Professional Negligence and Liability
Chapter 23
DIRECTORS AND OFFICERS
I. INTRODUCTION
23.1 Since a company cannot act in person, directors are the officers who are usually entrusted with the running of its affairs. The subject-matter of this chapter is the law relating to (i) the liability of company directors and officers to the company and (ii) their liability to third parties.1 As we shall see,2 although directors are not yet considered members of a profession, recent developments in the common law suggest that they are set upon such a course, at least in terms of the test as to the duty of care and skill owed, if not the standard of care required of them. 23.2 The Companies Act 1985 requires all companies to have directors,3 but it is the constitution of the company that determines the functions of the board. Article 70 of the Companies (Tables A to F) Regulations 1985 provides, in Table A,4 that “the business of the company shall be managed by the directors who may exercise all the powers of the company”. The nature of the directors’ powers depends upon the terms of the articles,5 subject to the overriding provisions of the Companies Acts and other statutes. Article 72 empowers the directors to delegate their powers to any committee consisting of one or more directors and to any managing director or any director holding any other executive office. 23.3 The fact that company boards possess broad discretionary management powers derives from the simple proposition that, particularly in the case of large companies, this is the most efficient manner in which to run a company. If shareholders were the body that took management decisions, that efficiency would largely be lost. But a system of centralised management carries with it the risk that directors might exercise their powers in their own interests, rather than in the interests of the company and its stakeholders as a whole. The common-law rules as to directors’ duties therefore operate as a constraint on the board’s exercise of its powers, while seeking not to bring about a situation in which the benefits of centralised management are thereby lost. 23.4 The rules as to the limits within which directors can exercise their powers began to develop in the nineteenth century, drawing much from the rules applying to trustees. The body of law concerning directors’ fiduciary duties and the duty of care, skill and diligence firmly remains, for the moment, part of the common law. However, both the Law Commission and the Company Law Review6 (“CLR”) have recommended a clear statutory restatement of the common-law principles governing directors’ duties, setting out “the principles, rules and standards that govern the way in which directors operate and by reference to which their performance is to be judged”.7 After an extensive period of consultation, the Company Law Reform Bill was introduced to the House of Lords on 1 November 2005 and published on 3 November. The Bill was brought forward to the House of Commons on 24 May 2006 and completed the Commons Committee stage on 20 July 2006, its title having changed to the “Companies Bill”, a somewhat surprising development, given that the whole essence of the CLR was to do away with the Companies Acts based on Victorian values and to create a truly reforming statute. The Bill codified the common law and fiduciary duties owed by directors. Under the Companies Act 2006 (the name of the statute following that of the Bill) directors are now required to have regard to a statutory code of seven duties in their decision-making.Four of the new duties came into force on 1 October 2007.The remaining three duties came into force on 1 October 2008. 23.4.1 The new statutory code of duties will be the subject of full treatment in future updates, once they have been the subject of interpretation by the courts.The general duties set out in the Act form a code of conduct, with seven general duties as follows:- (1) The duty to act within powers (section 171): this duty is very similar to that referred to at paragraph 23.68(1) below;
- (2) The duty to promote the success of the company (section 172): this new general duty, in which the term “success” is undefined, has two elements. First, a director must act in the way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members of a whole. Secondly, in doing so, the director must have regard to various factors: (i) the likely consequences of any decision in the long term; (ii) the interests of the company’s employees; (iii) the need to foster the company’s business relationships with suppliers, customers and others; (iv) the impact of the company’s operations on the community and the environment; (v) the desirability of the company maintaining a reputation for high standards of business conduct; and (vi) the need to act fairly as between members of the company. It remains to be seen how directors are to balance (and indeed show that they have balanced) these factors (for example, in the context of a takeover), the DTI’s 17 November 2005 Explanatory Notes making it clear that paying mere “lip service” to them will not suffice.
- (3) The duty to exercise independent judgement (section 173): this duty mirrors the duty to maintain independence of judgement and not to fetter discretion, referred to at paragraph 23.68(3) below;
- (4) The duty to exercise reasonable care, skill and diligence (section 174): this codifies the current common law position, as set out at paragraphs 23.38 et seq. below;
- (5) The duty to avoid conflicts of interest, actual or potential (section 175): this duty in part reflects the “no conflict” rule referred to at paragraph 23.68(4) below, although it wider in its scope. The Companies Act 2006 contains a new provision enabling the company’s board to relieve directors from liability for breach of this duty. Currently, only the shareholders are able to do this (although the articles may release directors from such liability altogether);
- (6) The duty not to accept benefits from third parties (section 176): this duty codifies the rule against exploiting one’s position as a director for personal benefit, referred to at paragraph 23.68(4) below; see also paragraphs 23.96.1 to 23.96.2 below for further discussion of section 176.8 The duty set out in the 2006 Act prohibits the acceptance of non-financial and financial benefits (including bribes) and there is no provision for board authorisation (although shareholders remain able to authorise the acceptance of benefits that would otherwise constitute a breach of this duty). The duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. Benefits conferred by the company (and its holding company or subsidiaries) do not fall within the scope of this duty; and
- (7) The duty to declare any direct or indirect interest in a proposed transaction or arrangement with the company (section 177):a similar provision, albeit not phrased as a duty as such, will require a director to disclose an interest in a transaction or arrangement with the company already entered into.This duty reflects, with slight modifications, the position under the Companies Act 1985 (and in the articles of most companies).
- (1) Section II looks at who is considered a director.
- (2) Section III identifies the beneficiaries of the common-law duties owed by directors.
- (3) Section IV analyses the duty of care and skill owed by directors.
- (4) Section V considers the various fiduciary duties owed by directors.
- (5) Section VI considers relief from liability for breaches of duty by ordinary resolution of the company.
- (6) Section VII deals with section 1157 of the Companies Act 2006 and its provisions as to discretionary relief from liability.
- (7) Section VIII is concerned with limitation of actions.
- (8) Section IX considers the various remedies available as a result of directors’ breaches of duty.
- (9) Section X analyses the ways in which directors may incur liability to parties other than the company.
II. WHO IS A DIRECTOR?
1. General
23.6 Before turning to the question of who are the beneficiaries of the various duties owed by directors, and the substance of those duties, it is useful briefly to consider who is considered a director for these purposes, since the term “director” is not confined to those who have been formally and properly appointed as directors of the company. In fact, as will be seen below, the test of whether the common-law duties apply is one that looks to the function the individual in question was performing.2. De facto directors
23.7 An individual appointed as a director but with a defect in his appointment, or an individual never appointed at all but acting as a director,9 will be a de facto, or assumed, director of the company. “De facto director” is not a term that is statutorily defined, although it may have its roots in section 741(1) of the Companies Act 1985.10 The term covers those who have assumed the role of directors or have been so held out to the outside world. In Re Kaytech International plc, Secretary of State for Trade and Industry v. Kaczer 11 the Court of Appeal approved the comments of Jacob J in Secretary of State for Trade and Industry v. Tjolle 12 where, in declining to formulate a single test, the judge said:“…it may be difficult to postulate any one decisive test. I think what is involved is very much a question of degree. The court takes into account all the relevant factors. Those factors include at least whether or not there was a holding out by the company of the individual as a director, whether the individual used the title, whether the individual had proper information (eg management accounts) on which to base decisions, and whether the individual had to make major decisions and so on. Taking all these factors into account, one asks ‘was this individual part of the corporate governing structure?’, answering it as a kind of jury question. In deciding this, one bears very much in mind why one is asking the question. That is why I think the passage I quoted from Millett J13 is important. There would be no justification for the law making a person liable to misfeasance or disqualification proceedings unless they were truly in a position to exercise the powers and discharge the functions of a director. Otherwise they would be made liable for events over which they had no real control, either in fact or law.”14