Impact of Sections in Companies Act 2006

Discuss and critically analyse the significance and the impact of sections 39, 40 and 41 of the Companies Act 2006

Abstract

In seeking to critically discuss and analyse the significance and the impact of sections 39, 40 and 41 of the Companies Act (CA) 2006, this essay will first look to provide an understanding of the background to this discussion by considering as to why – and with what purpose – the CA 2006 was put into place in the United Kingdom (UK) with a view to furthering the effective regulation of company law. Following on from this it will then be necessary to outline what sections 39-41 of the CA 2006 specifically relate to with regard to company law and also consider these provisions in terms of the overall context of the ongoing development of company law with a view to then improving the corporate governance framework and the administration of companies activities. Finally, this essay will look to provide for a conclusion with a summary of what are considered to be the key points that have been derived from this discussion in relation to the exact significance and the impact of the CA 2006 regarding the ongoing development of UK company law.

Introduction – Background – Why was the Companies Act 2006 enacted?

Corporate governance structures development domestically has previously been somewhat limited for achieving the effective instigation of a framework for all companies to look to adhere to. [1] By way of illustration, there is a need to recognise in the UK policy makers did not actually develop a universally applicable corporate governance regime until the 1990s with reviews undertaken in the form of the ‘Report of the Cadbury Committee on the Financial Aspect of Corporate Governance’ [2] amongst other leading to the enactments Combined Code of Corporate Governance in 2003, 2006 and 2010. This is because both corporate governance regimes and company directors roles within their respective companies were mainly covered by the decisions that were reached by the common law courts and the largely administrative Companies Acts (CA) of 1985 and 1989. [3] As a result, it has come to be recognised that it was only after a number of significant financial scandals, including companies as famous as Rolls Royce, [4] that a response was finally forthcoming resulting in a set of self-governance regulations being imposed for the regulation of companies supported by both government policy makers along with the London Stock Exchange. [5]

With this in mind, there is also a need to appreciate that company directors have the power to take majority business decisions on behalf of their companies with a view to administering their activities. As a result, it has been recognised that various duties are imposed on company directors to ensure that their respective companies’ interests are protected in the interest to their shareholders. To this end, under the common law and in keeping with the aforementioned limited nature of the CAs of 1985 and 1989, company directors’ duties have been taken to include – (a) the duty to act in good faith; (b) the duty to avoid conflicts of interest; (c) the duty not to profit from their office; and (d) the duty of care and skill. [6] The government has, however, recognised that the problem with the recognition of such duties on the part of company directors is that they are not that easily accessible so that company directors have had to often look to take advice in these areas with a view to ensuring they do not inadvertently breach any duty that is considered to have been enshrined in the case law. Therefore, this effectively meant that the government came to believe that the codification of company directors’ duties would serve to then make the law in these areas much more consistent, certain and accessible through the enactment and implementation of the CA 2006 that received Royal Assent in November 2006 and was fully enacted into domestic law in October 2009.

The Companies Act 2006 at sections 39-41 – Context & Development of Company Law

Companies board of directors legal powers mean that they can act on their given company’s behalf since these powers are not considered to be independent of the company so they may not carry out, in the company’s name, any activity the company cannot perform. Restrictions on what companies may and may not do have been largely removed including the ultra vires rule meaning individual companies can only carry out those activities expressly or implicitly provided for in their constitutions objects clauses as companies sought to give themselves a wide range of powers to guarantee their activities validity would not be questioned. [7] On this basis, section 31 of the CA 2006 provides, except where a company’s Articles of Association restrict a company’s objects, the company’s objects are unrestricted. Whilst a company’s constitution would have previously had to state the activities it could perform, the CA 2006 now provides that the constitution’s role regarding the powers of a company is to specify what restrictions are to be imposed on a given company as they may otherwise theoretically conduct an unlimited range of activities. [8] With this in mind, a company’s constitution will not only establish the activity the company may partake in but will also define the powers to be delegated to the directors from the particular company as they think fit. As well as a general delegation of power, The Articles of Association can also establish specific powers for directors including their powers – (a) to inspect company books; [9] (b) to refuse to register share transfers; and (c) to forfeit shares under Article 70 of the Articles of Association at Table A that says company directors shall manage the business and exercise all of its powers under the CA 2006 and any direction by special resolution of the particular company.

Therefore, in the event that the constitution of the particular company places any restrictions on the company or directors powers, those restrictions need to be observed by the directors in keeping with their duties to their company. [10] However, in the majority of cases, the presence or lack thereof of any such constitutional restrictions will have no bearing on third parties that are dealing with the particular company. Overall, however, there is a need to appreciate the CA 2006 looked to establish companies’ practical constitution at section 17, whilst sections 18-20 of the Act served to recognise the significance of a given company’s Articles of Association with regard to their administration. [11] This is because, whilst a company’s actions will not be questioned because of their constitution, [12] company directors can bind the company in ‘good faith’ [13] subject to any limitations [14] or where company directors act beyond their powers [15] . Therefore, whilst company shareholders’ major power is the right to vote on specific matters, their key strength is the managing of the companies themselves [16] so shareholders’ franchise has been characterised as the foundation “upon which the legitimacy of the directors managerial power rests”. [17] The reason for this is that company directors must look to bring about the maximisation of shareholders interests [18] so it is arguable the CA 2006 will serve to give greater emphasis to the rules and laws already established in relation to directors conduct in looking to work for the best interests of their company.

Section 39 of the CA 2006 recognised a company’s actions validity shall not generally be questioned because of a lack of capacity in their constitution and the fact company directors can bind the company they are working with under sections 40(1)-(5) with anyone acting in ‘good faith’, subject to any limitations, not limiting their liability or where directors act beyond their powers. [19] This is because it has been recognised that, in the event a particular company looks to involve itself in prohibited transactions under its constitution, those transactions may remain both enforceable and valid. To this effect, the CA 2006 has served to provide at section 40, where a third party looks to deal with a company in good faith, the directors power to bind the company – or to permit others to – is considered free of any restriction under the constitution. This serves to mean that any third party does not have to enquire if there is any constitutional limitation regarding the powers of company directors to permit a particular transaction so they are not expected to inspect the particular company’s constitution or even raise the issue with the directors during negotiations. In addition, section 40 of the CA 2006 has served to provide third parties will not be considered to be acting in ‘bad faith’ by reason only that they actually knew the specific transaction was beyond the company directors powers in a specific case. Moreover, the ‘constitutional limitations’ of company directors’ powers are specifically referenced under section 41 of the CA 2006, whilst only two resolutions can now be made company directors, [20] so it is no longer possible to then pass an extraordinary resolution or act without shareholder agreement.

Therefore, whilst company directors can call general meetings under Article 37 of the Articles of Association, [21] notice is still required for all directors and shareholders, [22] along with less restrictive requirements for their participation in company affairs. [23] This is because any acceptance of a company’s activities cannot be revoked [24] within 28 days [25] – although this may be done electronically [26] – because in many ways the enlightened shareholder value concept perpetuates shareholder primacy. However, where company directors powers have been established by the Articles of Association, the company cannot ordinarily intervene. Where specific powers have been delegated to a particular company’s board of directors, the company directors may look to exercise their powers and company shareholders are unable to look to override decisions taken by a company’s board of directors nor look to direct them with regard to how to act. [27] This means a shareholder can only bring a minority shareholder’s action where control is proved, so the procedure used may only be applicable where independence can be easily assessed. [28] This reflects the fact section 459(1) of the CA 1985 (now section 994 of the CA 2006) recognised “A member of a company may apply to the court by petition for an order” because they may argue their “company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself) or than any actual or proposed act or omission of the company … is or would be so prejudicial”.

As a result, the implementation of sections 39-41 of the CA 2006 has served to bring about the reinforcement of the traditional common law understanding of the fact a third party does not have to know, when looking to deal with a particular company, whether relevant internal management requirements have been fulfilled. [29] This effectively means that, as far as third parties are concerned, third parties are commonly permitted to expect, when they are dealing with company directors, directors of companies may commit their company to a specific transaction. However, in this regard, although express authority to act for a given company does not normally rest with individual directors, in some cases there is a need to recognised that a company director may have ‘apparent’ authority to act as their company’s agent where a third party believes the person is acting with the authority of the principal regardless of whether they have ‘actual’ authority. On this basis, there is a need to appreciate that the following conditions derived from the decision in Freeman & Lockyear v. Buckhurst Park Properties (Mangal) [30] are required that must be present if apparent authority is to apply – (a) There must be some representation the agent had the authority to act that does not need to involve an explicit statement of authorisation to the third party, but can take the form of conduct by the principal that gives the necessary impression to the third party; (b) The representation must come from people with actual authority to generally manage the business or a specific contract; and (c) The other party to the contract must have relied on the given representation. [31]

More generally, however, there is also a need to appreciate that equity has long traditionally had an inflexible rule that means company directors are in a fiduciary position and cannot profit from their work with their company without having to account for that profit to both the company and its shareholders – except where it has been otherwise provided for. [32] This is because company directors owe certain duties to their company and must have it and its shareholders best interests in mind regarding all aspects including money and its other tangible assets. [33] On this basis, where this kind of property belonging to the company is then misapplied, company directors are answerable to the company and its shareholders as trustees and should not allow their personal interests and their duties to the company to conflict [34] without accounting for it unless they disclosed the relevant facts and obtained the shareholders’ approval by ordinary resolution. [35] This is because company directors must report voluntarily whenever there may be a suspicion their personal interests may conflict with their company’s [36] to get shareholder approval without waiting for an actual conflict. [37]

Conclusion

In conclusion, having sought to critically discuss and analyse the significance and the impact of sections 39, 40 and 41 of the CA 2006, it is clear that sections 39-41 provide for the establishment of a given company’s constitutional limitations to its powers and, as a a result, those of the associated company directors. This because sections 39-41 of the CA 2006 have brought about the reinforcement of the traditional common law understanding of the fact a third party does not have to know, when looking to deal with a particular company, whether relevant internal management requirements have been fulfilled. [38] Section 39 recognised a company’s actions validity shall not generally be questioned due to a lack of capacity in their constitution and the fact directors can bind the company they are working with under sections 40(1)-(5) with anyone acting in ‘good faith’, subject to any limitations, not limiting their liability or where directors act beyond their powers. [39] This means any third party does not have to enquire if there is any constitutional limitation regarding the powers of company directors to permit a particular transaction so they are not expected to inspect the particular company’s constitution or even raise the issue with the directors. Section 40 also provides third parties will not be acting in ‘bad faith’ because they knew the specific transaction was beyond the company directors powers in a specific case. Moreover, the ‘constitutional limitations’ of company directors’ powers are referenced under the CA 2006 at section 41, whilst only two resolutions can now be made by directors, [40] so it is no longer possible to pass an extraordinary resolution or act without shareholder agreement to provide for further limitations upon the exercise of company directors powers.