Directors' Duties Notes

Supervision 4 Directors Duties I Directors & Duties Part 10 CA 2006 The Duties * * * * * s170 CA 2006 sets out the scope of the general duties and is followed by: * s171 Duty to act within powers? * s172 Duty to promote the success of the company? * s173 Duty to exercise independent judgment? * s174 Duty to exercise reasonable care, skill and diligence? * s175 Duty to avoid conflicts of interest ("Corporate opportunities Rule") * s176 Duty not to accept benefits from third parties? * s177 Duty to declare an interest in a proposed transaction s179 states more than one of these general duties can apply in any case. s178 states breach of the above duties attracts the same liability as breach of the common law rules. Hannigan states this is because the Government was unable to draft a satisfactory statutory codification of the myriad of remedies for breach of fiduciary duty. s170(3) states that the statutory duties "have effect in place" of the common law duties. However, s170(4) states that the duties must be interpreted and applied in the same way as the common law and equitable duties. Thus the existing authorities can still be invoked. Indeed, the Solicitor General confirmed that the existing authorities should be applied "except where it is obviously irreconcilable with the statutory statement." Indeed, Hannigan argues that there has been little evidence of radical change, so the court must be continuing to apply the old law. s232 CA 2006 states any provision which purports to excuse directors from liability for negligence, breach of duty or breach of trust in relation to the company is void! Who is a "Director"? * * * * * * A Director is an agent for the company (not the Members) and thus a FIDUCIARY!! (Thus trustees duties can apply here too! e.g. Re HastingsBass). But Directorfiduciaries are permitted to take far greater risks than other fiduciaries such as trustees! s250 CA 2006 defines it as "anyone occupying the position of director" Thus de facto AND de juro! De Facto Directors? * In HMRC v Holland Lord Hope stated there is no decisive test, it is a question of fact. Lord Collins (minority) stated the distinction between de facto/shadow is impossible to maintain Look for whether df is on equal footing to dj directors? uses the title of director? part of the "corporate governing structure" etc. Shadow Directors? * The focus here is on control over the (majority) of the Board. * In Re Hydrodam Millett J stated these "lurks in the shadows". Need to prove: i. Board of Directors purporting to act as such? ii. Board didn't exercise its own discretion but acted on the directions of others? * s251(2)(3) CA 2006 A professional advisor nor parent company is a "shadow director" * Buzzle Operations v Apple Look for "habitual compliance over a period of time" and a "causal connection between TP's wishes and Director's conduct" Nominee Directors? * Nominee directors owe their loyalty to the company not their nominee per Kuwait Asia v National Mutual Life. Managers * Whilst Gower & Davies once recommended "Directors" should include senior management, this stance has not been adopted by the courts. However, it has been 20 * adopted in Canada. * But there is nothing to stop Senior Management being de facto directors, or fiduciary duties via the employment contract! Past Directors * s170(2) CA 2006 applies the duties to avoid conflicts, third party benefits to former directors. Duties are owed to the Company * * * * s170(1) CA 2006 states all of the duties are owed to the company. Thus, in Peskin v Anderson Members are unable to sue Directors for breach of fiduciary duty! However, Mummery LJ noted that fiduciary duties may be owed to the shareholders if they establish a "special factual relationship between directors and the shareholders in the particular case." * E.G.: Re A Company Directors are not obliged to advise shareholders on a takeover bid, but if they do, they must advise them honestly, in good faith, not faudulently, and not to deliberately or carelessly mislead, and to accept the "Best Price". * Directors may also be held liable for other torts e.g. misrepresentation, misstatement etc. The Company Law Review addressed this "scope issue": * "Pluralist Approach" Companies and/or their directors could be liable to external stakeholder groups if they failed to protect the groups' interests? * "Enlightened Shareholder Value" Shareholder interests are primary but are best served if companies are responsive to a wider group of dynamics than the singleminded pursuit of profit I.E Sustainable wealth creation, not just short term!! CLR rejected the Pluralist Approach as unreasonable and ultimately adopted the ESV concept of a broad "sustainable wealth" creation system of duties. Why do we have duties? * * * Hansmann & Kraakman state it is an "agency problem" Where the welfare of one party ("Principal") depends upon the actions taken by another party ("Agent"). There are three main agency problems: * Controlling Directors Company Members ("Principal") and Directors ("Agents")? * Controlling Majority Minority ("Principal") and the Majority ("Agents")? * Controlling Company Stakeholders ("Principal") and Company & Directors ("Agents")? The law reduces "Agency costs" by aligning the welfare of the Agent with the Principal. E.G.: * Protecting creditors from opportunistic behaviour decreases credit rates? * Protection of minority shares increases the value of shares? * Protecting Owners against insider trading leads to increased pay for Directors? These problems are resolved by: * Trust & Reward Dividends, Salaries? * Compliance & Enforcement State Enforcers (Competition Commission? FSA? CPS etc) or Private enforcers (Shareholder Derivative Suits, Class Actions etc)? Others (Auditors, Lawyers etc) * Disclosure (Knowledge allows prospective principles to enter, and principals to exit the company at the right times) Was codification of the duties a good idea? * Ahern argues that codification of the duty has rendered it increasingly less accessible. s170(3)(4) CA 2006 requires a considerable knowledge of the caselaw. The duties must be sourced in the statute, and then interpreted in light of the common law, and the remedies in the common law too! This goes against statutory interpretation, which requires the "ordinary language" to be heeded, not the old case law! It omits major duties such as if director fails to 21 consider a "material consideration" his act is void under the rule in Re HastingsBass. The lack of codification for remedies means company lawyers are still concerned with conversion, equity and restitution! She concludes "Behind a facade of accessibility lies much complexity." s171 Duty to Act within Powers * * * * * * There are two parts to this duty: * s171(a) To act in accordance with the constitution? * s171(b) Not to exercise powers for improper purposes? In Re Smith & Fawcett Directors must act bona fide in the best interests of the company and not for "collateral purpose" In Hogg v Cramphorn Directors issued shares to defeat majority takeover bid. HELD the power to issue share capital was a fiduciary power which could be set aside if it was exercised for an improper motive even if the issue was made in good faith in the belief that it was in the interests of the company. But this was nevertheless ratified by the Company and thus upheld. What is a "proper purpose"? In Howard Smith v AMPOL PC held there is no test, it is ultimately fact specific. But the court should "...examine the substantial purpose for which it was exercised and to reach a conclusion as to whether that purpose was proper or not." In this case, D wished to takeover X. It already had a 55% majority. X resisted and issued shares to C which they said was to raise capital. HELD: Lord Wilberforce The "substantial purpose" was actually to block D's takeover (so that there would not be a majority of shareholders able to vote in favour of the takeover). As the share issue was for an "improper purpose" it was accordingly void. The PC held that the law takes a subjective approach to the question of whether Directors believe they are acting in good faith in the best interests of the company (not what the Director OUGHT to have done!). Consequently, it was unconstitutional for the directors to exercise their powers purely for the purpose of destroying an existing majority or creating a new majority which had not previously existed, and consequently it was not a question relating solely to the management of the company over which the directors had exclusive competence. * "Proper Purposes" is to be determined by construction of the Articles In this case, issuing shares undermined the division of power between Members and Board, as it decreased the Member's ownership of the company. * CLR suggested it should be left open for judicial development as to whether it should be grounded solely in the Constitution, or whether wider criteria could be considered. It is similarly improper for Directors to enter into contracts where they remain in the Directorial post so the shareholders couldn't exercise their right to appoint new directors per Lee Panavision v Lee Lighting. Criterion Properties v Stratford Properties MD entered into an agreement which allowed for the sale of certain assets to S if another party obtained control of Criterion. This is known as a "poison pill" in the world of takeovers, since it makes the company less attractive to outside predators because valuable assets could be sold off. HELD: It is a question of fact whether this contract would damage the company more than an outsider gaining control of the company. On these facts, it was held to be an abuse of power. The HL remitted the case to trial as a matter of agency: did Director had authority to issue the "poison pill" If he did, it was enforceable, if not, it wasn't! s172 Duty to Promote the Success of the Company * * This mimics the Trustee's duties to act bona fide in the best interests of the beneficiaries. There are two limbs: (1) The Director must act in good faith to promote the success of the company for the benefit of the members as a whole. (2) Director must consider the nonexhaustive factors to which Director must "have regard to" in s172(1) CA 2006: * Long Term Consequences? * Interests of Employees? * Fostering Business Relationships? * Impact on Community & Environment? 22 * * * * * * * * * * Reputation? * Act fairly between Members? It is pointless Only the most negligent Director would not have regard to these general factors! This neither adopts the Pluralist Approach (only enforceable by company) nor the Enlightened Shareholder Value as the shareholders aren't primary. The test is clearly a subjective test. Failure to consider factors seems to be linked to "improper purposes" in s171(1)(b) CA 2006. The duty is owed to the particular company? the director owes no duty of loyalty to the "group" per Charterbridge v Lloyds Bank. In this case, collapse of the Parent Group would be a "disaster" for the subsidiary, thus it was permissible to guarantee a loan to the parent company. The courts will not question the director's judgment unless it is so unreasonable, no reasonable director could have reached it per Lord Woolf in Equitable Life Assurance Society v Hyman. CREDITORS? * Creditors are not included in the list! * But their position is not prejudiced, as insolvency law protects them by preferences and undervalue transactions per s213214 IA 1986. * This duty only arises when the company is "doubtfully solvent" (Brady v Brady) or any "course of action which would jeopardise solvency" (Nicholson v Permakraft). * This duty is not owed to creditors individually or collectively, but as an extension of the duties owed to the company per Yukong v Rendsberg. It can only be enforced by the company or by the liquidator in insolvency (not the creditors themselves!). * In GHLM Trading v Kumar Maroo [2012] it was held that the s172 duty extends to consider creditors when in financial difficulties. Even if the transaction is not a "preference" it may nevertheless be a breach of the s172 duty! DONATIONS? * These are not in the financial interest of the company! * But companies often make donations... In Re Lee, Behrens & Co the test is whether the donation is "Reasonably incidental to the carrying on of company's business (ii) Bona fide (iii) To benefit and promote prosperity of the company" GOOD IDEA? * To the extent this is a "socialist Charter", it doesn't do very much There are huge enforcement problems! Limited enforcers, and many are competing goals thus you can't pin the director down. * The only real power is the SoS has a disqualification power against directors for breach of duty. * These considerations shouldn't be the concern of Company Law We do this protection through Environmental law, Employment law, Insolvency law etc. s173 Duty to Exercise Independent Judgment * Fulham FC v Cabra Estates C contracted not to oppose future planning applications on their ground. Was this an unlawful fetter on their duty to exercise independent judgment? HELD: No, they are entitled to bind the exercise of their powers if it is, on the whole, for the benefit of the company. s174 Duty to Exercise Reasonable Care, Skill & Diligence * * * This is both a duty of loyalty and a duty of care. The duty of care is objective per s174(2) CA 2006 The knowledge "reasonably be expected" (objective) and the skill that "the director has" (subjective). Whilst the director is free to delegate, this does not "absolve a director from the duty to supervise the discharge of the delegated functions" per Re Barings Bank (No 5). Thus the Directors must ensure adequate internal supervision and control systems! 23 * * The directors have a "continuing duty to acquire and maintain a sufficient knowledge and understanding of the company's business to enable them to properly discharge their duties" per Re Barings Bank (No 5). Just because employees have been fraudulent or negligent doesn't been this duty has been breached. It depends upon the adequacy of the internal controls per Lexi Holdings v Luqman. 24 Supervision 5 Directors Duties II s175 Duty to Avoid Conflicts of Interest * * * * * This duty is derived from two rules of equity: 1. A person in a fiduciary position is not entitled to profit from that position ("No Profit Rule")? 2. A person in a fiduciary position cannot, without consent, enter into engagements in which he has a personal interest conflicting with the interests of the person he is bound to protect ("No Conflict Rule") Whilst now expressed in statute, the courts will apply this duty in light of the CL/EQ per s170(4) CA The strictness of the duty is tempered by the "exceptions" in s175(3)(4) CA: 1. If the transaction is with the company itself? (this is governed by duty to declare s177 CA) 2. If the situation cannot reasonably be regarded as creating a conflict of interest? 3. If the matter is authorised by the directors? The noconflict and noprofit rules are applied with unyielding strictness to enable a company to be sure of its undivided loyalty of its directors. The duties are "exacting requirements, exactingly enforced" per Rix LJ in Foster Bryant v Bryant. There are two justifications: 1. Deterrent It discourages fiduciaries (i.e directors) to pursue their own interests at the expense of the beneficiaries (i.e shareholders) Hansmann & Kraakman's "Agency Problem" 2. Supervision A strict approach obviates the need for strict supervision by shareholders of the conduct or directors. A fiduciary who wants relief from strict application thus only needs to seek the informed consent of the shareholders after full and frank disclosure of all relevant matters per s180(4)(a) CA 2006? Congalen robustly and rightly argues that to relax these rules "would subvert the incentive structure of fiduciary doctrine if fiduciaries were encouraged to think that they can make a profit in breach of fiduciary duty and then proceed to court (if caught) to argue about how much of it they aught to be able to keep." Conversely, Lowry & Edmonds argue that its unyielding application operates harshly and unduly restricts entrepreneurial freedom to compete with companies. Hannigan rightly argues that a director who chooses not to seek authorisation should continue to be subject to the full rigour of the law. This is particularly true postfinancial crisis about the standards of directors' behaviour. * "The NoConflict Rule" s175(1) 1. 2. 3. 4. A director must avoid any situation in which he has, or might have, a direct or indirect interest that conflicts, or might conflict, with the interests of the company. This includes conflicts between "interests" and "duties" per s175(7) CA E.G.: His if director was director of 2+ companies, he has separate duties to advance the interests of each company. The holding of multiple posts is discussed below. "can have" is similar to "possibly may conflict" and this was defined by Lord Upjohn in Boardman v Phipps as when a "reasonable man" looks at the "relevant facts and circumstances" there is "a real sensible possibility of conflict". This is subject to s175(4)(a) CA that the situation cannot reasonably be regarded as creating a conflict. An important authority on the noconflict rule is Bhullar v Bhullar 2 Directors of a family company was in breach of the noconflict rule when they personally acquired a property adjacent to the company without telling the company it was available for purchase. The company's members agreed it would not acquire further properties. The intention was for the members to go their separate ways, but no formal steps were taken... HELD: Director's personal interest in acquiring the land was in conflict to their duty to promote the company's interests requiring them to communicate existence of 25 5. 6. the opportunity to the company which could consider whether to acquire it. # Thus directors can be liable for breach of noconflicts even where they do not use knowledge they have been 'tasked' to obtain, obtained from the company, and even in their personal capacities! # In Cooks v Deeks The PC held that where there is a clear conflict between personal interests in securing the contract and their duty to secure it for the company, the benefit of the contract belonged in equity to the company, and the directors were bound to hold it on behalf of the company. # In Industrial Development Consultants v Cooley D was MD of IDC, actively involved in negotiations to secure contract with T. It became clear T was not prepared to contract with IDC? but IDC approached D and offered him personally the contracts thus he resigned from IDC and accepted. HELD: As MD, D had a fiduciary position, and by using information that IDC was again looking to place these contracts, which came to him qua MD, it was his duty to pass this information to the company. What are the "Company's Interests"? # Cooks v Deeks and IDC v Cooley demonstrate when Director secures a contract the company has been actively pursuing for himself. # In Bhullar v Bhullar the company has an interest in acquiring adjacent property, even though it had decided not to pursue any further acquisitions. # The strict nature of the duty of loyalty eventuates the courts taking a generous view of the range of activities in which the company may have an interest? Hannigan thus states "it can be said that the courts favour a strict, possibly overinclusive, version of the duty." * In Commonwealth Oil v Baxter Offshore exploration, though not within the company's past or current interests, was sufficiently proximate to the nature of its activities in onshore exploration, to fall within the scope of the company's business thus breach of noconflicts rule. * In Re Allied Business & Financial Consultants Directors had been approached by T to sell property? the directors found a client who was willing to proceed on the basis that he would share the deal 50/50 with 2 of the 3 directors and no commission would be paid to the company. The company would not have accepted this opportunity. HELD: Whilst the company's primary business was provision of financial advice and assistance, it was acting essentially as an estate agent The company's "interests" are not limited to what it is actually doing? thus, by failing to secure a commission for the Company, the directors preferred their interests to the company's interests breaching the noconflict rule. # Thus, an onshore oil company has interests in offshore exploration? a company which has decided against further acquisitions has an interest in acquiring adjacent property? and a company which has never acquired investment properties has an interest in acquiring one... # However, in Wilkinson v West Coast Capital it was held that where shareholderdirectors were in a position as shareholders to block further acquisitions by the company (i.e had a majority stake of 50%), when the two directors took an acquisition opportunity personally, there could be no "real sensible possibility of conflict" as they would block any acquisition. But a nonshareholderdirector would be different as he couldn't block... He'd need the informed consent of the company. Multiple Directorships? # This extends to a conflict of duties per s175(7) CA. # If Director of Company A is also Director of Company B, there is plenty of 26 

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