot function without human agents. One of those agents is “Directors”. Companies are usually owned by Shareholders and managed by Directors. Once created or brought into existence a company is a legal entity in its own and it also has a legal personality to do everything a natural person can do. It is thereby known universally that a company can sue and be sued in its own right.

Director

In simple terms a Director can be defined as a person appointed or elected to manage and/or direct the affairs of a corporation. It has been seen that different countries have a different perception of what a Director in real essence means in their respective country. Henceforth this paper attempts to bring forth the various similarities and differences of the various roles played by directors in different jurisdictions. It also portrays these principal factors while comparing countries belonging to the same legal family and also gives a sneak peak at the difference found with countries belonging to a different legal family with that of countries belonging to the same legal family. Alternatively, this piece of work will be looking mainly at directors duties in United Kingdom with that of United States of America.

Section 250 of the Companies Act 2006 in UK defines the term “Director” as “In this Act, “Director” includes any person occupying the position of director by whatever name called”. [1]

Similarly, In the US, Section 8.01 (b), RMBCA defines “ All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of, its board of directors, subject to any limitation set forth in the articles of incorporation or in an agreement authorized under section 7.32(close corporation agreement).”

According to Kenneth S. Ferber [2] directors are not agents of corporations or shareholders nor are they trustees. They only serve in a fiduciary capacity as fiduciaries who must perform their duties with due care and good faith in the best interest of the corporation in order to increase the wealth of the corporation and in turn shareholders.

In Gould v. Hawaiian S.S. Co [3] the Delaware law held that board of directors comprises the management of the corporation.

Although the term Director has been defined in this Act (Companies Act 2006) yet it does not capture the essence of the term director and has instead been difficult to interpret who is and who is not a Director. This definition merely seeks to explain that someone can still be called a director even though he is addressed by different titles. [4] Whereas the definition of director followed in the USA states exactly who a director is though not defined specifically.

Who can be a Director?

There are different criteria’s in different countries questioning the qualification of directors. The first factor can be witnessed herein, in Britain according to Sec. 250 of the CA 2006, a director must be a person in law which would include companies, limited liability partnerships and overseas companies also “corporate directors” are referred to as such if a company itself acts as a director. In the UK this can be done largely through case laws. [5] It is to be noted here that unlike many countries the board of directors entirely comprising of foreign nationals can control registered companies in UK there is no requirement as such that a director has to be a British national only. A board of directors made entirely of foreign nationals can operate a registered British company. [6] On the contrary a country like Switzerland in which their law requires that at least one of their directors be a national of that country. There are certain statutory restrictions on who might be a director which is mandatory to be followed by all countries in the world. On the other hand Sec.8.02, RMBCA states:

“The articles of incorporation or by-laws may prescribe qualifications for directors. A director need not be a resident of the state of incorporation of the corporation, nor a shareholder of the corporation. The bylaws can provide that directors be resident s of a particular place, or own shares in the corporation, or have certain qualifications deemed necessary to serve as a director of the corporation.”

Delaware in the US was the first state to allow one person to incorporate who did not have to be a citizen of Delaware. [7]

The second factor is the Age. In Britain according to Sec. 157 [8] a person needs to be a minimum of 16 years old to become a director of a company.

Number of Directors’ in a company

In the UK, according to Sec.154 [9] a private company must have at least one director [10] and a public company must have at least two directors and in both cases at least one director should be a natural person. [11] In the US traditionally a minimum of three directors was required by most states to incorporate but in today’s time modern statutes and many states require a minimum of one director. [12]

Term of a Director

In UK a director serves for a period of three years rotation unless re-elected by proving that they have served the shareholders interest but private companies can have directors for life. There is a positive side to the term of office held by a director, in the UK though directors can serve for a long period of time yet they have strong rights of removal which helps in keeping the directors on their guard always. Alternatively, in the US the basic period a director can serve is one year unless the corporation decides on a three year rotation basis. In the US though it has weak removal rights this gap is filled by short terms in office. [13]

Are Directors’ Agents or not?

Different countries have different perspectives on addressing the problems of agency. In the UK directors are granted wide-ranging powers to run the businesses, Articles of Association (for public companies) 2006. Regulation 3 states:

“Subject to the Articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all of the powers of the company”

One of the primary functions drawn from the statement given above are the directors’ contractual powers as agents of the company who have enormous discretion to enter into any contract that they deem fit which will further more advance business of the company. Directors are considered to be agents of their company. The board of directors may delegate the right to contract on behalf of the company as “agents” to one or more directors, either generally, or for specific contracts up to a specified monetary limit. In comparison to the situation in US directors here are not “agents” of the corporation nor are they agents of the shareholders. Directors are elected by the shareholders to manage the corporation. They serve in a fiduciary capacity and as fiduciaries they must perform their duties in the best interests of the corporation with due care and in good faith with the sole aim of increasing the wealth of the corporation and shareholders. [14]

Directors Duties .

This part of the essay draws focus on the duties that directors owe to the companies and various other personalities who are a part of the company and how is it regulated in the UK and US. Also throwing light on the approaches takes by common and different legal families to the regulation in the conduct of directors and their differences. It will focus mainly on the principle found at common law and in the corporation law. Directors’ duties are derived from three main sources:

The ones that are imposed by Statutes, primarily the Corporations Law;

Then those imposed by Courts, particularly those duties arising from a directors’ fiduciary position; and

Those that are imposed by companies themselves, primarily by a Company’s Constitution and its duties towards other contracts such as Shareholder Agreements. [15]

Directors in the UK like directors in the USA own duties of care and loyalty to their corporation. A director also owes a duty of absolute loyalty and utmost good faith. In a comparison with other countries US corporate law is more eccentric. The Board of directors in the US are to a large extent governed by state corporate statute [16] whereas in the UK it is governed solely by the Companies Act 2006. Unlike UK the directors are not agents of their shareholders. Among many other duties, directors owe a fiduciary duty to act in the best interests of the corporation. A group of directors and individual director duties are dependent on a particular type of company, board structure and board dynamics. Out of all the important duties that a director owns to his company one vital duty is fiduciary duties of directors. [17]

Duties to the corporation

Drawing on the literature provided, it can be seen that one of the primary differences that can be highlighted between the UK and US law is that the duty of directors in Britain is owed as a whole to the corporation instead of owing it directly to the shareholders. [18] However, an in depth analysis shows that the directors’ duties in the UK to their company is basically a duty to their shareholders, but either of the countries way of interpreting the law has made a huge difference in understanding it as noted above. This can clearly be seen in the case of Percival v. Wright [19] as against the US where the directors owe duties to the shareholders as a body and not a duty to individual shareholders. [20] On the other hand as far as the duty of loyalty is concerned, directors of a company owe a duty to act bona fide and in the best interest of their company.

Duty of Care and Diligence

One of the principle duties of directors is the duty of care and diligence. In the UK this duty has been considered as reasonable care and the diligence of directors is a continuing obligation to keep informed about the activities of the company. In Foss v Harbottle [21] this rule was brought out more clearly, preventing the shareholders from bringing a negligent action against directors on the company’s behalf as the directors owe their duties to the company. The rule in this case considers the company and not the shareholders to bring a legal proceeding. In contrary to this rule it was held in Pavlides v Jensen [22] that in the absence of any proof against directors and in exception to the rule in Foss v Harbottle does not permit minority shareholders on behalf of the company to bring an action against negligent directors. In the US the duty of diligence means a duty performed with due care by a reasonably prudent person without negligence. The directors in the US under the ‘Business Judgement Rule’ are not liable for honest errors of judgement. [23] To avail oneself protection under this rule, it is important that the decision made by the director was made in a prudent and reasonable manner. The director should also make sure that proper inquiries and monitoring were made to aid in the decision and that the director employed a reasonable process to make that decision, there can be no conflict of interest. If a director insignificantly fails to apply these standards and it is evidenced that decision of the director is the cause of the damage then the director incurs personal liability to the corporation. [24]

Duty to employee

The board of directors of a corporation in UK as in contrast to the US has a specific statutory duty to its employees. [25] This once upon a time was not true in essence and the interest of the shareholders was not permitted to be considered by the directors. [26] In Parke v. Daily News Ltd [27] where this principle arose in situations when a company was winding up and payment to terminated employees had to be made. The courts in this matter held that payment made in such a situation would not further any business purpose of the corporation and was thereby the payment of a benefit to the employees belonging to the shareholders. These cases were overruled by the statutes in UK where the law in Sec.309 (1) [28] now provides that:

The matters to which the directors of a company are to have regard in the performance of their functions include the interest of their functions include the interests of their company’s employees in general, as well as the interests of its members.

Like a directors duty to its shareholders this duty is owed to the company alone and “is enforceable in the same way as any other fiduciary duty owed to a company by its director.” [29] This statute however gives no guidance on how to reconcile these interests if they ever conflict and also it does not throw light on the enforcement power to the employees. This statute merely requires and does not permit directors to take into consideration the employee as well as the shareholders interest. This is perhaps a matter for the business judgement of the directors. [30]

Duty to Creditors

In Multinational Gas and Pharmaceutical Co. V. Multinational Gas and Petrochemical Services Ltd., [31] it has been noted that directors do not owe a fiduciary duty to the creditors and this has always been a traditional view in the UK. This view was then questioned by the House of Lords in Winkworth v. Edward baron Development Co., in which there was a claim made by a wife, who also was a director and stockholder, trying to enforce an equitable interest in the matrimonial home owned by the company against a mortgagee seeking possession of it. Here her husband was the other stockholder and director of that company. While passing the judgement it was held that:

“A duty is owed by the directors to the company and to the creditors to ensure that the affairs of the company are properly administered and that its property is not dissipated or exploited for the benefit of the directors themselves to the prejudice of the creditors.” [32]

In the UK as in the US in case of insolvency or voluntary winding up of a company the directors do owe a fiduciary duty to the creditors. [33] In situations when insolvency becomes inevitable a statutory duties to the creditors is imposed and the protection of creditor interests through statutory regulation of a company capitalization perhaps is more stringent in the UK than in the US. [34]

On the other hand while looking at solvent and insolvent companies, in the US Creditors of an insolvent company can bring derivative claims against the directors on behalf of the company for breaches of fiduciary duties. Furthermore, directors’ duties with due regard to both solvent and insolvent companies are based on common law principles that over a period have been clarified and developed through case laws. Although there are provisions that allow certain transactions to be challenged [35] yet it does not contain provisions equivalent to the wrongful trading provisions in England and Wales, or the provisions in France and Germany prescribing certain time periods by which an insolvency filing must be made. [36]

Directors’ duties at Common Law when a company is solvent

In general, directors of solvent US companies owe fiduciary duties to the company’s shareholders, not the creditors. The principle fiduciary duties directors owe are:

Duty of Care. [37]

Though in the UK with the introduction of Companies Act 2006 which is making the law with regard to directors’ Duty of Care and Skill introducing an objective element to the test now however the law existing earlier to this was subject to old subjecting test of negligence especially in events leading to insolvency or bad faith transactions. [38] But it is to be noted here that in the American business judgement rule the focus is on procedure that is how decisions are arrived at rather than focussing on the decisions themselves.

Duty of Loyalty.

This is perhaps one of the most important requirement of a director towards his company in which directors should avoid engaging in a conduct that gives rise to conflicts of interest and they should also refrain from using their position to obtain a personal advantage (to the detriment of the company) as was seen in Cook v. Deeks [39] where the company had four directors including Mr. Cook. The other three directors diverted a contract away from the company that they had formed for the purpose of doing the contractual construction work for the Canadian railway. These directors then used their powers as directors in a wrongful manner in order to disclaim any further interest on the part of the company in that contract. The business judgment rule is inapplicable where there is a potential breach of the duty of loyalty.

Directors’ Duties when the company is Insolvent

With regard to breach of fiduciary duties in the US which is the most important duty of a director of a corporation it was an issues of debate for a while as to whether and to what extent can a creditor of an insolvent company bring a claim as opposed to a derivate claim on behalf of the company. This issue has been addressed to by the Delaware Supreme Court in North American Catholic Educational Programming Foundation Inc v Gheewalla [40] findings that creditors of an insolvent company has no right to assert claims against directors for the breach of fiduciary duties. The court in this case held that:

“When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation and for the benefit of shareholders.” [41]

The Delaware Supreme Court in Gheewalla has given out useful guidance for directors of struggling companies and the decision of the Delaware Supreme Court is considered to be very persuasive in other districts of the US Court. The decision in this case has broadened the horizon of looking at the duties of directors in a much wider context. This decision has also clarified that even when a company is insolvent do the directors owe a fiduciary duty only to the company and shareholders and this is done to protect the directors from direct claims of the individual creditors based on breach of duty. In reaching this decision, the court commented that creditors have sufficient existing protections including those that they may have agreed contractually, such as covenants and the taking of security as well as protections under bankruptcy law. The decision made in this case has removed a significant degree of negotiating leverage from creditors by removing the threat of a direct litigation claim against directors but non-the less the creditors can still bring derivative claims against directors on behalf of the company for breach of fiduciary duties, if they can satisfy certain procedural hurdles thereby giving a fair chance to both the parties in dispute.

Directors’ duty with regard to Conflict of Interest

This is one of the most important duties a director has towards his company in order to create an atmosphere of cleanliness in all its dealings within and outside a company. This duty has a different approach reached by the laws in both the UK and the US. In the UK this duty is called ‘The no- conflict rule’ Section 9.2.3 of the CA 2006 as well as in Aberdeen Ryl Co v Blaikie Bros [42] explains that directors should never put themselves in a position where their personal interests might conflict to the duties they owe to their companies. Moreover in the UK a director is not permitted to put himself in such a position even if he discloses his position to the board of directors and if a director finds himself in such a position he is bound to disregard his personal interests. There is another duty in the UK called ‘The no-profit rule’ also found in Sec. 9.2.4 of the CA 2006 where a director is obliged to express his personal interests gained unless expressly provided while holding office in that particular company from making a secret profit for himself using company assets, information or opportunities and if he does so then he is accountable to the company for the same. [43] This rule has been brought out in many cases such as Regal (Hasting) Ltd v Gulliver [44] , Cook v Deeks [45] and IDC v Cooley. [46] In the US a very different approach to the similar problem is addressed by Sec 8.31, RMBCA where, a conflict of interest transaction is not voidable by the corporation solely because of the directors’ interest in the transaction unless if any of the following are true:

If the board of directors or a committee of the board authorized gave prior consent or ratified the transaction which was already disclosed to them by the director himself,

If the same were known to the shareholders who were entitled to vote authorised, approved or ratified the transaction.

The transaction itself was fair to the corporation.

Looking at laws governing both countries there certainly is a clear distinction in both their approaches and their way of interpreting each law but it can be drawn from the illustrations shown above that both countries have drafted their laws very well and have taken ample care to justify its inclusion as statutes which has brought a generous deal of harmony in this particular field making life much less complicated and simpler.

Corporate Governance

“Company Law and Corporate Governance are right at the heart of the political agenda, on both sides of the Atlantic” [47] . According to the definition given by Parkinson [48] ‘Corporate governance is a system of control over the companies’ managers/directors and also a system where the company’s management is held accountable for its performance which in turn is measured against the company’s proper objective.’ Corporate governance has moved up from being a mere exercise to becoming a considerable concern for companies. The debate of corporate governance is intense and the convergence of ‘Codes of Best Practice’ is indeed desirable. In spite of the differences in corporate governance across the globe, there are signs of growing confluence [49] .When the scandal entailing the giant Enron hit the headlines, the United States were more exposed then the United Kingdom, but were in a much more stable position. The United Kingdom’s model of corporate governance is far from perfect but certainly their reviews have been a step in the right direction, ahead of other developing and transitional countries. Prior to the scandal The European Union had recognised a period of inactivity in respect of corporate governance but was actively addressing the situation. The harmonisation of the Codes of their Member States was the paramount issue they wanted to deal with but the Commission has recognised that complete harmonisation would take years and may never be perfect [50]

Conclusion

What is evident from this paper is that the role of the director of a company is not only that of a leader and one with sole authority but also that to channelize a sense of balance in the way the company is to be managed. For a company to survive and do justice to the shareholders and participants of the business there has to be harmony between the internal and external functions. This has been attained with the inclusion of the position of ‘directors’. This essay highlights the duties of this important position within the company and the implications it has on the shareholders, end users and other companies competing and/or complimenting the business. The reader gets an idea about the approaches taken by the different legal families to the regulation of the conduct of directors also iterating the differences in the duties of the directors of the compan