THE GENERAL DUTIES
The Act provides that directors owe the following duties:
• to act in accordance with the company's constitution and for proper purposes;
• to promote the success of the company;
• to exercise independent judgement;
• to exercise reasonable care, skill and diligence;
• to avoid conflicts of interest;
• not to accept benefits from third parties; and
• to declare interests in proposed transactions and arrangements.
This statement of duties does not cover all the duties a director owes to a company; for example, directors are required to consider the interests of creditors in times of threatened insolvency and have specific duties, such as to file company accounts. The first four of the duties listed above came into force on 1 October 2007. The final three duties, relating to directors' conflicts of interest, came into force on 1 October 2008.
The general duties also apply to shadow directors where, and to the extent that, they would have applied previously. This means that the laws relating to shadow directors are not comprehensively dealt with in the Act itself, and the uncertain common law principles remain the only authority. The government had no appetite to legislate definitively in this area, with Lord Goldsmith suggesting that the government regarded the common law as "still developing" and that it was "right to leave those areas, as now, to the courts...".
RATIFICATION OF A BREACH
Changes have been made to the manner in which a breach of duties may be ratified. The Act abolishes the right of a director to ratify his own breach by providing that the necessary majority for ratification at a shareholder meeting must be obtained disregarding any votes of the affected director. This may give rise to difficulties in practice; for example, where a major shareholder in the company is connected with a director seeking ratification. However, the Act does not abolish the right for directors to vote in their capacity as shareholders to authorise in advance, acts which may be in breach of their duties. Directors therefore have an incentive to seek prior authorisation of acts which would otherwise be a breach of their duties.
DUTY TO PROMOTE SUCCESS OF THE COMPANY ("ENLIGHTENED SHAREHOLDER VALUE")
The statutory duty which has generated the most debate is the duty of 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" (section 172 of the Act). The government has stated that "success" in this context would usually mean "long-term increase in value" where commercial companies are concerned. However, it is open to a company to adopt a different definition of "success" in its constitution. Shareholders could decide, for example, to define success in terms of short-term dividend maximisation.
The decision as to what will promote the success of a company is ultimately one for the good faith judgement of the directors, but whereas previously directors had to address the issue of corporate benefit, the new statutory provision also brings other factors into play. Under section 172 of the Act, a director, in fulfilling his duty to promote the success of the company, is to have regard (among other matters) to:
• the long term consequences of any decision;
• the interests of the company's employees;
• the need to foster 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.
This list of factors to be considered is expressly non-exhaustive and other factors may be relevant (and, if so, should be considered) for any decision to be taken by directors.
DAY-TO-DAY DECISION MAKING
Section 172 of the Act has given rise to the concern that directors will be exposed to an increased litigation risk, particularly in view of the new statutory provisions allowing shareholders to commence derivative claims against directors on behalf of the company in certain circumstances. These have been revised with the aim of making the criteria for bringing claims easier. There is also a (perhaps rather naïve) expectation that the enhanced content requirements for the business review will allow a greater level of shareholder scrutiny over company policies. Indeed, one of the stated purposes of the review is to enable the shareholders to assess how the directors have performed their duty to promote the success of the company.
The precise extent of the "regard" which must be had to these issues awaits judicial interpretation, but it is clear that a director is only obliged to "have regard" to the factors listed above in promoting the success of the company and is not required to actively promote the interests of the environment, the community and so forth. In addition, a director continues to owe his duties solely to the company (except in limited cases), not to the third parties whose interests they have to consider, such as employees, suppliers and local communities. However, the government has maintained (albeit with doubtful credibility) that consideration of the listed factors is not merely a formality, stating "The words ‘have regard to' mean ‘think about'; they are absolutely not just about ticking boxes... ‘have regard to' means ‘give proper consideration to'...".
Directors now have to be in the position that if challenged they will be able to satisfy third parties (and possibly the Court) that they did have regard to the above matters (and any other applicable matters) when making decisions. This will be the case for directors of all companies (whether a listed plc, private company or a subsidiary within a large group) making decisions in board meetings and meetings of committees down to an executive director making decisions on behalf of the company (for example choosing one contractor over another). Even if intuitively directors discount some or many of the factors listed above as being irrelevant, directors will need to have in mind the section 172 factors (together with any other relevant factors) when making decisions.
REQUIREMENT FOR PAPER-TRAIL?
There is a separate question regarding the need for a paper-trail and the extent to which it is prudent to record more detail of the board's consideration of the various factors. Companies need to decide what policies to put in place to ensure that directors fulfil their statutory duties while not hampering the decision-making process by unnecessary bureaucracy. Many company secretaries and corporate legal counsel are concerned that the new legislation will give rise to the unnecessary reworking and extension of board minutes as a defensive reaction. To a large extent this will depend on the matter being considered, but prima facie there should be no need for a record of the directors considering each section 172 factor expressly, or to issue negative statements for any factor regardless of its relevance to the matter under consideration. While company secretaries will continue to have to exercise discretion as to what particular matters should be minuted as having received attention, expansion of the board minutes for record purposes without reflecting the actual decision process would not be desirable.
It may be considered appropriate to remind directors of the list of factors to which (among other things) they must have regard when making decisions and to reflect in board minutes, by way of a standard minute, simply the fact that this reminder took place (similar to the form of section 317 minute which is now so familiar). However, it is for company secretaries to determine whether this is necessary and to exercise discretion as to any specific matters that need to be recorded in minutes, only doing so where it is necessary given their importance to the matter at hand. Thought must also be given to the company's usual board minute practice to ensure consistency. There is also a role here for the management team preparing briefing papers or policy presentations for board discussion to ensure that each of the listed factors is properly considered, and where appropriate, referred to in writing in the board papers. However, directors should note that delegating responsibility for the initial assessment does not serve as a substitute for independent consideration by the directors themselves.
CONFLICTS OF INTEREST
The rule on conflicts of interest has been the other hotly debated aspect of the codification of duties. Under section 175 of the Act, a director "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". This is a significant change to the previous rule on conflicts of interest. Where a material conflict of interest arose prior to 1 October 2008, the director concerned would take steps to mitigate the conflict by, for example, absenting himself from board discussions and, in extreme cases, standing down from the board. Under the new rule, however, a director is under a positive duty not to let the situation arise in the first place unless the board has given prior authorisation. This change in the law will require companies to operate more formal procedures regarding conflicts of interest and raise questions in particular, about the position of a director taking on multiple directorships. However, provided that a potential conflict has been authorised, the change should not result in the relevant director behaving in a different way than he would have done under the old rules when an actual conflict materialises.
The severity of the new rule is mitigated somewhat by a relaxation to the rule on authorisation of conflicts. Directors' authorisation may now be given in a private company where the constitution does not invalidate the authorisation, or in a public company where the constitution allows the directors to do so. This is a change to the law prior to 1 October 2008, which required the shareholders themselves to approve any such conflict by provision in the articles of association or by resolution. As not all conflict situations can be anticipated and each situation will be different, most FTSE companies have used this year's AGM to incorporate a general power for directors to authorise conflicts in their articles of association, in line with the recommendations of the GC100. When a board is making such a decision about authorisation, each authorising director will need to have regard to his own duties including the duty to act in a way he considers, in good faith, will be most likely to promote the success of the company. Shareholders therefore have the assurance that the board will only use the power to sanction conflicts where it is in the interests of the company. Questions remain, however, as to whether the power to authorise conflicts is capable of being delegated to a committee or must be used by the board of directors.
It will be interesting to see how market practice in this area will develop over time (no doubt aided by judicial interpretation). Although current experience suggests that initial fears about the practicalities of authorising conflicts and the need for a more bureaucratic approach to decision making appear to have been somewhat overstated, it is undoubtedly the case that these areas require more care and forethought than has previously been the norm.