Directors Are Now Subject to More Tightly Controlled Rules

The question visualizes that changes brought about by the codification of director’s duties in the Companies Act 2006 means that directors are now subject to more tightly controlled rules than ever before, especially when taking account the no profit and no conflict rule imposed on the directors as well as the enlightened shareholder value provided for in Section 172 CA 2006.This essay deals with both views that are in support and those that are against the statement by looking through the different duties that are codified under the Companies Act 2006 and comes up with a conclusion.

The codification of the general duties of directors in the Companies Act 2006 is considered to be a revolutionary step in the law. Pre CA 2006, the directors’ duties were based upon in common law and developed by equity. Presently, one no longer has to rely on common law and can look at Section 170 to 177 Companies Act 2006 which sets out all the general duties of directors in statutory form. The case of Percival v Wright [1] and Section 170(1) of the CA 2006 sets out that directors’ duties are owed to the company and not the shareholders. Section 170(3) goes on to say that the codified duties replace the previous rules and principles and Section 170(4) says that codified duties can be interpreted by previous case laws. Thus this means even though the rules don’t apply the previous case laws can be used to interpret the codified duties.

The question above sees s172 as relevant in increasing the extent of the rule that govern directors’ duties. This view-point is supported by a simple reading of the s172 of the CA 2006.It is immediately apparent that s172 does not shy away from providing what directors must and must not have regard to, which lends support to the statement that directors are now under much more tightly controlled rules than even before. The act provides that “A director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole” [2]

In doing so, the director is required to look at the likely consequences of any decision in the long term, the interests of the company’s employees, the need to foster company’s business relationships the impact of company’s operation on the community and environment, the desirability of the company maintaining a reputation for high standards of business conduct and the need to act fairly between the members of the company. [3]

If there were any enforcement brought against directors, claimants and courts can analyse whether directors have complied with these factors and therefore have much more scope for alleging that directors have acted wrongly. [4]

On the other hand, the courts in fact grant a large degree of discretion to directors. Indeed, the courts will only interfere and comment on the manner that directors have carried out their duties when it is considered that the director’s decision is unreasonable. Section 172 is highly subjective, since it is what the director considers and not what the court considers [5] .Therefore it can be difficult to prove breach of this duty. This gives a rather lenient approach to directors and it cannot be said that the rules to directors are tightly controlled than before.

A court does not generally substitute its own decision for a directors’ one, and thus, despite the fact there is now a huge list of criteria governing what directors should take into account of, on a practical basis directors are granted essentially the same freedom that they had before. [6]

There are other implications of s172 however. Commentators have pointed out that the confiscation of s172 in statute means that any claimants bringing actions against directors are much more able to rely on s172 to plead negligence on the directors. The fact that the director owes a positive duty eases the ability to bring such an action. [7]

Ultimately, the fact that a duty is set out in a statute makes it a stronger and more substantive duty that if it was simply preserved in the common law. Legislative intention is seen to be supreme and the codification of the duty under 172 can never be changed, while potentially the common law rules and equitable principles that provided that directors had duties towards companies could be. However to what extent such an assertion is valid can be disputed. The common law rules and equitable principles that provided that the directors had duties towards their companies was extensive in nature and well established. Indeed directors are seen as having a fiduciary duty towards a company rather than any other duty, which means that they have a duty to act in good faith at all times. Arguably this goes beyond the duty that is set out in s172 of the CA 2006 Act. Such law has been established for years and it is arguably as unlikely to change as the legislation itself would be. In this manner one can assume that s172 simply acts as a codification of the general principles and laws that previously existed which provided that the directors had a duty of care towards the company. [8]

It is questionable to what extent s172 might even be used.S172 sets out a general duty; meanwhile s33 of CA 2006 provides that directors and other officers of a company are bound by the general articles and provisions of a company. Thus there is a contractual claim that is able to be brought in the case of a director failing to comply with his general duties as set out in the memorandums of association or other memorandums of a company. Due to that s172 is doubtful to be effective in practice as a contractual claim is seen as stronger than a tortuous one, with greater remedies that are able to be provided,s172 is therefore hardly revolutionary in its provisions. [9]

The statement points out that the fact the no-conflict [10] and no-profit [11] rules are now codified, alongside considerable changes being made in relation to disclosure and ratification, lends support to the view that directors are now subject to more tightly controlled rules than ever before. Also Section 170(2) CA 2006 mentions that even if the director ceases to be a director of a company, he continues to be bound by the no-conflict and no-profit rule. This is evidence in support of the view that directors are subjected to tighter rules.

The no profit rule is a general rule where a director is not able to make any personal profit or gain in his dealing with the company’s property without accounting to shareholders for any such profit made. Thus, for example if a director purchases share price at par when the share prices are being sold on the market for a higher value, he must account to the company for any profits made. [12]

Section 175 and 177 of the CA 2006 Act provides that a director is under an active duty to disclose any profit that he has made by virtue of being a director of a company. These statutory rules of disclosure means that a director is not only required to account for any

secret profits made, if he is discovered to make any such profits, but is required to actively

disclose to the company when the particular profits are made. The failure to disclose would be a breach of his statutory duty. [13]

The no profit rule is linked to the no conflict rule, for one sees that the rationale behind the provisions of Section 175 and 177 of the Companies Act 2006 is that a director is considered to be acting under a conflict of interest he is acting both for his benefit and for his company’s benefit. This too is linked to the fiduciary nature of a director’s duty – the fact that his role is intended to be one that is always carried out in the interest of his company means that he cannot carry out a role to further his own interests.

The 2006 Act does indeed go far in providing for disclosure and ratification that further strengthen the no conflict and no profit rules. The general rule under company law is that any decision undertaken by a company, even if not undertaken with authority at the time it was first made, can retrospectively be provided with such authority if it is ratified by an ordinary or special resolution of shareholders of the company. The matter will be different however if the shareholders of the company subsequently ratify the decision that was made by the director to enter into the contract. This rule is however subject to an exception. A director is never allowed to benefit from the company he is director of, even if the decision made by the director which leads to such a benefit being gained is later ratified by the shareholders. The law here makes a specific exception providing that duties on directors are even more onerous with regards to the no-profit and no-conflict rules than they are in other areas of company law. [14]

The 2006 Act provides for even more substantive provisions in the no profit rules and render any actions n the law governing the liquidation of a company. The liquidator of a company in the course of winding up is able to investigate any instances of personal profits made by directors on behalf of the company and render any actions undertaken by the director personally liable to himself rather than bind the company. Thus, for example if a director has entered into a contract which provides him with some personal benefit, a liquidator is able to hold that the director is personally liable for the contract and his assets rather than the company’s assets are to be used to pay for any outstanding sums due under the contract.

One can see the fact that the 2006 Act governs the liability of directors to an extent that it allows for personal liability shows that the rules here are particularly strict. [15]

However the question is not that the 2006 Act provides that directors are subject to strict rules, but that the rules the directors are subject to are stricter than ever before. This is not true as the actual fact the duties of directors mentioned were all previously contained in case law. In the case of Grencor ACP v Dalby [16] the court held that the fact that a director had a fiduciary duty towards his company meant that he was not able to benefit from his role in the company for to do so would be a conflict of interest and that he had to declare to the company any situations that might arise that would lead to such a conflict of interest occurring. Therefore, it can be seen that this is just a copy and paste of the no profit and no conflict rule that are now found in the 2006 Act. Also the leading case of Bhullar v Bhullar which says directors must avoid any conflict of interests’ in particular corporate opportunities.

A similar conclusion can be reached with the leading case of Regal (Hastings Ltd) v Gulliver [17] which was decided in 1942. Here, the directors had manipulated the buying and selling between subsidiary and parent companies so as to provide personal profit to themselves. The House of Lords held that the defendants had made their profits by reason of the facts that they were directors of Regal and in the course of the execution in the office. They were in breach for failing to account their profits to the company. The common law also provided similar rules with regards to any improper action carried out by directors. Thus, in the case of Re William C Leitch Bros Ltd [18] which was decided in year 1932, the court held that if a liquidator had found that a director had engaged in wrongful trading he could be held to be personally liable for any debts incurred by the company as a result of that wrongful trading. This is similar to the powers provided to liquidators under the 2006 Act. In this circumstance, it can be said that the 2006 Companies Act is simply a codification of rules that were previously found in common law.

Now we would deal with the enforcement of the rules that are against the directors. The question states that it can be argued that now directors are subject to ‘tightly controlled rules than before’. In order to say that the directors are subject to stringent rules than before requires a look whether these rules can be enforced. It is important now to deal with the mechanism that is capable of being used to utilise the rules in the Companies Act 2006 against directors.

Furthermore, if the rules exist but cannot be enforced then it cannot be said that directors are subject to stricter rules. As established, the enforcement action can only be taken against a director by a limited class of people. Directors’ duties are owed to the company therefore only the company and members acting behalf of the company are able to enforce particular rules against directors.

The courts will not interfere if there is no action taken in the first place by the members of the company that is directly affected. Thus, it can be assumed that the fact action can only be brought by a limited class of people and cannot be enforced easily means that directors are not subject to tightly controlled rules than before.

Recently, however there are developments in the law which supports the view in the question that directors are subject to stricter rules than before. For example there is now a statutory derivative action which is introduced in the Companies Act 2006.A derivative claim is defined as ‘those proceedings by a member of the company (a) in respect of a cause of action vested in the company and (b) seeking relief on behalf of company’. [19]

Pre Companies Act 2006, a similar provision to the derivative action was seen enshrined in the rule of Foss v Harbottle. However back then, in order to bring action against directors a majority consensus of shareholders of a company was needed.

Now, the statutory derivative provision is codified in Section 260 – Section 264 of Companies Act 2006.A statutory derivative action allows actions to be brought by any member of the company even if there is no majority consensus to such an action being brought. [20] This puts the directors at a greater risk and it nevertheless increases the scope of action that can be brought against directors. It can be said that due to the derivative action being introduced directors are subjected to tighter rules.

However, in the case of Burland v Earle it was held that minority shareholders can bring action on behalf of their company if the directors were bringing about frauds on minority by doing wrongs against the company. Therefore this was not the case in the past that only majority shareholders would be able to take action against directors. This case was decided in 1902 and is an exception to the Foss rule.

Post Companies Act 2006, the statutory derivative action has many exceptions to it thus it can be questioned how far an extent it has and how successful it is in its action. Now, it is not the case that any shareholders can take action against directors. Permission is required from the court before the shareholders can take any action. In considering if the permission is to be given or not the courts will consider if there is enough evidence to support the claim that is brought or if the claim is not a valid one. [21] Thus it can be seen that the derivative action would be limited by the courts due to the fear of opening of floodgates against directors. The courts kept in mind these concerns when introducing the statutory derivative provision.

Directors now will have discretion in how to carry out their duties in the companies and the courts will only intervene if there has been a particular unacceptable act that has taken place. The 2006 Companies Act can be said to be the same rules that were introduced in Foss v Harbottle. The only change is the presumption. Previously it was the majority actions by the shareholders would be brought subject to exceptions, but the rule now is that minority actions are allowed, but subject to exceptions as well.

Since the 2006 Act came into effect there are two claims [22] brought to the court against the directors. The judges were unimpressed and did not give permission for the claim to proceed. Thus the claims failed. A recent case that appears to be similar to the ruling that was in Foss v Harbottle is the case of Franbar Holdings Ltd v Patel [23] .The court came to a decision that a court ruling was not appropriate since the company has allowed for a petition procedure which could be used.

In Mission Capital plc v Sinclair [24] , the courts refused permission to claim a derivative action where a notional director was unlikely to attach much importance to the claim and the alleged damage was speculative. As can be seen by the two cases above bringing a derivative action is never easy and to get permission from the courts to further the claim made is difficult as the courts will look into different factors and evidence.

As can be seen the general duties of directors that are now codified in Companies Act 2006 appears to be similar and is an extension of the old law which was previously in Companies Act 1985.It appears to be that Section 172 is a little more than a gloss on the previous duty to act bona fide in the interests in the company. [25]

In conclusion, it is clear that Section 172 has gone far in trying to ensure that directors’ duties are adequately codified. Thus Section 172 of CA 2006 specifically sets out that directors owe a duty to the company and provides a non-exhaustive list of factors which they are required to have regard to in making decisions for the company. The no-conflict and no-profit rule are also codified along with the rules in relation to disclosure and ratification which means the directors cannot benefit from their position and status. The Act also introduces the new statutory derivative action which allows minority shareholders to take action against directors if there is impropriety in the company.

However, in my opinion these rules are the same rules that were previously contained in the common law and equitable principles. The duty in Section 172 is seen in the fiduciary nature of directors. The rules of no-profit and no-conflict are derivatives of that rule. Even the statutory derivative action is a restatement of what had been established in Foss rule.

Therefore, I would disagree with the statement that the 2006 Act means that directors are subject to tighter controlled rules than before. It cannot be said so because these rules have existed before in common law and the 2006 Act is just a reformulation of the previous laws which have existed before.

BIBLIOGRAPHY

Books

A Morse, Palmer’s Company Law, Annotated Guide to the Companies Act (Sweet & Maxwell) [2006]

A Hudson, Equity and Trust – Cavendish [2009]

A J Boyle, J Birds, Company Law – Jordan Publishing [2009]

B Hannigan, Company Law – Oxford University Press [2009]

C Wild, S.Weinstein, Smith and Keenan Company Law – My Law Chamber [2009]

P Davies, Gower and Davies, Principles of Modern Company Law – Sweet & Maxwell [2008]

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A Keay, M Loughrey – “Something new, something old, something borrowed” [2008] LQR 469

Bill Davies – Codified obstacles, New Law Journal [10 Oct 2008]

Bill Davies – The bank directors’ duties – time for the new enlightment? –Private Law Vol 3 [2010]

Bill Davies – More than a bottom line [24 July 2008] NLJ Vol 158 Issue 7331

H.Hirt – Ratification of director’s duties 25 CL 7 pg 198