Ashfords Solicitors - Codification of Directors' Duties; Promoting the Success of the Company

For the last 300 years, the duties of directors have largely been developed by case law. One of the priorities of the Companies Act 2006 was to make the law more "consistent, certain, accessible and comprehensible" by introducing a statutory statement of directors' duties.

The Act contains seven general duties which reflect the existing law. Directors must:

act within the powers of the company;
promote the success of the company;
exercise independent judgment;
avoid conflicts of interest;
not accept benefits from third parties;
declare any interest in proposed transactions or arrangements with the company; and
exercise reasonable care, skill and diligence.

In exercising the duty to promote the success of the company, directors must have regard to:

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 relationship;
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 the members of the company.

The business community, and in particular the CBI and GC100 which represents legal counsel from FTSE 100 companies, has expressed concern that the duty to promote the success of the company may have the effect of increasing bureaucracy with the effect of making the decision making process more cumbersome and potentially increasing the liability of directors.

It is argued that the vast majority of decisions that a company will take on a day to day basis are taken with speed and minimal process. They are often delegated outside a formal board meeting. The new provisions may lead to an increased emphasis on documentary records, and by requiring supporting paperwork for these decisions, companies will lose valuable flexibility and competitiveness. If litigation arises, the directors will wish to prove that they have paid due regard to the listed factors, which can be done more easily where they have minuted their discussions.

However, in the House of Lords Lord Goldsmith disagreed that there would be a need for a paper trail and did not consider that directors would be in breach if they could demonstrate that they had considered every factor.

In addition, although the Explanatory Notes to the 2006 Act make it clear that it is not sufficient to pay lip service to the requirement to consider the six factors, it also clarifies that there will be no liability for a mere process failure if the director acts in good faith and the failure has no impact on the decision. So it seems a director will not be in breach of duty if he fails to have regard to a factor which would have no impact upon the resulting decision.

It should also be borne in mind that a company is already required to have regard to the interests of its employees, but it is virtually unheard of for board minutes to expressly refer to this.

The new law is unlikely to be interpreted to mean that directors need to evidence all their thought processes, whether in regard to the six factors or anything else.

Board minutes do not need to become a medium for systematically recording whether each factor was considered irrespective of whether or not it has an impact.

Arguably the list of 6 factors simply represents the matters which a director would in any event have considered when exercising his normal duty of care and skill. The key for directors will be to continue to ensure they exercise their judgment in good faith, and have properly considered the wider implications of their actions.

GC100 have suggested that, at least for important decisions of larger companies, oard room briefing papers prepared by management for consideration by the board are a more appropriate place in which to refer to the relevant factors than the board minutes.

Only time will tell how the courts approach the statutory statement of duties after the codification comes in to force in October 2007. In the interim, it is important that directors are aware of their duties and rather than implementing unworkable processes, paper trails and prescriptive minutes containing negative statements, directors should keep a proportionate record of the reasons for their decisions in light of the significance of the decision to be made, and where appropriate seek advice.

Ashfords is regulated by the Solicitors Regulation Authority. The information in this article is intended to be general information about English law only and not comprehensive. It is not to be relied on as legal advice nor as an alternative to taking professional advice relating to specific circumstances.

6th July 2007

Key Contacts

Codification of Directors' Duties; Promoting the Success of the Company

Introduction