DEBATE ON THE SCOPE, FORM AND CONTENT OF DIRECTORS DUTIES IN THE CONTEXT OF THE STATUTORY STATEMENT OF DIRECTORS DUTIES AS CONTAINED IN THE COMPANIES ACT 2006.

by mmm150 (student)

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DEBATE ON THE SCOPE, FORM AND CONTENT OF DIRECTORS’ DUTIES IN THE CONTEXT OF THE STATUTORY STATEMENT OF DIRECTORS’ DUTIES AS CONTAINED IN THE COMPANIES ACT 2006.

The debate concerning the scope, form and content of directors' duties is one of the oldest issues in company law. Before 2007, the duties of directors in England and Wales were based on common law, and the idea of equitable principles and statutory provisions (Companies Act 1985).

The Companies Act 2006 includes a new statutory statement of the general duties of directors in place of the common law and replaces the additional rules on directors' duties relating to fair dealing which were previously found in the Companies Act 1985. The new Act also introduced a new statutory right for shareholders to sue directors in the company's name and most of these acts are already in force. The new codified directors' duties came into effect in two tranches: one, in 2007 and the other in 2008.

The provisions contained within the Act mean a very significant rewrite of company law with approximately two-thirds of the Companies Act 1985 repealed. Government accepts that directors' duties are fundamental to company law, so the Act attempts to provide greater clarity as to what is expected of directors. Historically, the argument relating to company directors' duties centred on the question of who the directors are accountable to in the first place. It was particularly evident in Berle-Dodd's debate with Berle advocating the so-called shareholder primacy concept whilst Dodd supported the stakeholder primacy theory.

The aim of this essay is therefore to critically assess the duties of Director as contained in the 2006 Company’s Act. This will be achieved using Berle and Dodd's debate on corporate accountability. It will also explain how Berle and Dodd would potentially react to the new provisions on the directors' duties.

The duties which came into effect on 1 October 2007 include: duty to act within powers; duty to promote the success of the company; duty to exercise independent judgment; duty to exercise reasonable care, skill and diligence; duty to avoid conflicts of interest; and, duty not to accept benefits from third parties.

Section 171 codifies the previous common law position under which a director must exercise his powers in accordance with the terms on which they are granted and only exercise powers for the purposes for which they were conferred.

The duty to promote the success of the company made significant differences between the old common law regime and the new regime in the formulation of the directors' duty of loyalty to their company. Previously the common law required directors to act in good faith in the interests of their company. The new provisions require a director to act in the way 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. In doing so, he must have regard to a non-exhaustive list of six factors:

‘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 the environment; the desirability of the company maintaining a reputation for high standards of business conduct; and the need to act fairly as between members of the company’’.

There is still some uncertainty around the scope of the new duty, for example, the meaning of the term success of the company. This was resolved during the Parliamentary debate in which it was suggested that success means ‘what the members collectively want the company to achieve’ and that for a commercial company success will usually mean long-term increase in value; and whether the term members as a whole means just the present members of the company or whether, as under the old common law, the duty is owed to present and future members.

A Director has a duty to exercise independent judgment. This duty is not infringed by a director acting in accordance with an agreement entered into by the company which restricts his discretion, nor is it infringed by his acting in a way authorised by the company's constitution. There are, however, some differences between the old and the new duties. The fact that the duty is not breached when a director acts in a way authorised by the company's constitution, coupled with the broad definition of "constitution" means that the exercise of the directors' independent judgment may now be subject to more interference from shareholders than was previously the case.

Furthermore, a director has a duty to exercise reasonable care, skill and diligence. This is defined as being the care, skill and diligence that would be exercised by a reasonably diligent person with: the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and the general knowledge, skill and experience that the director has.

In addition, a director has a duty to avoid conflicts of interest. Section 175 states that: "A director of a company must avoid a situation in which he ...

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In addition, a director has a duty to avoid conflicts of interest. Section 175 states that: "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". Examples of this may include, directorship of more than one company where the interests of the companies conflict or possibly may conflict or being a major shareholder of the company. The Court of Appeal has confirmed this principle in Peskin v Anderson where it was held that the general fiduciary duties of directors are owed only to the company as a whole. Identifying what is meant by company as a whole sometimes poses a problem. The expression has on a number of occasions been assigned a very narrow interpretation to mean that the duty is owed to the general body of shareholders, present and future as in Multinational Gas & Petrochemical Co v Multinational Gas & Petrochemical Services Ltd. However, Alexander v Automatic Telephone Co shows that English courts have been rejecting the idea that the company owes duties to anyone else besides the general body of shareholders.

More so, a director has a duty not to accept benefits from third parties. This provides that a director must not accept a benefit from a third party conferred by reason of him being a director or his doing (or not doing) anything as a director.

This duty stems from the fiduciary duty upon a director not to make a secret profit. It largely encapsulates the previous law, and is not considered to impose a new restriction upon directors. There is no scope for authorisation by independent directors, so a director would need to seek shareholder authorisation.

Finally, a director has a duty to declare interest in proposed transaction or arrangement. If a director has an interest in a proposed or an existing transaction with the company, he must declare it.

Despite these duties which the Company’s Act stipulates, there have been several debates between Berle and Dodd’s on corporate accountability. The debate centred on the question: to whom are corporations accountable?

Berle argued that all powers granted to a corporation are necessary and at all times exercisable only for the benefit of all the shareholders as their interest appears. It has been suggested that his arguments are logical because the shareholders are the legal owners of the company having invested in the share capital and it is sensible to suggest that they are the ultimate beneficiaries of whatever success it enjoys since they are entitled to what is left over after other claims the company is obliged to meet have been satisfied.

Dodd, in his argument saw corporations as economic institutions that have a social role to play as well as making profits for shareholders, and that companies had responsibilities to the company's stakeholders, such as shareholders, employees, customers and to the general public; he emphasised that:

‘it is undesirable ... to give increased emphasis at the present time to the view that business corporations exist for the sole purpose of making profits for their stockholders. ... [P]ublic opinion, ... is today making substantial strides in the direction of the view of the business corporation as an economic institution which has a social service as well as a profit-making function, that this view has already had some effect upon legal theory, and that it is likely to have a greatly increased effect upon the latter in the future.‘

Since the Berle and Dodd dialogue took place, the argument could be put simply as shareholder primacy theory against the stakeholder theory (Dodd's argument). From Dodd's statement above, it is clear that directors should look beyond profit maximisation and the position of the stakeholders should be echoed in the legal obligations imposed on management.

In his analysis, Dodd referred to the legal model of the company as a purely private enterprise with shareholders being key figures. Dodd's idea was that company could take into account a variety of stakeholders' interests, balancing these with the interests of shareholders. Berle thought that the shareholders' interests should be given preference, whereas, Dodd’s opinion was that the latter was unenforceable. It has been suggested that Dodd’s theory be embraced because Dodd's analysis on the nature of the model of the company was more developed.

Attenborough in his article clarifies that the belief that the purpose of the modern company is to maximise shareholder value, along with typical capital market and ownership features, characterises the Anglo-American shareholder primacy paradigm. This is often contrasted with the continental European perception of the company, which revolves over a stakeholder theory

In assessing this Act in relation to the debate, Attenborough claimed in his article that many practitioners traditionally view UK Company law as firmly sticking to the shareholder primacy theory. However, the latter does ensure that the interests of shareholders as the most important stakeholders in the company are adhered to by the directors in exercise of their duties.

In order to understand the ideas behind the directors' duties laid out in sections 171 -177, we would have to look into the various reports produced by the Company Law Review Steering Group. It was perceived by many that the CLRSG's review could be an excellent opportunity for policy-makers to deal with the flaws and drawbacks in the complicated relationship between directors and stakeholders.

Goddard in the White Paper suggests that directors' duties are owed to individual shareholders, and that the economic model of principal-agent is reflected in company law through the equating of the company's interests with that of the shareholders. This is a clear indication in favour of Berle's shareholder primacy theory.

The CLRSG clearly saw that directors-stakeholders' issue should be formulated as a vital one in its deliberations. When identifying two possible approaches to addressing the issue, the CLRSG used the definitions of enlightened shareholder value and pluralist model rather than the expressions shareholder primacy or stakeholder theory.

The enlightened shareholder value model does not fall conveniently under Berle's principle and at the same time has some characteristics of Dodd's theory. The CLRSG's initial concern was that the preferential scheme of the law fails to recognise that businesses are wealthier where participants operate cordially as teams, and that directors should appreciate the wider interests of the society in their decisions. While the question of shareholder primacy seems to take a central place in the ambit of section 172 of the Act, it can be inferred from the presence of six external factors as mentioned earlier to which directors should have due regard that the CLRSG saw the need to examine more closely elements that based Dodd's work. It is very important to consider the two CLRSG views: that of stakeholder (or pluralist) model and the enlightened shareholder value model.

The first favours Dodd's theory. Establishing relationships of trust between the company and its employees is crucial as in the highly competitive world the abilities and skills of the workforce are an important factor governing the company's potential to compete. It can also be assumed that employees may be reluctant to get firm-specific skills or invest their time and effort in the company if they do not find the company's management credible or if they feel that priority will automatically be given to the shareholders; employees that have trust in their employers will be more willing to acquire firm-specific skills and this in turn can have a positive effect on profits. Wider responsibilities such as those to the society and the environment are also fundamental to corporate success. It can be claimed that responsible behaviour of this kind can lead to increases in profits by reducing costs, because certain environmental projects such as waste recycling and energy conservation can have optimistic effects on profit margins. Acting as a responsible community organisation can also reduce costs by creating its own advertising and good publicity.

Whilst accepting the stakeholder theory arguments above as commendable, the CLRSG contemplated these and subsequently rejected the pluralist theory. The CLRSG was confident that the pluralist approach was neither workable nor desirable in the United Kingdom. Although the CLRSG did express some support for the objectives behind the pluralist approach, its main concern was that there is no feasible way of enforcing such a duty.

In addition, it was alleged that pluralist theory would require substantial reform of the law on directors' duties. Roach in his article noticed that a significant redefinition of directors' duties will be required. Instead of defining the company simply as the body of shareholders, a new definition would have to be introduced that would take into account all the other relevant groups. For example, the introduction of a pluralist approach may impose more obligations on the company. Furthermore, the enhancement of the position of non-shareholder stakeholders may demand additional representation or protection from the corporate governance mechanisms, which will inevitably result in significantly all-embracing reforms.

Irrespective of the arguments in favour of the pluralist model, the enlightened shareholder value model does the opposite; the CLRSG drafted its statement of directors' duties with an enlightened shareholder value model in mind. However, the fact that a director should also take into account a non-exhaustive range of factors and that includes having regard to the interests of employees and creditors shows that UK law moves a bit away from the concept of pure shareholder value theory as advocated by Berle.

The question arises on whether the approach taken by the CLRSG is appropriate. Academic writers have argued that it does not go so far as to include the community and the environment in its list of relevant factors that the directors may need to consider. This might be a fundamental inclusion that is especially evident when comparing section 172 of the Act with its predecessor - section 309 of the Companies Act 1985, which is limited to employees only and states. From the foregoing discussion, it is interesting to note the parallels between the work of the CLRSG and the works of Berle and Dodd in the 1930s.

The duty to promote the success of the company in section 172 of the Act and the underlying enlightened shareholders value model takes its basis from Berle's shareholder primacy. The Act makes clear that directors have to act in the interests of shareholders, however, taking due account of the interests of employees, suppliers, consumers and the environment. In this way, the Act still recognises that wider constituencies and their relationships with the shareholders can have a positive impact on the company's profits.

However, section 172, nonetheless, shows the tendency towards the shareholder primacy standard. In particular, no method of enforcement of directors' general duties by non-shareholder constituencies is provided, and without that the real effect of the new legislation is largely ineffective. This supports Berle's principle objection of unenforceability in relation to Dodd's model and is still a significant area of difficulty.

On paper, the Harvard debate was won by Dodd. Historically, however, it is Berle's opinion that has led. The Companies Act 2006 is a further example supporting the latter. The Companies Act 2006 is a brave step towards doing what Dodd and numerous other academics have been incapable of doing the last century.

QUESTION 2:

LEGAL ADVICE TO JOHN (DIRECTOR OF YOUNG PACKAGING LIMITED)

A Director has a duty to avoid conflicts of interest (s.175 CA 2006). This was confirmed in Peskin v Anderson where it was held that the general fiduciary duties of directors are owed only to the company as a whole. This duty is owed to the general body of shareholders, present and future (Multinational Gas & Petrochemical Co v Multinational Gas & Petrochemical Services Ltd).

Furthermore, a director has a duty not to accept benefits from third parties (s.176). This means that a director must not accept a benefit from a third party conferred by reason of him being a director or his doing (or not doing) anything as a director. This duty stems from the fiduciary duty upon a director not to make a secret profit. It largely encapsulates the previous law, and is not considered to impose a new restriction upon directors.

In addition, a director has a duty to declare interest in proposed transaction or arrangement. If a director has an interest in a proposed or an existing transaction with the company, he must declare it.

Applying these principle to the case at hand, it is evident that John is a director of Young Packaging Ltd (YP Ltd) and therefore in breach of s. 175, 176 and 178, of the Company’s Act 2006. John has acquired the land through the company he works for as a director and he decided to purchase the land for his own interest thereby breaching his fiduciary duty. John will account for the profit that he has made on the land. If John had not been a director and did not discover the land through YP Ltd, he will have the power to make use of the land for his own business.

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