English Law Standards for Limited Liability Company

Critically discuss whether English law requires directors in English limited liability companies to behave to a sufficiently high standard in their conduct of the affairs of such companies. Illustrate your answers by reference to case law post Companies Act 2006 if relevant.

The Companies Act 2006 sets out the specific duties that directors owe to the companies which they manage. It is to the benefit of directors that they understand and observe the importance of these duties. The legislation and other associated statuses cover general business functions such as tax, employment, health and safety to specific duties which individual companies carry out in the delivery of their services. The Act addresses the exposure and the extent to which directors could become personally liable. This requires that directors are expected to behave to a standard as they manage the affairs of their companies.

The CA 2006 supersedes and codified the accepted common law and equitable duties of directors, however, this may not be termed as an exhaustive classification of the duties of directors as the view is that common law duties do continue to operate within a limited scope.

The directors of a company form the board of the company and are empowered to make decisions and take actions within defined limits on behalf of the company as set out in the company’s articles. Chapter 2 of Part 10 of the Companies Act centers on the general duties of directors.

The Scope and Nature of General Duties

The general duties are based on certain common law rules and equitable principles as they apply in relation to directors and have effect in place of those rules and principles as regards to the duties owed to a company by a director. Also, the general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties. Chapter 2;170(3,4) Part 10 Companies Act 2006¹. Chapter 1 of Part 11 Companies Act 2006² deals with derivative claims instituted due to breach of duty by directors. The general duties, 171 to 177 of Chapter 2 of Part 10 of the Companies Act 2006¹ include;

171 Duty to act within powers

The actions taken by a director should be in line with the company’s constitution, and only exercise powers for the purposes for which they are conferred. The company’s constitution in this case refers to the company’s articles, the decision taken based on the articles and the decisions of the shareholders which are binding on the company.

In West Coast Capital(Lios) Limited [(2008) CSOH 72] ³, Tesco Holdings Ltd failed in its attempt to gain complete control of Dobbies Garden Centres Plc because West Cost owned part of the shares and were not willing to sell on to Tesco. Tesco eventually succeeded in gaining 65% control of the company while WCC held on to their 35%. The new board of directors of Dobbies decided against paying dividends but proposed to raise further capital,

£150 million via a new shares issue. WCC opposed this and sought to block the move because Tesco wanted to force them out of the business unfairly. Lord Glennie, in the Court of Session; the directors had exercised their powers under S 171 and the consideration was the purpose for doing this which was raising further investment. It was only where improper motivation could be established that this could be the basis for unfair prejudicial conduct and a possible breach of duty under S171. He therefore found in favour of Tesco.

172 Duty to promote the success of the company

Directors should only engage in actions that will drive the success of the company and should be in good faith bearing in mind that this will be beneficial to the members. They should consider the possible consequences of any decision in the long term on the stability of the company, the impact on the employees ensuring that they are not deprived and can continue to deliver their best services for the company, develop and improve on business relationships with customers and suppliers, contribution to the community and environment, ensuring that the company maintains a reputation for high standards and conduct and also upholding fairness amongst members

The duty imposed by this section will depend on any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company. Success for a business is viewed in the Act as an increase gained in value over a considerable period. A director should act or make his or her judgment in good faith having considered the impact of any decision or action on the company, its owners (shareholders), staff, external parties such as suppliers and customers, the community and the environment.  

In Franbar Holdings Ltd v Patel & others [2008] EWHC 1534 (Ch)⁴; Franbar, a shareholder had a 25% stake in the company and Casualty Plus held the remaining shares. Differences arose over the management of the company as Franbar alleged that the directors of the company, appointed by Casualty Plus had diverted business opportunities away from the company to Casualty Plus, suspended one of Franbar’s nominated directors and did not make available required financial information.

Franbar launched a claim for breach of the shareholders’ agreement, an unfair prejudice petition and a derivative claim. The court refused permission to continue a derivative claim in this case having concurred that a notional director would not grant importance to the derivative claim and the claimant was already pursuing the other claims. His demands were best served this way.

In Mission Capital Plc v Sinclair and another [2008] EWHC 1339 (Ch) All ER (D) 225(Mar)⁵ ; the company had terminated the employment and directorships of two executive directors for failing to provide financial information and achieve the set financial forecast. Mission Capital subsequently started proceedings against the former directors who also started a counterclaim seeking to be reinstated on the grounds of unfair prejudice and breach of shareholders agreement and also issued a derivative claim against the continuing directors. The court refused permission for a derivative claim to continue having adjudged that the claimant’s request could be addressed through the other claims.

Furthermore, Mission Capital could also decide to remove the directors who the derivative claim had been issued against as they would not attach importance to this.

In Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch); [2010] B.C.C. [2011] 1 BCLC 498, [2010] BCC 420 ⁶, the claimants; shareholders in Westrip, accused the defendant directors of engaging in unacceptable conduct amounting to breaches of duty by the defendants and this had led to the company losing ownership and control of an asset. This was a valuable mining license and that, but for their intervention, the company could have lost almost all the remaining assets.

The claim was refused as the court held that a derivative claim instituted for the benefit of the company by a claimant may be allowed provided there were other benefits that he or she could derive from the claim however, in a case where the person making the claim had participated in the alleged conduct, the claim may be refused. The strength of the claims against the directors was weak and lacked the merit to grant permission.

173 Duty to exercise independent judgment

Directors should be objective in their decisions. This duty is not breached by their acting in accordance with an arrangement duly entered into by the company that constrains the future exercise of moderation by its directors, or in a way authorised by the company’s constitution. It is may be advisable for a director to seek and rely on the advice of others however, the fundamental decision lies with him or her. A director should be in a position able to make decisions independently and not have others enforce their decisions and preferences on him.

174 Duty to exercise reasonable care, skill and diligence

Directors should exercise sufficient care, skill and expertise in their operations. This will mean that a director should have or strive to acquire the care, skill and diligence that is required to function effectively in his/her role. The requisite operational knowledge, expertise and proficiency that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company

Reasonable care and expertise will imply that the director promptly addresses issues that could impact on the stability of the business. The director may also delegate to capable employees or professionals where applicable. 

In Gregson v. HAE Trustees Ltd [2008] 2 BCLC 542⁷, the corporate trustee and its directors were sued for alleged breach of trust and failure in their duty by not fully considering the implications of decisions made in the management of funds in the trust. They had kept back investments in a family company that had been previously put into the trust and the company had now become insolvent. The claim was on the basis that the directors were in breach of their duty to the corporate trustee and the claim against them was part of the trust property, therefore a claim against them could be made obligatory by her as a beneficiary. The directors opposed this. The High Court held that the dog-leg principle could not hold as the directors’ duties were owed to the corporate trustee in its own right therefore a claim for breach of duty would not succeed.

In Brannigan v Danes – [2016] All ER (D) 276⁸ ; the claimant, B was a minority shareholder of a company, Portobello Estates Ltd (PEL). PEL had been incorporated as a special purpose vehicle in relation to certain development projects. B brought a derivative claim against the other directors and shareholders alleging that the first defendant, S, had been negligent and/or had acted in breach of duty in failing properly to progress a development project, which led to loss of profit of £22m. B contended that the defendants were brothers and had close business connections that and the breach could have been avoided. Furthermore, an alternative planning permission was discovered by B which demonstrated bad faith on the part of the defendants. The court refused permission to progress the claim. It was not unusual to have multiple planning applications as they could be made in stages hence would not amount to bad faith. Furthermore, PEL had decided against proceeding with the claim having sought legal advice on the matter, extreme cost involved and the fact this may be unaffordable.

In Stainer v Lee and others [2010] EWHC 1539 (Ch)⁹, the minority shareholder sought a representative action against the other two directors who were majority shareholders of the company.  One of the directors had loaned company funds to other director’s company the company was owned and controlled by the first director. The other director failed to pay any interest on the loan and the minority shareholder decided to apply for permission to continue derivative claim seeking relief on behalf of the company against the other directors. The Chancery Division of the High Court granted the application, subject to some control, namely that permission would be limited to the conclusion of disclosure and terms as to costs pursuant to s 261(4) of the Act.

Similarly, Cullen Investments Ltd and another v Brown and others – [2015] All ER (D) 81¹⁰, courts granted the permission sought having proven that he will be disadvantaged

175 Duty to avoid conflicts of interest

Directors should stay clear of situations in which he/she has, or can have interests that are at variance, or possibly may create disputes, with the interests of the company.

One should consider the exploitation of any property, information or opportunity (and it is irrelevant whether the company could take advantage of the property, information or opportunity). This duty does not refer to a conflict of interest due to a transaction or arrangement with the company. It is also not contravened if the situation is not expected to lead to a conflict of interest or if the matter has already gained the prior agreement of other directors

In a private company, where a transaction has been proposed and agreed by the directors or in a public company where the constitution enables the directors to authorise a transaction once it is proposed and reviewed by them in line with the constitution, there is no breach. The concerned directors will usually have no voting rights on the matter and the minimum number required by constitution to agree the decision must be met

Differences of interest also includes a clash of interest and duty and a variance of duties.

Towers v Premier Waste Management Limited [2011] EWCA Civ 923¹¹; Mr. Towers had been a Director of Premier Waste Management Limited, a specialist waste disposal and treatment company. Towers fell out with the board and left the company in December of 2003 and afterwards, it became clear that Towers had accepted a personal loan without payment from Mr Colin Ford, a customer of the company without notifying the board. The loaned items were returned in 2008 after Mr Ford had invoiced the company for the cost of hiring the equipment.

The company made a claim against Ford, refusing liability for the hire charges and a further claim against Mr. Towers for the profits received. Ford made a counterclaim for the cost if hire of his equipment. The High Court ruled that Towers should pay the company the sum of £7,997.31 which included cost and interest of the hiring the equipment. He was also to pay the cost of the action. The decision was upheld by the Court of Appeal who concluded that by failing to disclose the loan of the equipment, Towers had breached his duties to the company which included the no conflict principle and duty not to make a secret profit. By his concealment of the loan, he did not act honestly and reasonably.

On the contrary, in the case of Foster Bryant Surveying Ltd v Bryant & Anor [2007] EWCA Civ 200¹² ; the Court of Appeal found that there was no breach of fiduciary upholding the decision of the High Court. Foster and Bryant were directors of the company and the large part of their work came from Alliance. On being notified that he would be made redundant, Bryant resigned however Alliance decided to keep his services and funded him to set up his own practice. Foster had sought for Bryant to contract his services through his company, FBS but the idea was rejected.

The company sued Bryant on the grounds of having breached his fiduciary duties of loyalty and diverting corporate opportunities to himself. This was rejected in High Court and the decision was further upheld in the Court of Appeal. Rix LJ delivering the lead judgment identified the challenge in addressing the situation in which a departing director may or may not be held to have breached their fiduciary duties and given that this was facts based it could be held that Bryant’s resignation was innocent of any disloyalty or conflict of interest.

In, O’Donnell v. Shanahan [2009] 1 BCLC 328¹³, Allied Business & Financial Consultants Ltd’s business consisted of providing clients with financial advice & assistance. A director came across an opportunity to secure interest in an investment property whilst in a business transaction and he proceeded with the opportunity. The other director filed a derivative claim alleging conflict of interest & breach of the duty not to make a profit.  The claim was dismissed on grounds that, although the opportunity came to the director’s attention in course of acting in his capacity as such, it was not an opportunity in the company’s line of business.

Also in Helmet Integrated Systems Ltd v. Tunnard [2007] IRLR 126¹⁴the court held that it was not a breach of contract or fiduciary duty where a senior employee takes steps to start his own company which rivalled his current employers while he is yet to end his existing contract but the company was yet to commence operation.

 176 Duty not to accept benefits from third parties

Directors should avoid accepting third party benefits which is offered to them due to their position as a director or doing anything as director. The “third party” here refers to a person other than the company, and this could be corporate or a person acting on behalf of a corporate organisation.

Where the benefit in question does not affect the duty of the director, this should not give rise to a conflict of interests and whilst this is not a basis for the receiving benefit to be authorised by the directors, the acceptance could be agreed by the company’s shareholders. The company’s articles may also allow that directors may legitimately receive third party benefits up to a certain value, provided they do not breach the relevant provisions of the company’s constitution.

177 Duty to declare interest in proposed transaction or arrangement

Where a director in any way, directly or indirectly has an interest in a proposed transaction or arrangement with the company, he is required to declare the nature and extent of that interest to the other directors. This could be made at a meeting of the directors, by notifying the other directors in writing or a general update. If the position changes, it is best that further declaration should be made and such declaration must be made before the company commits to the affected transaction. Where there is no variance or divergence that could lead to a conflict, a director may not be required to declare his/her interests in the transaction. This is also applicable if the other directors are already aware.

Conclusion

The success of a company rest is dependent on the directors who also ensure that the interests of the company as well as shareholders is protected. Directors are appointed agents and they owe duties to the company, the standard demanded of them is high and the Companies Act 2006 has helped in clarifying this with restrictions and guidelines on what is expected of directors. Directors’ are appointed by shareholders to manage the company’s affairs for the benefits of the shareholders. The success of any company depends on having good, dedicated, knowledgeable and honest directors. Therefore, success can only be achieved, if the directors and are supported by the shareholders in carrying out their functions. From the reference cases, the courts pay due attention to director’s duties and how these duties are performed.  The courts however do not seek to encourage unnecessary litigation being aware that the burden of expectation placed on directors is high and that many shareholders may seek to raise challenges where possible. The cost of litigation and proceedings is high and many companies are unable sustain endless litigation on matters on limited consequence.

Directors play important parts in a corporate governance system and fulfilling their duties is primary to sustenance of the operational system in which the organization exists. Directors can also play multiple roles in organisations depending on the size of the organisation and often, their powers and responsibilities could be extensive.

1. Chapter 2;(177 -177) Part 10 Companies Act 2006
2. Chapter 1; Part 11, Companies Act 2006
3. West Coast Capital(Lios) Limited [(2008) CSOH 72]
4. Franbar Holdings Ltd v Patel & others [2008] EWHC 1534 (Ch)
5. Mission Capital Plc v Sinclair and another [2008] EWHC 1339 (Ch) All ER (D) 225(Mar)
6. Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch); [2010] B.C.C. [2011] 1 BCLC 498, [2010] BCC 420 
7. Gregson v. HAE Trustees Ltd [2008] 2 BCLC 542
8. Brannigan v Danes – [2016] All ER (D) 276
9. Stainer v Lee and others [2010] EWHC 1539 (Ch)
10. Cullen Investments Ltd and another v Brown and others – [2015] All ER (D) 81
11. Towers v Premier Waste Management Limited [2011] EWCA Civ 923
12. Foster Bryant Surveying Ltd v Bryant & Anor [2007] EWCA Civ 200
13. O’Donnell v. Shanahan [2009] 1 BCLC 328
14. Helmet Integrated Systems Ltd v. Tunnard [2007] IRLR 126

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Bibliography and Case Law References:

1. Chapter 2;(177 -177) Part 10 Companies Act 2006
2. Chapter 1; Part 11, Companies Act 2006
3. West Coast Capital(Lios) Limited [(2008) CSOH 72]
4. Franbar Holdings Ltd v Patel & others [2008] EWHC 1534 (Ch)
5. Mission Capital Plc v Sinclair and another [2008] EWHC 1339 (Ch) All ER (D) 225(Mar)
6. Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch); [2010] B.C.C. [2011] 1 BCLC 498, [2010] BCC 420 
7. Gregson v. HAE Trustees Ltd [2008] 2 BCLC 542
8. Brannigan v Danes – [2016] All ER (D) 276
9. Stainer v Lee and others [2010] EWHC 1539 (Ch)
10. Cullen Investments Ltd and another v Brown and others – [2015] All ER (D) 81
11. Towers v Premier Waste Management Limited [2011] EWCA Civ 923
12. Foster Bryant Surveying Ltd v Bryant & Anor [2007] EWCA Civ 200
13. O’Donnell v. Shanahan [2009] 1 BCLC 328
14. Helmet Integrated Systems Ltd v. Tunnard [2007] IRLR 126