Directors' Duties
One of the three most contested issues in company law (next to shareholder remedies and insolvency)
Directors as fiduciaries:
Directors as fiduciaries:
- Directors are in a very important position.
- The law imposes obligations on important people because they can take advantage of others.
- They owe loyalty to other people.
- The 'agency problem': placing obligations on agents of companies so they cannot 'rip off' the principle (the company and its shareholders).
- Directors' duties are codified in the CA 2006 but only to consolidate that which is already established by common law (s.170(4))
- Section 170(1) states that the duties of the directors are owed to the company.
- Is 'the company' just the company as a separate entity or to the company as a whole?
- To the company as whole (Percival v Wright 1902): not to individual shareholders (Peskin v Anderson) and not to creditors.
- You can't look through case law and establish that 'the company' is its shareholders.
- Company as a whole: general body of shareholders, present and future (Gething v Kilner 1972).
- Directors have an indirect duty to creditors (direct duty is to the company).
- When the company is in distress they must take into account the interests of creditors.
- In certain circumstances, the duties the directors owe are owed in such a way that they must take into account the interests of creditors. S 172(3) doesn't tell us what these circumstances are.
- The case law is not clear.
- When the company is insolvent, directors HAVE to take into account the interests of creditors.
- 'Financial difficulty' is not clear
- One argument is that if a director can reasonably expect insolvency could occur as a result of their actions, they must take into account creditors' interests
- Contractarians believe that the only people whose interests should be taken into account are the shareholders, and the main aim is maximising their wealth.
- Communitarians take a public view of company law and consider stakeholders' interests, believing that they are social institutions that have a public impact.
- Duties apply to shadow directors
- Ultraframe UK Ltd v Fielding 2005: shadow directors don't owe fiduciary duties to the company, but they do have a duty of care.
- Yukong Line Ltd of Korea v Rendsburg Investments Corp of Liberia (No2): shadows owe fiduciary duties...
- Based on loyalty and trust
- Acting properly with the company
- Acting in good faith
- No mention of them in s 170 but in 178(2) there is an implication that all of them from s 171-177 apart from 174 on the duty of care regard fiduciary duties.
- This mandates that a director subordinates his or her interests to that of the company.
- The notion of fiduciary duty is a product of the law of equity
- It ensures that a person in a discretionary position is trusted to serve the interests of another person
- If the duties were not there, directors would act in their own interests
- Self-dealing: acting for himself/herself (fiduciary duty)
- Shirking: not doing their jobs properly (duty of care)
- Directors are almost like trustees (but they are not!) as they are both fiduciaries - directors can take risks, but trustees cannot
- Section 171: they have a duty to act in accordance with the company's constitution.
- The powers that have been granted to the directors must be exercised for the purpose for which they were granted.
- Directors must act in good faith, but they must also use their powers for a proper purpose
- When the courts look at whether the directors have exercised their powers for the proper purpose, they use a subjective test and objective considerations: they look at what the directors thought, and also whether the evidence suggests that it wasn't for a proper purpose
- The burden of proof is on the claimant, not on the director
- There are cases where shares have been issued to prevent others taking control rather than to raise capital.
- Hogg v Cramphorn Ltd: company was threatened with a takeover. The directors established a trust for the company's employees and lent money to the trust so they could buy shares with the company. More shares: less interest. Court looked at whether the power was used properly. Even though they thought it was the best thing for the company, their primary purpose was to stop the takeover rather than to raise capital.
- Howard Smith v Ampol Petroleum: Two companies that were trying to take over a company. Company didn't want Ampol to takeover, they'd rather Howard Smith, so issued shares.
- Court said you have to look at the basis for power. Then they look at whether it was bona fide (in good faith), then what the purpose was. If the dominant (primary) purpose is improper, the directors are acting outside their power. If substantial purpose is proper then they are okay.
- Extrasure Travel Insurances Ltd v Scattergood 2003: Got to identify the power whose exercise is in question; got to identify the purpose for which the power was delegated to the directors; must then identify the substantial purpose for which the power was in fact exercised and decide whether that purpose was proper.
- 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, and in doing so have regard to:
- The likely consequences of any decision in the long term;
- The interests of the company's employees;
- The need to foster the company's business relationships with suppliers, customers and others;
- The impact of the company's operations 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.
- "Have regard" - not follow completely.
- 'Enlightened shareholder value': most controversial issue in the Companies Act 2006.
- Continuation of the requirement to act in the company's best interests.
- Re West Coast Capital (LIOS) Ltd 2008
- Cobden Investments Ltd v RWM Langport Ltd 2008
- Shepherd v Williamson 2010
- Not a lot of guidance from the law.
- There is a lot of director discretion: provided the directors act in good faith, their discretion is broad.
- Good faith is the only limitation.
- Prima facie, it is difficult to say that a director is not acting in good faith.
- The duty to act bona fide in the best interests of the company was assessed on the basis of a subjective test (Re Smith and Fawcett Ltd 1942).
- Charterbridge Corp Ltd v Lloyds Bank Ltd 1979: Applicable. Take what directors say at face value. The onus is on C to say D couldn't have been acting in good faith. C must produce evidence to suggest that D couldn't have been acting in good faith because of what D knew or did.
- Extrasure v Scattergood 2003: 'the fact that D's alleged belief was unreasonable may provide evidence that it was not in fact honestly held at the time...'
- Difficult to know what the 'success of the company' actually is.
- 'Members as a whole': courts have held that is means present and future shareholders.
- 'Have regard to...' No explanation in the provision of what this means.
- Does it mean directors are merely to take interests into account insofar as it promotes benefits to shareholders?
- The duty of care and skill has not been strictly applied historically
- Directors must be diligent in exercising their functions as directors.
- Re City Equitable Fire Insurance Co Ltd: A director need not exhibit in the performance of his/her duties greater skills than may reasonably be expected from a person of his/her knowledge and experience - SUBJECTIVE TEST.
- A director isn't bound to give continuous attention to the affairs of his/her company.
- Norman v Theodore Goddard 1991
- Objective and subjective test
- 'A director of a company must exercise reasonably care, skill and diligence.'
- This means the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge skill and experience that may reasonably expected of a... director;... and the general knowledge, skill and experience that the director has.
- Re Barings PLC (No 5):
- (1) Duty to acquire and maintain a sufficient knowledge and understanding of the company's business and affairs so they can discharge their duties. (2) Directors have to supervise people they delegate authority to. (3) Every case is different: you can't apply standards to every director in every company.
- Skill: a director isn't bound to bring any special skills. This changes if someone is appointed to a specific/specialist role.
- Non-executive directors are judged on their experience and what the reasonable person would have done.
- Diligence: directors have to attend meetings unless they have a good reason not to. They should have an active interest. They should try to find out what is going on.
- Directors are not to profit from their positions unless expressly permitted to do so.
- Directors have a duty to avoid conflicts between their personal interests and the interests of the company.
- This is because they are in a position where they could exploit circumstances to their own benefit.
- This is codified in s175(1): "A director of a company 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."
- Aberdeen Railway Co v Blaikie Bros: X was a director in A Ltd. He was also a partner in partnership B. He arranged for a contract where A Ltd bought shares from partnership B. A Ltd entered into the contract through X's agency. A Ltd sought to invalidate the contract. The Court agreed with A Ltd. X had acted improperly in entering into the agreement. If conflict is disclosed, it is okay. There was no disclosed conflict so the contract was voided.
- Courts will not consider whether the contract is a fair one.
- At common law it was not necessary to disclose where the conflict is trivial (Movitex Ltd v Bulfield).
- The test as to whether something constitutes a conflict is whether a reasonable person looking at the facts would think that there was a real, sensible possibility of conflict (Bhullar v Bhullar 2003).
- S175(2) deals with the no-profit side.
- This applies in particular to the exploitation of any property, information or opportunity. It is immaterial whether the company could take advantage of either.
- Cook v Deeks: Company (X Ltd) had 4 directors (A, B, C and D), who were also shareholders. They built railways. A, B and C were negotiating with a party wishing to build a railway. To do this they set up another company (Y). D was not happy. A, B and C were the majority shareholders and approved what they had done. D went to the courts. The directors A, B and C were liable to X Ltd. Wrongly subjected to the contract. Blatant exploitation of a company opportunity. The court said it was equitable fraud.
- Regal (Hastings) Ltd v Gulliver: R Ltd owned a cinema. R wanted to acquire two other cinemas and sell all three as a package to a buyer. The problem was, they had to buy the leasehold interests. R set up a subsidiary company to own all shares in X Ltd. To buy the cinemas, they needed £5k. The company could only put together £2k. The directors said they would put in £500 each to buy them. Instead of selling the cinemas, they sold the company, X Ltd. The new owners (Z) realised that they sold the shares to them. Z brought an action against the directors who put in money because when they put money in, they got a profit back. The directors argued that it was unfair, but they were liable. They had to account to the company for the profits they had made. Courts said it didn't matter that R Ltd couldn't do the deal without the money.
- CMS Dolphin Ltd v Simonet 2002: If an ex-director takes advantage when information or opportunity arose during term of office the no-profit provision still applies.
- Industrial Development Consultants Ltd v Cooley: C was an agent (and director) acting on behalf of IDC. Tried to make a contract with X for architectural work. X went directly to C and asked if he could do the job himself. C entered a contract with X after leaving IDC because of 'stress'. IDC said C breached duty. Court held C liable for breach of duty - he got the contract because of his position as the managing director of IDC. IDC had wanted the work - the contract fell through because of X.
- S175(3)(4): This duty does no apply to a conflict of interest in relation to a transaction or arrangement with the company.
- (4) This duty is not infringed - (a) If the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or (b) if the matter has been authorised by the directors.
- Unless the constitution specifically states that in a private company the directors cannot give authorisation, they can approve a conflict.
- In a public company, you can't approve unless it specifically states that they can.
- Approval can be obtained under s 175(6)(7): A quorum is a minimum number of people that have to be in a meeting to decide something. The directors in question (or any other interested director) can't make up the numbers, and their votes don't count.
- A director mustn't accept a benefit from a third party conferred by reason of his being a director, or by his doing (or not doing) another as a director.
- This outlaws bribes.
- A third party is a person other than the company.
- The director won't be liable if the acceptance of the benefit can't be regarded as likely to give rise to a conflict of interest.
- If a supplier gives a director a bottle of champagne or chocolates for work at Christmas, for example, this will not apply.
- If a company is to make a contract with another company and a director has an interest in the agreement, they must disclose this to his/her company.
- The declaration may (but need not) be made at a meeting of the directors or by notice in writing (s184) or general notice (s185).
- If a declaration of interest under this section is inaccurate or incomplete, a further declaration must be made.
- Any changes must be made aware before the contract.
- If the director doesn't know of the agreement they don't need to disclose.
- They are assumed to know of it if it is reasonable that they should've known.
- A director also has to disclose direct or indirect interests.
- Under s177(1) they now have to disclose the extent of their interest.
- Lee Panavision Ltd v Lee Lighting Ltd 1992: D disclosed his interest informally to the directors but not in the board meeting (but this was held to be okay).
- Neptune (Vehicle Washing Equipment) Ltd: One director company. Director didn't disclose his interest because he was the only one in the room. He was held liable.
- Now under statute, this isn't the case - if there are no other directors you don't need to.
- Directors must not fetter their discretion
- Codified what exists at common law
- Gwyer v London Wharf (Limehouse) Ltd 2002: Directors must exercise their own independent judgment when reaching a decision
- Thorby v Goldberg 1964; Fulham Football Club v Cabra Estates 1994: Directors can delegate functions to managers, but not their independent use of their powers
- Someone wishes to do something and wants the right to do something. They make an arrangement with the company to do that. The director cannot do this personally.
- The duty is not breached if he/she restricts his/her discretion if the director acts according to the constitution or as a result of an agreement properly entered into by the company
- Overarching principle: is it in the best interests of the company?
- People didn't want the government to codify duties. This section allows the court to use its discretion (they are more flexible).
- The duties developed are no more than duties of loyalty
- Item Software (UK) Ltd v Fassihi 2004: Duty to tell the company if they've done something wrong (and against the company's interests).
- British Midland Tool Ltd v Midland International Tooling Ltd 2003: Directors are required to disclose to their companies attempts made by a competitor to 'poach' them from the company.
- Consequences of a breach and remedies flowing from the breach are applied from common law.
- Companies could use (mandatory/prohibitory) injunctions or accounts of profits (director must account for profits; profits made from the breach are then turned over to the company) against the director (equitable remedies). Account of profits: JJ Harrison (Properties) Ltd v Harrison 2001.
- Equitable compensation:
- A company can claim damages for any loss suffered by the company because of breach of duty of care
- A third party can be held liable if it can be established that he or she had given knowing assistance
- A third party has been said to be potentially liable if he/she was acting dishonestly, even if the third party received no benefit from the breach (Royal Brunei Airlines Bhd v Tan 1995).
- If a director breaches his/her duty and as a result has passed a benefit to a third party, there is no need to establish dishonesty, even though dishonesty will often be present. The third person would need to be reasonably aware enough that something is not right (turning a blind eye).
- If the third party knew about the breach, he or she could be regarded as a constructive trustee
- Willing to lift the corporate veil to see who is running the company/pulling the strings if a director sets up his/her own company to take the benefit (Adams v Cape Industries 1990 - facade/sham)
- Ratification (giving approval): any decision by a company to ratify conduct by a director amounting to negligence/default/breach in relation to the company must be taken by the members, and without reliance on the votes in favour by the director or any connected person (family).
- Could ratify a conflict of interest and duty (North-West Transportation Ltd v Beatty 1887).
- Could not ratify where director hasn't acted in good faith (Attwool v Merryweather 1867).
- Could not ratify where director has acted dishonestly or without regarding the interests of the company (Cook v Deeks 1916).