The Companies Act 2006: Directors' duties (and first commencement order)
09.01.07
Introduction
The Companies Bill (formerly the Company Law Reform Bill) received Royal Assent on 8 November 2006 and is now the Companies Act 2006. The Act is the largest piece of legislation ever passed by Parliament.
Following the distribution of our Corporate Governance newsletters in 2004 and 2005, last year's Dispute Resolution and Technology briefings and our briefing note last month which examined the impact of the new Act specifically in a banking context, a further update regarding the Act is set out below. It is (unless otherwise stated) addressed to Directors of all companies, public or private, quoted or not, large and small. Further updates will follow as the Act is progressively brought into force.
The issues featured are:
- the first ever statutory code for Directors - now finalised and in large part coming into force on 1 October 2007
- the principal consequences for Directors who breach their duties
- other provisions of the Act which are coming into force in January 2007
Directors' duties
Much has already been written on this subject. Prior to 8 November 2006 all of it was speculative and a good deal of it scaremongering. Now we can assess the final version of the Directors' code of conduct on its merits, and begin to prepare for its coming into effect. All but the conflict of interest duties, which are due a year later, are expected to come into force on 1 October 2007.
The purpose of the table which follows is to summarise the new code, and highlight practical actions you should be considering.
| The new code | Practical tips |
|---|---|
| 1 For the first time there will, from October 2007, be a statutory code which addresses your "general duties" as a Director. | Familiarise yourself with the code – see sections 170 to 181 of the Act. There is no reason not to copy it to all Directors, and every reason you should. |
| 1.1 (A) To act in accordance with your company's memorandum and articles of association. (B) To exercise your powers as a Director only for the purposes for which they are conferred. | Familiarise yourself with your powers as a Director as set out in the memorandum and articles. Look out for any restrictions on your powers. |
|
1.2 From October 2007 you will be under a duty, as a Director, to act in the way you consider – in good faith – would be most likely to promote your company's success, for the benefit of shareholders as a whole. In doing so you will need to have regard to at least the following matters:
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You must, of course, always act in good faith. You must also in your decision-making processes exercise reasonable skill, care and diligence (see 1.4 below). It will be a matter for your business judgment to articulate what "success" means in any given set of circumstances, and what would be most likely to promote it. This list is not exhaustive, nor do the listed factors appear in any particular order. You will need to consider, in each case, the advantages of minutes recording the matters which you have taken into account when reaching a decision. This need not be taken to extremes however – the Government has indicated that Directors will not be required to keep additional records as a result of the re-phrasing of the statutory duty. These will be the considerations which apply to Directors of solvent companies. If your company is insolvent and progressively as it nears insolvency, shareholders' interests will be displaced by those of creditors. |
| 1.3 To exercise independent judgment. | The Government has said that this duty is "about Directors having to make up their own judgments and not follow blindly the views of another without considering the interests of the company". This duty would not prevent a Director, for example, from exercising a power to delegate conferred by the company's memorandum and articles of association. |
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1.4 To exercise reasonable care, skill and diligence. The standard required of you as a Director will from October 2007 explicitly be – and in this case we would say it is now – that level of care, skill and diligence which would be exercised by a reasonably diligent person with:
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If you read the two limbs of this test closely you will see that it is demanding. It may have practical implications for you – for example, training or professional development generally, or for improving information flows and other processes within the business. Consider this: what would your stakeholders expect of a Director doing the job you do? Would they have even higher expectations given the sort of person you are, and your particular background? |
| 1.5 To avoid conflicts of interest. As a Director, you must actively avoid situations in which you have (or can have) an interest (direct or indirect) that conflicts (or possibly may conflict) with your company's interests. |
This statutory duty (coming into force on 1 October 2008) is drafted very widely, though it would not prevent Directors from entering into transactions with their own companies which are otherwise lawful. Also, note that conflicts will be able to be "authorised" in certain circumstances by the independent (nonconflicted) Directors. Take advice on your memorandum and articles – changes may be required. Addressing one particular concern which had been raised in the legislative process, the Solicitor-General commented that "There is no problem with people holding multiple directorships". Care will be needed however on their part where actual or potential conflicts raise their head. |
| 1.6 You must not accept a benefit from a third party (i.e. other than the company and its group) which is conferred by reason of your being a Director, or your doing (or not doing) anything as a Director. | Note that this duty, like that described at 1.5 above, will not be infringed if your acceptance of the benefit "cannot reasonably be regarded as likely to give rise to a conflict of interest". |
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1.7 (A) To declare any interest you have – directly or indirectly – in a proposed transaction or arrangement with your company.
(B) To declare any interest you have – directly or indirectly – in an existing transaction or arrangement that has been entered into by your company... |
Consider any and all such interests you either know about or ought reasonably to be aware of, and make disclosure as appropriate. Again, a Director will not need to declare an interest which cannot reasonably be regarded as likely to give rise to a conflict of interest. Unless already notified under 1.7(A) above. (This is not strictly part of the new code - but see sections 182-7 of the Act.) Nb. From 1 October 2007 non-disclosure under 1.7(B) is a criminal offence, punishable by a fine. |
Summing up
These will be hugely important duties, expressed for the first time in statute - currently, Directors' duties are enshrined in court cases litigated over the centuries. Every Director will need to be clear what they say, and should think about what they will mean in practice. The language is new, and in some cases it is unclear how the new duties will be construed by the courts. This is particularly so in the case of the duty to promote the success of a company. In October 2007 this will displace the current obligation, which we know and love: the basic fiduciary obligation on every Director to act in good faith in his or her company's interests.
In many cases, the right course of action will be clear to you, and - once all the general duties appear in one place - you may well feel able to proceed with more confidence.
In cases of doubt, take professional advice.
Breach
Breach of a duty, as before, may expose Directors to civil and (from October 2007, as mentioned at 1.7(B) above) criminal liabilities, as well as to the risk of disqualification. Directors in breach may find themselves under an obligation to pay damages or compensation, or to restore property or account for profits as appropriate.
However, as is the case now - and notwithstanding the references above to employees, suppliers, customers and others - your duty is owed to the company alone. True, the new Act puts onto a statutory footing the so-called "derivative suit". This is a procedure by which shareholders are able to sue a Director in the company's name, even if the incumbent management has decided not to take action. There are several safeguards built into the system however to discourage frivolous claims.
Is that it?
No! The new code is far from comprehensive; it only codifies the so-called "general duties". It does not address your many other obligations as a Director, even in company law - for example to prepare accounts, and to comply with the special rules regarding Directors' loans, long-term service contracts and transactions with your own company, including payments to you for loss of office. (These special arrangements may require shareholder approval.) Nor does the code address your obligations as a Director under competition law, the criminal law, health and safety, environmental law and the law of insolvency. If you are a Director of a quoted company or operate in other highly-regulated sectors, you will be subject to more stringent duties still.
If in doubt, take professional advice.
First Commencement Order
The new Act is being introduced progressively. Watch out for some of the more imminent changes being brought about by the first Commencement Order under the Act:
From 1 January and 20 January 2007
E-communications
A number of provisions on electronic communications are being brought into effect in January. Some relate to the duty of Companies House to accept electronic filing (from 1 January). New from 20 January is the ability on a company's part to use electronic communications with shareholders as the default position. Every company will need to consider whether it is necessary to make changes to its articles of association (and seek shareholder approval) as a result. The relevant Disclosure and Transparency Rules may require shareholder approval to the continuing use of electronic communications.
From 1 January 2007
Websites and e-mails
The rules which currently require disclosure of a company's name, the place where it is registered, its registered office and registered number have been extended to require disclosure also in documents circulated in electronic form and on company websites. Technically, this is not part of the Commencement Order, but the new law will in due course be replaced by similar provisions in the Act.
From 20 January 2007
Directors' reports (in the annual accounts)
One development which comes into effect on 20 January relates specifically to the directors' report and remuneration report, as distinct from the remainder of the annual accounts. As a Director you will be liable, in respect of any such report first sent to shareholders on or after 20 January, to compensate the company out of your own pocket for any loss it suffers:
- as a result of any untrue or misleading statement in it or the omission from it of anything which is required; but only
- if you knew the statement to be untrue or misleading or were reckless as to whether it was untrue or misleading, or you knew the omission amounted to "dishonest concealment of a material fact".
In many ways this is a welcome development. First, Directors are expressed to be liable only to the company rather than, for example, to shareholders or potential investors. Secondly, since the provision at (b) confines your potential liability to situations involving something known to be untrue or misleading or to recklessness, it has been referred to as a "safe harbour" for directors. (The safe harbour does not apply to statements outside the directors' reports, for example any chairman's letter accompanying the accounts; nor would it affect any associated criminal liability.)
Section 212 notices (public companies only)
Section 212 of the Companies Act 1985 is repealed from 20 January and replaced by section 793 of the new Act. A section 212 notice is a notice which a public company can issue to a person whom it believes to be interested in its shares to find out more details about the ultimate owner(s). Note that the definition of what constitutes an interest in shares is the existing definition for section 212 notice purposes - while, for disclosure of major shareholdings (see below), a completely different definition is being substituted. Changes to your articles of association may nevertheless be desirable.
Disclosure of major shareholdings (public companies)
The existing provisions of the Companies Act 1985 (sections 198 et seq.) relating to the disclosure of holdings of 3 per cent and above to a public company, are to be repealed on 20 January. They are being replaced by rules derived from the EU Transparency Directive and contained in the Disclosure and Transparency Rules.
The regime is broadly similar. Note however that the current rule requires a notification where a person acquires or disposes of an interest in shares; the new rule will apply where a person acquires or disposes of shares carrying voting rights (or rights to acquire such shares) and/or specified financial instruments which give an entitlement to acquire voting shares (but not, or not yet, instruments purely giving economic exposure to the underlying shares such as contracts for differences).
Timing for implementation of the Act
The Government has indicated that it will bring a remaining provisions of the Act into force progressively and in any event by October 2009. (The next tranche is due in April.) October 2009 may seem a long time away but a lot of work still needs to be done before then. Many detailed provisions need to be set out in secondary legislation and further consultation on some aspects of the Act is anticipated.
Consolidation into one Act
The final text of the Act was published only on 7 December 2006 and the first Commencement Order was made on 20 December. The Act retains many provisions of the existing law and restates them with the new provisions. The full text of the Act can be obtained from the Office of Public Sector Information
Key Contact
David Vaughan, partner, +44 (0)121 214 1002, david_vaughan@wragge.com
This alert may contain information of general interest about current legal issues, but does not give legal advice.
