Duties Owed by Directors of Listed Companies

Critically evaluate the duties owed by directors of listed companies set out in the companies Act 2006.

INTRODUCTION

A company is a species of corporation which is a district kind of organisation . this means that it is body of bodies; technically, an artificial person composes of natural persons. For the purpose of much legislation it considered as a legal person. A company is separate legal personality. The concept of separate legal personality was firmly established by House of Lords in the leading case Solomon.vs Solomon and co.Ltd [1] .the director of a company is not liable personally for the acts of the company. The director is the main organ of the company. The company is a legal person. A legal person must act through a natural person. A director is usually appointed under the companies Articles of Association in the general meeting. The director of the company carries the many important obligations and responsibilities. It is not a position which should be undertaken without a full appreciation of these responsibilities and knowledge of the personal liabilities conferred to the directors. The director of the company have a power to take majority business decisions on behalf of the company. The companies Act 2006 set the duties of directors of companies. There are many responsibilities given to the all directors of the company it may be executive or non executive duties. A directors duties derived from the companies constitution that is memorandum of association and article of association .

GENERAL DUTIES OF DIRECTOR

There are some general duties prescribed by Companies Act 2006 and it is described here in after. For example, director of company have a duty to promote the success of the company. However companies act will not permit directors to violate their duty to act within their powers, even though they believe that their deed would promote the success of the company.

A director of a company should act in as prescribed in the constitution of the company and he must exercise his powers for which purpose it is conferred. For example, “a director of the company exercising his authority to issue shares for the principal purpose of diluting a particular member’s shareholding, as opposed to the proper purpose of raising capital or other appropriate purposes, would be breaching this duty. The liability is strict: if the director’s substantial purpose was not the purpose for which the power was conferred, it will not matter if he exercised the power in good faith or in the belief that it would promote the success of the company for the benefit of the shareholders as a whole. For these purposes a company’s constitution includes the company’s memorandum and articles of association, decisions taken in accordance with the articles and any members’ resolutions and agreements affecting the company

When a director of a company discharging his duty he must consider to long term consequences of that decision , company’s employees interest, the company’s business relationships with suppliers, customers and others, effect of operations of the company on the community and the environment, desirability of the company maintaining a reputation for high standards of business conduct; and the need to act fairly as between the members of the company.

This is not an complete list and, depends upon on the circumstances and business nature of each company there may be some other factors that the directors need to consider when they are exercising the powers of the company. This duty will apply to all decisions made by a director, not only to formal decisions taken by board of directors of a company.” [2]

The companies Act2006 directs two specific qualifications to the duty to promote the success of the company for the benefit of its members as a whole:

“If the purposes of the company consist of or include other purposes, the directors’ duty will extend to promoting the success of the company with a view to achieving those purposes; and such duty is subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company. Accordingly, the directors of a company facing financial difficulties will have an overarching duty to protect the interests of its creditors. The question arises as to how to record appropriately the fact that directors have considered those matters required to be considered under the 2006 Act. The Act contains many specific provisions about responsibilities of directors. A company’s constitution will also define their functions. But general directors propriety of conduct and standards of skill and care are laid down by complex and inaccessible case law. The basic goal for directors should be the success of the company in the collective best interest of shareholders, but that directors should also recognise, as the circumstances require, the company’s need to foster relationships with its employees, customers and suppliers, its need to maintain its business reputation, and its need to consider the company’s impact on the community and the working environment.

The directors’ general duties to the company should be codified in statute largely as proposed in the Final Report. The basic objective of directors, and the matters to which they should have regard when acting in furtherance of it. All the directors of a company should be subject to the same set of general duties, regardless of any particular duties they might have under service agreements as employees.

The three categories of directors duties are as follows; Fiduciary duties, Statutory duties, Duties of skill and care.

Fiduciary duties

A legal relationship of confidence between two parties that is a fiduciary duties.

“The relationship of a director to his company is sometimes described as that of trustee, particularly in the older cases. But unlike a trustee in the strict sense, a director will rarely have the property of the company vested in him as legal owner. A director, too will be expected to take commercial risks on behalf of the company which would be a breach of duty in a trustee. In these and other respects a director is not strictly a trustee. It is better to describe his relationship to a company as that of a fiduciary” [3] .

Directors Fiduciary Duties are as follows

1)act in good faith in the best interests of the Company

2)not to make secret gains ,to avoid conflicts of interest

and 3)to act bona fide in the interests of the company

It is clearly established that directors are under a duty to act bona fide in what they consider, and not what a court may consider, is in the interests of the company and not for any collateral purpose. The overriding nature of this obligation was stressed in two cases concerning takeover bids. In Dawson International plc v Coats Patons plc [4] the court accepted that an agreement between a target company and a bidder company which proved that the board of the target company would recommend the bid, and would not encourage or co-operate with any other bidder which might emerge, was subject to an implied qualification derived from the law which defines directors’ overriding duties to other company and their shareholders. The qualification was that, if circumstances altered materially, the board could decide in fulfilment of their continuing duty to the company and its shareholders not to implement the agreement.

“There is a obligation on the part of directors to act bona fide in the interest of the company has been defined as an obligation to act in the interest of the shareholders and it is the directors subjective opinion as to the interest of the co-operators as general body, balancing the short term interest of the present members against the long term interest of future members. The directors duty requires to treat all share holders equally . for example they cannot inform some members while payment is outstanding on other members share.. However where there are different classes of share holders so decisions may adversely effect the interest of the company as one of what is fair as between different classes of shareholders and fairness does not always require identity of treatment” [5] . “In Mutual Life Insurance Co of New York v Rank Organisation Ltd the directors were not in breach of their duty to act fairly when they decided that it was in the best interests of the company to make a rights issue to only some of the holders of ordinary shares. That decision by the directors excluded the company’s American and Canadian shareholders from the rights issue and was done in order to avoid the onerous regulatory requirements of those jurisdiction.” [6]

It is the duty of the directors for treating the creditors in the same manner as shareholders, ie for defining the duty to act bona fide in the interests of the company as encompassing creditors interests in some circumstances. This approach has its origins in dicta in a number of Australian and New Zealand decisions. In Walker v Wimborne [7] the company’s directors, in breach of their duties to the company and its creditors, guaranteed loans of another company in the group at a time when the company was itself in serious financial difficulties. The court found the transaction exposed the company to the probable prospect of substantial loss and was undertaken in accordance with a policy adopted by the directors in total disregard of to the interests of the company and its creditors.

“The matters to which the directors of a company are to have regard in the performance of their functions have been expanded by statue to include the interests of the company’s employees in general as well as the interests of its members. In the light of that wording, however, it would be very difficult to establish that the directors have failed to comply with the requirements of the section. In any event, as the duty is owed only to the company the rule in Foss v Harbottle will come into play and enforcement of the duty will be at the discretion of the company. It is a statutory provision without teeth but nevertheless it represents a tentative step towards recognising the employees role in the enterprise.” [8]

Duty to Avoid Conflicts of Interest

section 175 of the 2006 Act says that 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. This applies, in particular, to the exploitation of property, information or opportunity, whether or not the company could take advantage of that property, information or opportunity. Where directors place themselves in a position where their duties and their personal interests conflicts, any contract involved is voidable at the instance of the company. The leading case about on directors conflicts of interest is Aberdeen Rly company. vs. Blaikie Bros [9] where a company was entitled to set aside a contract for the purchase of equipment entered in to between it and partnership when it transpired that the chairman of the directors is obliged to purchase goods on behalf of the company at the lowest possible price while as a member of the partnership he wishes to sell the goods at the highest price. Where such a conflict exist, the law recognises that the director ,despite his best intentions, may be swayed by his own self interest. There are advantages in applying such a strict non conflict principles there is certainty resulting from the absolute prohibition and savings in terms of the time and money which would otherwise be expended if the courts had to be satisfied as to the fairness of each transaction. But there are also disadvantages. Prohibition may force a company to incur costs as where the company is forced to contract with an outsider when an insider is the sole or most favourable source of the good or services which the company requires.

Duty to Exercise Independent Judgment

Section 173 of the 2006 Act says that a director must exercise independent judgment. This duty will not, however, be infringed by a director acting in accordance with an agreement entered into by the company that restricts the future exercise of the directors’ discretion or in a way authorised by the company’s constitution . This Act does not prevent directors from seeking advice from experts when they are taking any decision. In the case of Re city equitable fire insurance [10] , a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably expected from a person of his knowledge and experience. A director is not bound to give continues attention to the affairs of the company. The three limbs of Rommer J’s test may be stated as follows:

The subjective formulation of required skill means that director must display such skill as their personal qualification warrant. More is expected of experienced men of business. However, there are indications that an objective standard has been introduced by statute in certain circumstances.

The degree of diligence required of a director depends on the facts of each particular case broadly he must exhibits his duties such care as an ordinary man might me expected to take on his own behalf .

If any of the Directors are appointed as representatives of major shareholders or who are directors of other companies in the same business field need to take special care to guarantee that their decisions are made independently in the welfare of the company; whilst a director can listen to and take into account the views of others, his decisions must not be influenced by the third parties interest.. Such directors of company must also think whether their circumstances give rise to a conflict circumstances which would require prior approval.

Duty to Exercise Reasonable Care, Skill and Diligence

section 174 of the companies act2006 says that A director must exercise the care, skill and diligence for the interest of the company that would be exercised by a reasonably diligent person who has both: the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company and the general knowledge, skill and experience that the director in question actually has. While “the objective test referred to above sets down the fundamental standard to which a director must exercise his duties, he must, in addition, bring to bear any particular skills and experience he may possess in order properly to discharge his duty. Regard must also be had to the director’s role in the company; for example, a non-executive director will not generally be expected to have as close a day-to-day knowledge of the company’s affairs as an executive director, and the advanced legal knowledge and experience of a legal director would not be expected of, say, a marketing director. Such a legal director would, however, be expected to bring his personal knowledge and experience of legal practice to bear in carrying out his own duties.” [11]

City Equitable Fire Insurance Co. [12]

The law on this issue is dominated by the decision in Re City Equitable Fire Insurance Co Ltd in 1925 where an insurance company suffered large losses as a result of the fraudulent activities of its managing director, a person described by the court as a daring and unprincipled scoundrel. In considering the conduct of the remainder of the board, the court reviewed many of the older authorities, some dating back to the previous century, and concluded that it was impossible to describe the duty of directors in general terms because of the wide variety of companies and functions which would have to be encompassed.

A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. This is a subjective test of skill with the nature and extent of the duty depending on the nature of the business and the particular knowledge and experience of the individual director. So a non-executive director who was a corporate financier and who failed to read and understand the company’s statutory accounts was found to have fallen below the minimum standard of competence expected of him. However, while the degree of skill expected will vary according to the individual, the standard of care required is such care as an ordinary man might be expected to take in the same circumstances on his own behalf.

“A director is not bound to give continuous attention to the affairs of his company. His duties are of an intermittent nature to be performed at periodical board meetings, and at meetings of any committee of the board upon which he happens to be placed. He is not, however, bound to attend all such meetings, though he ought to attend whenever, in the circumstances, he is reasonably able to do so.

Executive directors appointed under service agreements will usually be required to give exclusive attention to the affairs of their companies while non-executive directors, certainly in public companies, would be expected to attend board meetings although private companies will operate a more relaxed regime.

In Dorchester Finance Co Ltd v Stebbing no board meetings were held and two of the three directors rarely attended at the company’s premises. All three directors, including the two inactive directors who had acted bona fide throughout, were liable for losses incurred when unsecured loans were made by the third director which subsequently turned out to be irrecoverable. The inactivity of the two directors was such that they had failed to perform any duty at all as directors of Dorchester. Complete inactivity in relation to, and complete un involvement with, the running of a company, in the absence of special circumstances, may warrant a finding of unfitness justifying disqualification.” [13]

In respect of all duties that having regard to the exigencies of business and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly.

It is obvious that a company could not help to run its business in an efficient manner if the directors were required to do everything themselves and were not permitted to delegate on a wide scale. An intelligent devolution of labour must be possible. Having permitted delegation, the law does not require that the directors should distrust and constantly supervise those to whom tasks have been delegated for this would defeat the whole purpose.

In Huckerby v Elliott a director of a gaming club was not negligent in failing to check whether the club had the appropriate licence when the task of obtaining it had been delegated to someone else. In Dovery v Cory the director of a banking company was not negligent in relying on the assertions of the chairman and general manager of the company, whose integrity, skill and competence he had no reason to doubt, with the result that dividends were paid out of capital and advances made on improper security. The court did not accept that the director should have watched either the inferior officers of the bank or verified the calculations of the auditors himself; nor was he required to examine the entries in the company’s books.

A statutory statement

A modern statutory approach to the issue of care and skill can be found in the wrongful trading provision in the Insolvency Act 1986 which judges a director’s conduct by objective standards for the purpose of ascertaining whether he knew or ought to have known or concluded that the company was wrongfully trading. Wrongful trading involves continuing to trade when there is no reasonable prospect of avoiding insolvent liquidation. Here it is necessary to judge the director’s conduct against the conduct that might be expected of a reasonably diligent person having both:

a). the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and

b). the general knowledge, skill and experience that director has.

Enforcement of the duty

Breach of a director’s duty of care and skill be a wrong done to the company and in respect of which the company should sue. This is the rule in Foss v Harbottle. If the company decides not to proceed then a shareholder can only bring an action on behalf of the company if he can bring himself within the fraud on the minority exception to the rule in Foss v Harbottle. However, it can be noted here that, mere negligence on the part of the directors is not sufficient to bring a case within the fraud on the minority exception although an action may be brought in the case of self-serving negligence. Where the shareholders have authorised the allegedly negligent activity then no action can be taken against the directors. Negligence in the management of the company’s affairs may justify a petition alleging unfairly prejudicial conduct.

“Directors have both collective and individual responsibility for ensuring they are sufficiently aware of the company’s affairs in order to be able properly to fulfil their duties. This is an active obligation. It is, however, possible for a director to delegate the performance of his duties if delegation is permitted by the company’s articles of association. The delegating director will be responsible for ensuring that the particular task is delegated to an appropriate person and for supervising that person’s performance.” [14]

Duty to Not to Accept Benefits from Third Parties

“Section 176 of companies act says that a director should not accept any kind of benefit from third party which is granted because of his being a director or his doing or not doing anything in his capacity as a director. The duty of director will not be violated if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. Benefits conferred by the company, persons acting on their behalf, its associated companies, and benefits received from a person who provides the director’s services to the company, are excluded.

The duty of a director will continue to apply after a person ceases to be a director in respect of things done or excluded by him while he was a director. For eg., a past director will be in breach of this duty if he utilize property as a result of knowledge gained during his time as a director and to do so conflicts with the interests of that company.

It is to be noted that there should not be de minimise that There is need not be It should be noted that there is no de minimise that affect in relation to this duty. Unlike the duty to avoid conflicts of interest where conflicts can be authorised by the board, a director obtaining a benefit from a third party can only be authorised by the members of the company.” [15]

“Duty to Declare Interest in Proposed Transactions or Arrangements with the Company

section 177 of the companies act 2006 says that It is the duty of the directors to declare to the other directors about the nature and extent of any interest, whether direct or indirect, in an arrangement or proposed transaction with the company. In order to apply this duty, the director need not be a party to the transaction. For example, in a contract, the interest of another person with the company may require the director to make a disclosure under this duty, if the other person’s interest amounts to a direct or indirect interest on the part of the director. That would be the case if the director was economically interested in the other contracting party, for instance.

The declaration must be made before the company enters into the transaction or arrangement, and where a declaration of interest proves to be or becomes inaccurate or incomplete, a further declaration must be made if the company has not yet entered into the transaction or arrangement when the director becomes, or should reasonably have been, aware of the inaccuracy or incompleteness.” [16]

No declaration will be required:

where the director is not aware of the transaction or his interest or arrangement (unless he should reasonably been aware of the relevant matters);

if the interest cannot reasonably be regarded as likely to give rise to a conflict of interest;

if, or to the extent that, the other directors are already aware of the interest (and for this purpose the other directors are deemed to be aware of anything of which they ought reasonably to be aware); or

if it concerns the terms of the director’s service contract which have been (or are to be) considered at a board meeting or board committee.

On the for making such disclosures, there are no restrictions, but there are specific provisions under 2006 Act made for declarations to be made in writing or by way of a general notice of declaration. The nature and extent of the interest must me stated by this general notice, and the connection with the relevant person, can be made:

in the esteem interests of the relevant director (whether as member, officer, employee or otherwise) in a specified body corporate or firm, in which case he is regarded as interested in any transaction or arrangement that may, after the date of the notice, be made with that body corporate or firm;

in association with any other specified person, in which case he is regarded as interested in any transaction or arrangement that may, after the date of the notice, be made with that person; and

only at a meeting of the directors or if the director takes reasonable steps to ensure it is brought up and read at the next meeting of directors after it is given.

.However, a duty to disclose an interest in connection with a proposed transaction or arrangement arose under section 317 of the Companies Act 1985, the duty of disclosure continues under that Act and not the 2006 Act.

Requirement to Declare Interests in Existing Transactions or Arrangements Entered into by the Company

According to the section 182 of the companies act 2006 A director must declare the nature and extent of his direct or indirect interest in an existing transaction or arrangement entered into by the company. Again, the director need not be a party to the transaction for this duty to apply. However, this obligation does not apply if or to the extent that the interest has already been declared under the duty to declare an interest in a proposed transaction or arrangement as des The declaration must be made as soon as is reasonably practicable, and even if the declaration is not made as soon as it should have been, it must still be made. Where a declaration of interest proves to be, or becomes inaccurate or incomplete, a further declaration must be made.

No declaration will be required if any of the circumstances which exclude a director from having to make a declaration under section 177 of the 2006 Act apply.

In this case, declarations must be made:

at a meeting of the directors;

by written notice; or

by general notice

This obligation (which, technically, is not one of the general duties of directors) will come into force on 1 October 008.cribed above.

Consequences of breach of duty of director

The breach of directors duties which is newly incorporated in the bodies the same as the consequences of breaching the common law rule or equitable principle from which they are drawn.

The damage will awarded as remedy for a violation of the duty of care, skill and diligence. The court will grant Injunction to aside of the transaction, restitution and account of profits restoration of the company property held by the director; and damages are the remedies of breaches of other general duties.

Under the Company Directors Disqualification Act 1986, a breach of duty could also have been grounds for the termination of an executive director’s service contract, or disqualification as a director. In the case of breaches of the newly codified duties also these remedies will remain available.

In general, subject to certain exceptions, only the company may bring an action against a director to recover its losses for a breach of the duties referred to above. The 2006 Act also provides shareholders with a new derivative right of action that will enable shareholders to bring an action against a director on behalf of the company in respect of “a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company”.

Relief from liability

Although directors general duties are strict, there are a number of ways in which directors may be relieved from liability.

a). where conduct by a director amounting to negligence, default, breach of duty or breach of trust is ratifiable, it can be ratified by a resolution of the disinterested members of the company by majority or unanimous consent.

b). section 239 does not affect any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law as to act that are incapable of being ratified by the company. Thus as required by equitable rules, the director must make full disclosure to the company before ratification.

c). CA 2006, s. 182 requires direc