The Companies Act 2006 - Do Directors Have Anything to Fear?

With 1,300 sections, the Companies Act 2006 is the largest piece of legislation on UK statute books and its protracted coming into force has generated an equally sizeable volume of debate, most notably over its treatment of directors’ duties.

In discussion of the draft bill in the House of Lords, Lord Hodgson captured the essence of this debate: "People who have spoken to us fear a double whammy. In Part 10, directors’ duties are widened, while Part 11 makes it easier for shareholders to commence actions against directors. There is concern. Is it justified?"

Does the act in its final form give directors anything to fear? The cautious view is that the act provides a platform for increased shareholder power and places a greater burden on directors.

In fact, very little has changed, with those rights and burdens already existing to a substantial extent. Directors of well-run companies have little, if anything, to fear from the act. Directors do, however, need to know where they stand under the new regime.

DIRECTORS’ DUTIES - A NEW CODE

One aspect of the act is to clarify and codify what has previously been an amorphous set of rules governing directors’ conduct. The new rules are based on what has gone before while offering a greater degree of clarity. Under the new code, directors should:

• Continue to owe their duties to the company
• Remain under those duties after leaving office
• Remain under a duty to act within the company’s powers and for proper purposes
• Exercise independent judgment in running the company’s affairs
• Owe a duty of care to the company
• Avoid conflicts of interest
• Concern disclosure of interests in company dealings
• Promote the success of the company in good faith for the benefit of its members as a whole

The last duty is accompanied by a list of factors directors must bear in mind when taking decisions. The list, which is not exhaustive, includes the need to act fairly between members, to consider the interests of employees and the impact of business decisions on the environment and the desire to maintain a reputation for high standards of business conduct.

It may initially appear there are contradictions between a company’s commercial interest and its newly-expressed obligation to the environment, or between the interests of current and potential future shareholders. In reality, however, while the list of factors that directors must take into account has been expanded by the new code, the underlying objective remains the same, namely, corporate governance in the overall corporate interest.

Whether this new regime brings with it any increased exposure for directors depends partly on how directors conduct themselves and partly on the ease with which disgruntled shareholders are able to challenge that conduct.

DIRECTORS’ CONDUCT UNDER THE NEW CODE

There may also be an initial concern with increased bureaucracy and discouragement of corporate risk-taking.

As far as the question of bureaucracy is concerned, there is undoubtedly some force in the suggestion that directors will have to demonstrate they have taken decisions on a proper basis (in accordance with the code).

Certainly, prudent directors may choose, even if only out of self-protection, to record the reasons for their decisions more fully than they have done so previously.

Regardless of motivation, such moves, if conducted correctly, would benefit a well-run company.

In regard to the perceived threat to risk-taking, there seems to be no compelling reason why directors should become any more risk averse in terms of making commercial judgments about their business and in doing so weighing up the various relevant factors.

SHAREHOLDER LITIGATION

The act introduces a new regime under which disgruntled shareholders can voice their dissatisfaction through the courts. This aspect of the act moves toward a modern, flexible and accessible criteria for determining whether a shareholder can pursue an action.

Put briefly, the new rules make it easier for proceedings to commence, but provide a rigorous early screening process which must be undergone before a claim will be allowed to continue. This new approach seeks to strike a balance between providing access to justice for appropriate cases and weeding out unmeritorious or nuisance claims. Overall, it is likely that the new rules will not make it significantly easier for disaffected shareholders to bring claims against directors and it seems clear that only sensible claims should see the light of day. A reasonable balance appears to have been struck.

SMOOTH RIDE

The passage of any new major piece of litigation, let alone one as significant as the new Companies Act, is always likely to promote interested parties and their lawyers to test newly-drawn boundaries. The Companies Act 2006 is likely to be no exception, and we may well see in the next few years some difficulties and some interesting questions arising out of companies bedding down under the new regime.

However, a sober analysis of the new provisions suggests that hitherto responsible and conscientious directors should have little to fear. There may be some changes ahead, but since the act is designed to encompass what has gone before and to promote the overall objective of responsible corporate governance, the ride should be reasonably smooth for those who already strive to reach that objective.