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Directors’ duties

Chapter 12


Directors’ duties


Chapter Contents


12.1    Introduction


12.2    The nature of the duty owed


12.3    Duty to promote the success of the company


12.4    Duty to exercise independent judgement


12.5    Directors’ exercise of powers for a proper purpose


12.6    The duty of care and skill


12.7    Fiduciary duties


12.8    Use of corporate opportunities


12.9    Competing with the company


12.10  Benefits from third parties


12.11  Personal liability of directors


12.12  Limiting the liability of directors


12.13  Directors’ contracts


12.14  Substantial transactions


12.15  Control of political donations and expenditure


Summary


Self-test questions


Further reading



12.1  Introduction


One of the most significant changes brought about by the Companies Act 2006 is in relation to the statutory code of duties that a director owes to a company (ss 170–177 CA 2006).


A person who ceases to be a director continues to be subject:


(a)  to the duty in s 175 (duty to avoid conflicts of interest) as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was a director; and


(b)  to the duty in s 176 (duty not to accept benefits from third parties) in relation to things that were done or omitted by the director before he ceased to be a director.


Section 170(4) provides that the general duties shall be interpreted and applied in the same way as the common law rules or equitable principles and regard should be had to the corresponding common law rules and equitable principles in interpreting and applying those general duties.


It is therefore proposed to consider pre-existing case law that impacts on the interpretation of these duties.


After the passage of the Companies Act 2006, the minister responsible for steering the legislation through the House of Commons, the Rt Hon Margaret Hodge MP, the Minister of State for Industry and the Regions, issued guidance on the statutory duties of directors in the Act.


She noted that she and other ministers were questioned about the meaning of provisions. Some of the responses and statements she considered may be helpful to those interested in what the provisions meant and a structured collection of them was therefore issued. Some of them are reproduced here as guidance and to indicate the scope of the duties under the Act.


Guidance for company directors


1   Act in the company’s best interests, taking everything you think relevant into account.


2   Obey the company’s constitution and decisions taken under it.


3   Be honest, and remember that the company’s property belongs to it and not to you or to its shareholders.


4   Be diligent, careful and well informed about the company’s affairs. If you have any special skills or experience, use them.


5   Make sure the company keeps records of your decisions.


6   Remember that you remain responsible for the work you give to others.


7   Avoid situations where your interests conflict with those of the company. When in doubt, disclose potential conflicts quickly.


8   Seek external advice where necessary, particularly if the company is in financial difficulty.


The minister noted that there are two ways of looking at the statutory statement of directors’ duties: on the one hand it simply codifies the existing common law obligations of company directors; on the other – especially in s 172, the duty to act in the interests of the company – it marks a radical departure in articulating the connection between what is good for a company and what is good for society at large.


It is noted that the statutory expression of the duties is essentially the same as the existing duties established by case law, the only major exception being the new procedures for dealing with conflicts of interest.


It is noted also that for most directors, who are working hard and put the interests of their company before their own, there will be no need to change their behaviour.


Compared with the pre-existing definitions of the common law duties of directors, however, the new statutory statement captures a cultural change in the way in which companies conduct their business.


12.2   The nature of the duty owed


The traditional view in British company law was that directors owed their duties to the company, which was interpreted as the provider of capital – that is to say, to the shareholders. This duty was owed to the shareholders as a body and not to individual shareholders. Thus, in Percival v Wright [1902] 2 Ch 421, where certain shareholders approached the directors asking them to purchase their shares at a time when secret takeover negotiations were going on, the directors failed to mention this to the shareholders. In subsequent litigation, it was held that the directors were not in breach of duty to the shareholders. The directors owed their duty to the shareholders as a body and the court took the view that premature disclosure of the takeover negotiations would have been detrimental to the shareholders. The position is different if the approach is made by the directors to the shareholders. In such a situation, the directors constitute themselves as fiduciaries vis-è-vis the shareholders: see Briess v Woolley [1954] AC 333. In Allen v Hyatt (1914) 30 TLR 444, the appellants contacted the respondents with a view to obtaining options from the respondent shareholders so that they could deal with representatives of the company. The appellants did not disclose to the respondents that they were buying their shares on their own account and had entered into a secret arrangement to conceal from the other shareholders information that they should disclose as directors. The Privy Council upheld the Court of Appeal to the effect that the appellants were trustees for the respondents. In Peskin v Anderson [2000] 1 BCLC 372, the Court of Appeal confirmed that there need to be special circumstances to justify the imposition of fiduciary duties on directors to particular shareholders.


The case involved the de-mutualisation of the RAC club in Pall Mall with payouts to members. Former members of the club who retired prior to the cut-off date argued that the directors were in breach of fiduciary duty for not disclosing the plans. The Court held that there were no special circumstances requiring particular attention to those former members.


In contrast, in Platt v Platt [1999] 2 BCLC 745, the court ruled that a fiduciary relationship existed between a director (Keith) and his two brother shareholders (Colin and Denis), who had been duped into transferring shares to the brother director in their BMW franchise which was later sold at a considerable profit.


Other jurisdictions take a more liberal view of the duty owed to individual shareholders. Thus, in Coleman v Myers [1977] 2 NZLR 225, the New Zealand Court of Appeal held that the managing director and chairman of a company owed fiduciary duties to the shareholders of the company in a takeover situation. Indeed, even in Great Britain, it seems that in certain situations the courts are willing to hold that a duty is owed to individual shareholders. This seems to be the case in takeover situations: see Gething v Kilner [1972] 1 WLR 337. This case concerned a takeover bid by Town Centre Securities Ltd for the stock of the Rochdale Canal Company.


Shareholders of Rochdale complained that the Rochdale board was recommending the takeover offer to its shareholders without disclosing that they had received some contrary advice. Town Centre was also implicated in the supportive action of the Rochdale board, so it was claimed.


Brightman J accepted that the directors of an offeree company owe a duty to their shareholders to be honest and not to mislead. On the facts of this case the judge considered that there had not been any wrongdoing.


Note that the decision in Percival v Wright in relation to the purchase of shares by directors is obviously now subject to legislative provisions on insider dealing; and indeed the proposition that directors of a company may purchase the shares of other shareholders without disclosing pending negotiations for the purchase of the company has been doubted by Browne-Wilkinson VC in Re Chez Nico (Restaurants) Ltd [1992] BCLC 192. In this case a letter had been sent by the largest shareholder in the company to other shareholders. The intention was to purchase their shares and then to transform the company from a public company to a private one.


In this case, Browne-Wilkinson VC doubted the proposition in Percival v Wright to the effect that there was no legal requirement to disclose the circumstances of the acquisition to the shareholders.


Particular problems may arise in relation to nominee directors. In Hawkes v Cuddy & Others [2009] 2 BCLC 427 (also called Re Neath Rugby Club Ltd), Neath and the Ospreys were two rugby clubs. Neath formed part of the region in which the Ospreys were the regional team. Hawkes and Cuddy formed a joint venture. They set up Neath Rugby Club Ltd. Hawkes was a director of Neath, as was Cuddy’s wife. They had 50 per cent each of the shares. Cuddy was a nominee director for Neath Rugby Club on Ospreys’ board. Neath Rugby Club held 50 per cent of the shares of Ospreys; Swansea Rugby Club held the other 50 per cent.


The relationship between Hawkes and Cuddy broke down. Hawkes presented a petition under s 459 of the Companies Act 1985 (s 994 CA 2006). He alleged that Cuddy, as a nominee director, failed to represent Neath Rugby Club and, indeed, had acted against its interests on the board of Ospreys. Cuddy and his wife presented a cross petition based on the breakdown of trust and confidence and the deadlock that resulted.


At first instance the judge held that Cuddy, as a director of Ospreys, owed a duty to Hawkes to consult him and Neath, as well as a duty to Ospreys. He held that Cuddy had fulfilled the duty. He also held that deadlock would allow a petitioner to wind up on the just and equitable ground, and so it did also under s 994 of the Companies Act 2006 (formerly s 459 CA 1985).


On appeal in the Court of Appeal it was held that the duty owed by Cuddy was to Ospreys Ltd, although he could take account of Neath Rugby Club Ltd and of Hawkes, but his overriding duty was to Ospreys Ltd.


It was also held that facts sufficient for justifying a winding-up order on the just and equitable ground did not necessarily mean that an order would similarly be given under s 994, as although there was an overlap, the two were not co-terminous and the conduct may not amount to unfair prejudice.


The courts are notoriously reluctant to interfere with directors’ thinking. In R (People and Planet) v HM Treasury [2009] EWHC 3020 the government was the majority shareholder: the Royal Bank of Scotland. The government was accused of breaking undertakings relating to climate change and human rights. The court held that the Treasury was entitled to adopt a commercial approach in the exercise of its powers.


12.3   Duty to promote the success of the company


Section 172(1) of the Companies Act 2006 now provides that a director of a company must act in the 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. This clearly preserves the principle in Percival v Wright in statutory form.


In a debate during the passage of the Bill through Parliament in the House of Lords, Lord Goldsmith spoke, as follows, about the ‘success of the company’:


What is success? The starting point is that it is essentially for the members of the company to define the objective they wish to achieve. Success means what the members collectively want the company to achieve. For a commercial company, success will usually mean long-term increase in value. For certain companies, such as charities and community interest companies, it will mean the attainment of the objectives for which the company has been established.


(Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255)


He continued:


… for a commercial company, success will normally mean long-term increase in value, but the company’s constitution and decisions made under it may also lay down the appropriate success model for the company … it is essentially for the members of a company to define the objectives they wish to achieve. The normal way for that to be done – the traditional way – is that the members do it at the time the company is established. In the old style, it would have been set down in the company’s memorandum. That is changing … but the principle does not change that those who establish the company will start off by setting out what they hope to achieve. For most people who invest in companies, there is never any doubt about it – money. That is what they want. They want a long-term increase in the company. It is not a snap poll to be taken at any point in time.


(Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 258)


Section 172(1) goes on to provide that in promoting the success of the company the director must have regard amongst other matters to:


(a)  the likely consequences of any decision in the long term;


(b)  the interests of the company’s employees;


(c)  the need to foster the company’s business relationships with suppliers, customers and others;


(d)  the impact of the company’s operations on the community and the environment;


(e)  the desirability of the company maintaining a reputation for high standards of business conduct; and


(f)  the need to act fairly as between members of the company.


The previous common law rule in Percival v Wright, with regard to a duty being owed to the providers of capital, had previously been extended by statute to include the interests of employees by the Companies Act 1980, s 46. This was then consolidated in the Companies Act 1985, s 309. Previously it was inappropriate for directors to take account of the interests of employees. The point was exemplified, for example, in Parke v Daily News Ltd [1962] Ch 927, where a single shareholder succeeded in obtaining an injunction to restrain directors from making payments to employees in excess of their legal entitlements where a business was ceasing to exist.


Since the introduction of the new duty in 1980 there have been few examples of the extended duty being demonstrated in decided cases. In Re Saul D Harrison & Sons plc [1995] 1 BCLC 14, the directors justified their decision to carry on running the company inter alia in terms of protecting the interests of employees. This was therefore regarded by the judge as appropriate.


However, this was the extent of the existing duty by directors when the new provisions in the Companies Act 2006 came into being.


There were certain dicta in decided cases indicating a wider range of interests that directors should take account of, even prior to the Companies Act 2006. In Lonrho Ltd v Shell Petroleum Co Ltd [1980] 1 WLR 627, Lord Diplock had referred to the interests of creditors as something that directors should take account of.


That said, there was, for example, considerable doubt in common law as to whether a duty was owed to creditors. Thus in Liquidator of West Mercia Safetywear Ltd v Dodd [1988] BCLC 250, while the Court of Appeal held that a director of an insolvent company must have regard to the interests of its creditors, there was no wider principle invoked. Similarly, in Colin Gwyer & Associates Ltd v London Wharf (Limehouse) Ltd [2003] 2 BCLC 153, the judge spoke of the need for a company that was insolvent or of dubious solvency to take account of the interests of creditors.


In addition, s 214 of the Insolvency Act 1986 did make it clear that a duty was owed to creditors of the company in the event of the company’s insolvency by directors and shadow directors.


Section 172(1) has been stated to enshrine in statutory form the principle of ‘enlightened shareholder value’. There was much discussion of ‘enlightened shareholder value’ during the passage of the legislation. In the House of Lords, Lord Goldsmith said:


The Company Law Review considered and consulted on two main options. The first was ‘enlightened shareholder value’, under which a director must first act in the way that he or she considers, in good faith, would be most likely to promote the success of the company for its members … The Government agrees this is the right approach. It resolves any confusion in the mind of directors as to what the interests of the company are, and prevents any inclination to identify those interests with their own. It also prevents confusion between the interests of those who depend on the company and those of the members.


(Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255)


In the House of Commons, meanwhile, Alistair Darling spoke as follows:


For the first time the Bill includes a statutory statement of directors’ general duties. It provides a code of conduct that sets out how directors are expected to behave. That enshrines in statute what the law review called ‘enlightened shareholder value’. It recognises that directors will be more likely to achieve long-term sustainable success for the benefit of their shareholders if their companies pay attention to a wider range of matters … Directors will be required to promote the success of the company in the collective best interest of the shareholders, but in doing so they will have to have regard to a wider range of factors, including the interests of employees and the environment.


(Alistair Darling, Commons Second Reading, 6 June 2006, column 125)


12.4   Duty to exercise independent judgement


Section 173 of the Companies Act 2006 provides that a director of a company must exercise independent judgement. This puts it beyond doubt that a director who is placed on a board as a nominee of a substantial shareholder or otherwise must act in accordance with the interests of the company that he is serving rather than the interests of the nominator.


In the House of Lords, Lord Goldsmith, in interpreting independent judgement, spoke as follows:


… the clause does not mean that a director has to form his judgement totally independently from anyone or anything. It does not actually mean that the director has to be independent himself. He can have an interest in the matter … It is the exercise of the judgement of a director that must be independent in the sense of it being his own judgement … The duty does not prevent a director from relying on the advice or work of others, but the final judgement must be his responsibility. He clearly cannot be expected to do everything himself. Indeed, in certain circumstances directors may be in breach of duty if they fail to take appropriate advice – for example, legal advice. As with all advice, slavish reliance is not acceptable, and the obtaining of outside advice does not absolve directors from exercising their judgement on the basis of such advice.


(Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 282)


Thus while a director may enter into an agreement to act in a particular way where he believes in good faith that this is in the company’s interest, he may not enter into a contract to vote in a particular way regardless of whether this is in the best interests of the company or not; see Fulham Football Club Ltd v Cabra Estates plc [1992] BCC 863.


12.5   Directors’ exercise of powers for a proper purpose


Section 171 of the Companies Act 2006 provides that a director of a company must:


(a)  act in accordance with the company’s constitution; and


(b)  only exercise powers for the purposes for which they are conferred.


This statement of duty reflects the pre-existing position in case law.


On occasion, the question of whether directors have exercised their powers for a proper purpose has arisen in decided cases. The most common example of the exercise of directors’ powers in decided cases is the power to issue shares.


12.5.1  Power to issue shares


It is no longer necessary for private companies with one class of share to obtain authority from the company’s shareholders before allotting shares. The Act permits directors of such companies to allot shares unless the articles provide otherwise (s 550 CA 2006). This does not, however, apply to companies with more than one class of share, or to public companies. In such cases there must be authorisation for the exercise of the power of allotment in the company’s constitution.


The power to issue shares is given for the purpose of raising necessary capital for the company. Any other purpose is not prima facie a legitimate exercise of that power. However, the courts have recognised that other purposes may be validated by the company in general meeting. Thus, for example, it is an improper purpose to issue shares to defeat a takeover bid, but the exercise of the issue of shares for this purpose may be validated by the company in general meeting. In Hogg v Cramphorn Ltd (1967), a takeover bid was proposed which the directors genuinely believed not to be in the best interests of the company. To block the takeover bid, the directors issued 5,000 additional shares which were to be held on trust for the employees of the company. The court held that the issue was not a proper exercise of the directors’ powers and was therefore invalid. However, the court ordered that a meeting of the members should be held which could, if it considered it appropriate, validate the issue. At this company meeting, the new shares would not be able to vote. In the event, the issue was ratified.


A similar conclusion was reached in Bamford v Bamford (1970). It is not every issue of shares for extraneous purposes that can be validated, however. If the purpose of the issue of shares is clearly to further the directors’ or majority shareholders’ own personal interests, the issue cannot be validated by the company in general meeting; see Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 (a Privy Council case from Australia). In this case, there were rival bids for the share capital of a company. The majority shareholders favoured one bid. The directors who favoured a different bid issued additional shares to the bidding company to place the majority shareholders in a minority position. The Privy Council held that the issue was an improper exercise of their powers as it was designed to thwart the wishes of the majority shareholders.


In Clemens v Clemens Brothers Ltd (1976), two shareholders held the entire share capital of a company and the majority shareholder used her voting power to pass a resolution authorising the issue of new shares to an employee trust scheme. This was held to be invalid. The effect of the new issue of shares was to reduce the other shareholder’s holding (that of her niece) to less than the 25 per cent stake where she had been able to block a special resolution. Foster J considered that the exercise of the majority’s voting power in this case was being used inequitably against the minority shareholder and this was therefore held to be invalid.


In an earlier unreported decision, Pennell, Sutton and Moraybell Securities Ltd v Venida Investments Ltd (1974) (unreported, but noted in (1981) 44 MLR 40 by Burridge), the majority proposed to increase the share capital of the company. The minority had sought a declaration that this constituted a fraud on the minority and asked for an interlocutory injunction. The minority succeeded. Templeman J held that there was a prima facie case of abuse of powers by the company’s directors and the judge considered that the company was a quasi-partnership company based on mutual trust and confidence.


In Criterion Properties plc v Stratford UK Properties [2004] 1 WLR 1846, a director of the claimant company caused it to enter into an agreement whereby an excessive payment had to be made if control of the company changed or if some of the management team left. It was said in the case to be excessive and it was questioned as to whether the director in question could conclude the contract.


12.5.2  Power to refuse to register a transfer of shares


There are, however, other examples of the exercise of directors’ powers that are subject to the same fiduciary duty. In Re Smith and Fawcett Ltd (1942), the question arose as to the exercise of the directors’ power to refuse to register a transfer of shares. By the articles of association, the directors had unlimited discretion to refuse to register a transfer. The appellant sought to register 4,001 shares in his name after the death of his father, who had previously held the shares. The directors refused to register the transfer but offered to register a transfer of 2,001 shares, provided that the applicant sold the other shares to one of the directors at a price proposed by the directors of the company. The High Court held that the directors were acting within their discretion and this was upheld by the Court of Appeal.


12.5.3  Power to enter into a management agreement


In a similar way, the question of the exercise of directors’ powers arose in Lee Panavision Ltd v Lee Lighting Ltd [1992] BCLC 22. In this case, the claimants had acquired an option to purchase the defendants. The claimants also had a management agreement by which they ran the defendants’ business and they also nominated the company’s directors. It was clear that the option to purchase the business was not to be exercised and that the management agreement would therefore be terminated. Since the claimants wished to continue managing the business, they ensured that the directors of the defendants voted in favour of a second management agreement perpetuating the claimants’ control of the company. Subsequently, the directors of the defendants were removed from office and the defendants announced that they did not consider themselves bound by the second management agreement. The claimants sought an injunction to prevent breach of the second agreement. The defendants alleged that the directors had not disclosed their interest in the agreement. Harman J held that the agreement was void at the instance of the defendants and that the agreement had not been entered into in the interests of the defendants. This was upheld by the Court of Appeal. Harman J had also held that it was voidable on the basis of the failure of the directors to declare their interests to a board meeting. The Court of Appeal took the view that there was no breach of what is now s 177, since the interest of the directors was known to all members of the board.


12.5.4  Other powers


The powers of directors that are subject to directors’ fiduciary duties also extend to other areas including:


(a)  the power to borrow money and grant securities: see Rolled Steel Products (Holdings) Ltd v British Steel Corporation (1986);


(b)  the power to call general meetings;


(c)  the power to provide information to shareholders; and


(d)  the power to make calls on partly paid shares.


Even where there is no breach of duty in relation to the exercise of powers by directors, there is the possibility of a petition alleging unfair prejudice under ss 994–996 of the Companies Act 2006.


12.6   The duty of care and skill


This duty is now provided for in statute by s 174 CA 2006.


It is provided that a director of a company must exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with:


(a)  the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director; and


(b)  the general knowledge, skill and experience that the director has.


This provides for an objective standard but one raised by the actual knowledge, skill and experience of a particular director if this is greater.


The old law was set out in Re City Equitable Fire and Insurance Co Ltd [1925] Ch 407. The company had experienced a serious depletion of funds and the managing director, Mr Bevan, was convicted of fraud. The liquidator, however, sought to make other directors liable in negligence for failing to detect the frauds. Romer J, in what has become the classic exposition of the director’s duties of care and skill, set out three propositions. There are, in addition, one or two other general propositions that seem to be warranted by the reported cases:


1   A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. A director of a life insurance company, for instance, does not guarantee that he has the skill of an actuary or of a physician. In the words of Lindley MR, ‘if the directors act within their powers, if they act with such care as is reasonably to be expected from them, having regard to their knowledge and experience, and if they act honestly for the benefit of the company they represent, they discharge both their equitable as well as their legal duty to the company’: see Lagunas Nitrate Co v Lagunas Syndicate