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Print articleThe New Statement of Directors' Duties – A Big Deal or Not?
November, 2006 - Bernice Dunsmuir
After nearly eight years in the offing, the Companies Bill looks likely to become law in November of this year, although it is likely that most of its provisions will not take effect until autumn 2007.
Despite being a massive piece of legislation, for the most parts its provisions have not been controversial and have generally been welcomed.
The same cannot, however, be said for those parts of the Bill dealing with the duties a director owes to the company making it easier for a shareholder to take action against a director who has breached his duties. These provisions have provoked a huge debate in the media and in the House of Lords and are due to be considered by the House of Commons.
Is this outcry justified? It has to be said that much of the criticism has been largely exaggerated. Yes, there are changes and there will be some uncertainty, but the repercussions for directors will not be as severe as some commentators would have us believe.
A director owes certain duties - to exercise reasonable skill, care and judgment; not to exceed powers given to him; and to avoid conflicts of interest. One of the most basic duties is "to act in good faith in the interest of the company". These duties are not set out in statute, but have evolved over a great many years through case law and common law and are well established. Through the Bill, the Government has attempted to codify these duties for the first time in UK law. While some think they should have stayed well alone, most commentators applaud the rationale.
So far so good. However, the Bill goes further. The duty "to act in good faith in the interests of the company" has become a duty "to act in a 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, according to the Bill, a director must take account of a number of stakeholder factors, including:
- the long-term consequences of any decision;
- the need to foster relationships with suppliers, customers and others; and
- the impact of operations on the community and the environment
Comment has generally fallen into two camps - those, like the CBI and IoD who think the clause goes too far, is too onerous and intrusive and will pave the way for shareholder activist groups to buy one share and then take a director to court for, for example, not having due regard to the environment.
Then there is the other camp, with groups such as the Trade Justice Movement, who don't believe that the clause goes far enough and would like it to be strengthened so that the stakeholder factors should not simply be taken into account, but be absolute obligations in their own right.
These political views have clouded the issue for directors out there trying to grapple with the issue of how the new statement of duties will affect them and if is there an increased risk of litigation.
As a fictional example, a director of (fictional) Oil Exploration plc is considering the acquisition of certain licences that would involve drilling for oil in area X. Area X is an area of outstanding natural beauty. The new duty requires directors of Oil Exploration to consider the environmental impact of their decisions, which is likely to be considerable. Does that mean the directors would be in breach of that duty if they decide to go ahead? No - the duty is the duty to promote the success of the company for the members as a whole, which means taking decisions which increase the value of the company – and the environment is one factor to be considered in deciding how the success of the company will be furthered. What it might mean is that directors have to consider if there are ways of minimising the environmental impact, eg running the pipelines through a different route, if that route is an equally viable option. How far alternative routes need to be considered is again a matter for directors and concerns the size of the issue in question - proportionality is the key.
Directors of Oil Exploration plc have considered their options and decided to go ahead as originally planned. Can an activist group take him to court alleging a breach of the duty? While the procedure has been changed to make it a little easier for an aggrieved shareholder to take a director to court and an activist group could start an action, but really that is no different to the remedy available to them now. Furthermore, the shareholder can only continue if it can be proved that the Director’s duty to promote the success of the company has been breached, and the shareholder therefore is looking for a remedy on behalf of the company.
As many commentators have pointed out, that we do not know how the courts will proceed under this new legislation, but there is nothing to suggest they will overturn a practice of a great many years and start second guessing boardroom decisions.
Is the new statement of directors' duties a big deal or not? For many directors of well run companies the answer has got to be no - most well run boardrooms already consider the stakeholder factors in making decisions. The only real change is that the paper trail may have to be fuller in order to evidence that relevant factors were considered. For directors of companies where decisions are less well debated, consideration of the stakeholder factors should be given and the minutes drafted to reflect that, but for all, the duty remains to do your best to promote the success of the company and proportionality is the key.
Despite being a massive piece of legislation, for the most parts its provisions have not been controversial and have generally been welcomed.
The same cannot, however, be said for those parts of the Bill dealing with the duties a director owes to the company making it easier for a shareholder to take action against a director who has breached his duties. These provisions have provoked a huge debate in the media and in the House of Lords and are due to be considered by the House of Commons.
Is this outcry justified? It has to be said that much of the criticism has been largely exaggerated. Yes, there are changes and there will be some uncertainty, but the repercussions for directors will not be as severe as some commentators would have us believe.
A director owes certain duties - to exercise reasonable skill, care and judgment; not to exceed powers given to him; and to avoid conflicts of interest. One of the most basic duties is "to act in good faith in the interest of the company". These duties are not set out in statute, but have evolved over a great many years through case law and common law and are well established. Through the Bill, the Government has attempted to codify these duties for the first time in UK law. While some think they should have stayed well alone, most commentators applaud the rationale.
So far so good. However, the Bill goes further. The duty "to act in good faith in the interests of the company" has become a duty "to act in a 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, according to the Bill, a director must take account of a number of stakeholder factors, including:
- the long-term consequences of any decision;
- the need to foster relationships with suppliers, customers and others; and
- the impact of operations on the community and the environment
Comment has generally fallen into two camps - those, like the CBI and IoD who think the clause goes too far, is too onerous and intrusive and will pave the way for shareholder activist groups to buy one share and then take a director to court for, for example, not having due regard to the environment.
Then there is the other camp, with groups such as the Trade Justice Movement, who don't believe that the clause goes far enough and would like it to be strengthened so that the stakeholder factors should not simply be taken into account, but be absolute obligations in their own right.
These political views have clouded the issue for directors out there trying to grapple with the issue of how the new statement of duties will affect them and if is there an increased risk of litigation.
As a fictional example, a director of (fictional) Oil Exploration plc is considering the acquisition of certain licences that would involve drilling for oil in area X. Area X is an area of outstanding natural beauty. The new duty requires directors of Oil Exploration to consider the environmental impact of their decisions, which is likely to be considerable. Does that mean the directors would be in breach of that duty if they decide to go ahead? No - the duty is the duty to promote the success of the company for the members as a whole, which means taking decisions which increase the value of the company – and the environment is one factor to be considered in deciding how the success of the company will be furthered. What it might mean is that directors have to consider if there are ways of minimising the environmental impact, eg running the pipelines through a different route, if that route is an equally viable option. How far alternative routes need to be considered is again a matter for directors and concerns the size of the issue in question - proportionality is the key.
Directors of Oil Exploration plc have considered their options and decided to go ahead as originally planned. Can an activist group take him to court alleging a breach of the duty? While the procedure has been changed to make it a little easier for an aggrieved shareholder to take a director to court and an activist group could start an action, but really that is no different to the remedy available to them now. Furthermore, the shareholder can only continue if it can be proved that the Director’s duty to promote the success of the company has been breached, and the shareholder therefore is looking for a remedy on behalf of the company.
As many commentators have pointed out, that we do not know how the courts will proceed under this new legislation, but there is nothing to suggest they will overturn a practice of a great many years and start second guessing boardroom decisions.
Is the new statement of directors' duties a big deal or not? For many directors of well run companies the answer has got to be no - most well run boardrooms already consider the stakeholder factors in making decisions. The only real change is that the paper trail may have to be fuller in order to evidence that relevant factors were considered. For directors of companies where decisions are less well debated, consideration of the stakeholder factors should be given and the minutes drafted to reflect that, but for all, the duty remains to do your best to promote the success of the company and proportionality is the key.
Footnotes: Bernice Dunsmuir is an associate specialising in Corporate Finance with law firm Shepherd and Wedderburn. |
