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Directors' duties and derivative actions

One of the key aims of the Bill is to provide a statutory statement of directors' duties. These new duties were introduced from 1 October 2007. In codifying directors' duties, the Government's intention was for the most part not to change them but to establish good business sense for companies to embrace wider social responsibilities.

A Ministerial statement has been issued containing guidance for directors on what these duties mean, based on the Government's statements made in Parliament:

This also includes the following high-level guidance as to how directors should act to ensure compliance with their duties:

  • Act in the company's best interests, taking everything you think relevant into account
  • Obey the company's constitution and decisions taken under it
  • Be honest, and remember that the company's property belongs to it and not to you or to its shareholders
  • Be diligent, careful and well informed about the company's affairs. If you have any special skills or experience, use them
  • Make sure the company keeps records of your decisions
  • Remember that you remain responsible for the work you give to others
  • Avoid situations where your interests conflict with those of the company. When in doubt disclose potential conflicts quickly
  • Seek external advice where necessary, particularly if the company is in financial difficulty.

Conflicts of interest (ss 175-177)

The Act will change the rules on directors' conflicts of interest by allowing independent directors to authorise a director's conflict of interest arising in respect of any property, information or opportunity that conflicts or may conflict with the interests of the company (currently this would require shareholder approval).

For private companies such authorisation will be permitted provided it is not prevented by the company's articles, for public companies will need to be expressed permitted by the articles. However, the duty to avoid conflicts and possible conflicts is slightly expanded and there are still concerns as to whether directors who hold multiple directorships (for instance, non-executives) will be caught by this slightly amended duty.

The Government is consulting on whether these provisions should be brought in from 1 October 2008 (as expected), or postponed until 1 October 2009.

Derivative Claims (Part 11)

As from October 2007, the codified 'derivative claims' provisions make the procedure for minority shareholders to make a claim in the name of the company clearer, and thus may lead to pressure groups acquiring shares in order to instigate claims against the directors. However, before a claim can be brought there is a requirement to demonstrate a prima facie case, looking solely at the claimant's evidence (which should prevent "fishing expeditions").

If such case is demonstrated, the courts can require evidence from the company but must refuse permission to continue the claim if it considers that a director acting in accordance with the new duty to promote the success of the company would not seek to continue it, or if the conduct in question has been ratified by shareholders. If the court is not obliged to refuse permission to continue the claim, it must consider a range of factors including whether the claim is brought in good faith, and take into account the views of other shareholders who have no interest in the claim, in deciding whether to allow the claim to continue. These various hurdles should prevent nuisance claims getting off the ground and thus fears of mass litigation are likely to be unfounded.

Enlightened shareholder value (s 172)

The "enlightened shareholder value" duty has been controversial and was one of the most hotly debated of the Act's provisions.

Section 172 requires each director to act in a way that (s)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 factors such as:

  • The likely long term consequences
  • The interests of employees
  • Relationships with customers and suppliers
  • The impact of the company's operations on the community and environment
  • The desirability of maintaining a reputation for high standards of business conduct
  • The need to act fairly as between members of the company
  • The legislation makes it clear this is not an exhaustive list.

This duty to promote the success of the company broadly replaces the old fiduciary duty to act in the company's best interests. However, the meaning of "success for the benefit of the company's members as a whole means" is unclear - the Government has stated "success" in this context will usually mean "long-term increase in value" for commercial companies.

The Government has also said that the decision as to what will promote the success of the company, and what constitutes such success, is one for the director's good faith judgment - the Government's view is that this ensures that business decisions on, for example, strategy and tactics are for the directors, and not subject to decision by the courts, subject to such decisions having been made in good faith.

It is important to note that Section 172 imposes a single duty to work for the benefit of shareholders - and not a separate set of duties in relation to the stakeholders represented in the list of factors. Each factor should be taken into account in the context of its implications for the success of the company, and thus its members as a whole. Therefore, despite some fairly widespread concerns within the business community, this is not introducing a so called "pluralist" or "multi-stakeholder" approach, which would otherwise have made it very difficult for boards to make decisions.

Most well run PLCs that have a properly functioning board should be little affected by these codified provisions; when making decisions, such boards should already take account of any factors that could impact on the company's success (including those mentioned in this duty), and such potential implications should be reflected in properly prepared board papers. Less effective boards, for instance those that previously did not consider the wider implications of decisions that could impact on the company, may need to improve their management and decision making processes in order to comply with this duty - this is one of the benefits the codified provisions are designed to achieve.

The Government has consistently tried to provide comfort to directors on the impact of the provisions. For example, the Attorney General, Lord Goldsmith, said in the Lords: "There is nothing in this Bill that says there is a need for a paper trail..... I do not agree that the effect of passing this Bill will be that directors will be subject to a breach if they cannot demonstrate that they have considered every element. It will be for the person who is asserting breach of duty to make that case good.....[Derivative claims] will be struck out if there is no decent basis for them".

However, particularly until there is case law to suggest that the courts will throw out nuisance claims and not overturn business decisions, lawyers are likely to advise directors to keep detailed records of how they took the various factors into account in order to protect directors against claims by shareholders for breach of duty.

It is important to remember that the duty is owed to and enforceable by the company alone. Therefore, only the company (or its shareholders on behalf of the company) can bring an action against a director for breach of this duty, and the director will only be liable if the company can demonstrate that it has suffered loss as a result of the breach of duty.