Directors' Duties Company Law Notes (FULL)

Directors' Duties Company Law Notes (FULL)

Here are the law notes on directors' duties that were helpfully prepared by an undergraduate law student from a top UK uni. Enjoy and share!

Directors Duties

Introduction and Historical background

Prior to the Joint Stock Companies Act 1844 the penalties of the Bubble Act would affect businesses which traded freely transferable shares without the permission of a royal charter. A director’s duties in statutory companies were those set out in the incorporating Act-

  • In partnerships all partners were entitled to manage and owed a duty of utmost trust to other partners who were all agents for each other and responsible for all partnership’s activities and debts
  • In deed of Settlement companies those who managed the business were trustees who held the title to the company for the beneficiaries (the shareholders)
  • Shareholders as beneficial owners had both an interest in the company’s assets and undertook unlimited liability for the company’s debts

The emergence of the company as a self-owning entity distinct from the shareholders had a corresponding effect on nature of director’s fiduciary duties à shifted from being owed to the shareholders to being owed to the company

  • Limited Liability Act 1855 separated shareholders from financial responsibility for the company’s financial arrangements
  • The doctrine of separate corporate personality meant the shareholder did not own the assets of the company ‘neither a shareholder nor a simple creditor of a company has any insurable interest in any particular asset of the company’ (Macaura v Northern Assurance Co Ltd [1925])
  • Thus a shareholder remained the owner by virtue of owning a function of the company- the fruits of corporate activity; the profits
    • Some cases the company is construed as its assets but in others it is construed as the function of the assets, that of making profits
  • Eventually early emphasis on the company as function was superseded by a judicial understanding of the company as being its productive assets
    • This new emphasis brought creditors into the equation
  • By 1980s the ideological emphasis has been upon the company as a competitive contractual being in the same way as a director may be
    • Interest in this period: while larger significant companies have a dispersed and passive membership whose separateness is evident both materially and legal, the reigning ideology is neo-liberal contractarianism which contrasts and relies upon an active capital investor
  • Company came to be construed as a nexus of contracts in which the competing interest of the contractees are pursued and encapsulated

Therefore chronologically the three periods are:

  • Company defined by its function (1850-1910)
  • Company defined by its assets                                                                      (1910-1980)
  • Company defined as competitor or a nexus of competition (1980 onwards)

The Development of Directors’ Duties- and principles uncovered at each stage

Directors duties to the company as function (1850-1910)

During this period great deal of law suggested that a doctor’s fiduciary duty was owed solely to the function or purpose of a company- that of making profits:

  • The short-term interest of the shareholders (in the form of dividends) was seen to be more important than the protection of company assets (which provided comfort to creditors)
  • During this period a director would not be in breach of his duties if he diminished company assets in order to pay dividends (to shareholders)
    • When assessing the legality of dividends the court need not consider capital losses from previous years (Dent v London Tramways Company 1880). The issue highlighted in this case is that what needs to be considered is not whether the value of the assets had diminished or whether the failure to observe the articles should be rectified but whether or not there were sufficient profits made that year to pay dividends à if there were sufficient then dividend could be paid without consideration of the assets
  • Some attempts were made to protect the assets of the company
    • Trevor v Whitworth 1887- court established the capital maintenance rule that a company could not buy back its own shares
    • BUT right after this case Lee v Neuchatel Asphalte Co 1889 ‘it is entirely with the shareholders to decide whether the excess shall be divided among them or set apart as a reserve fund for replacing assets, and the court has no power to intervene with their decision however foolish or imprudent’
    • There was no requirement to replace assets lost in trading before a dividend was declared
      • Companies Act only made one restriction in respect of declaration of dividends: that no divided could be paid except out of profits
    • Flicroft’s case- dividends which were paid on failse accounts put forward by the directors which made debts look like assets were held to be personally repayable by the directors responsible notwithstanding that they had not personally benefited from the dividends
    • KEY: the protection of assets that might diminish in value as a result of pursuing profits for dividends was not an object of the Companies Acts
      • The duty to the company was not to protect tangible property but to protect the short-term interests of shareholdings
  • Strict self-dealing rules were established in this period, reflecting the continuation of the trustee principles into the modern company
    • The strict principles of trusteeship were transported into a director’s duties and remained until the 2006 act
    • The strict application of these principles famously articulated by Lord Cranworth in Aberdeen Railway Co v Blaikie Brothers
      • HoLs struck down a contract under which the company had agreed to buy an order of chairs from a firm in which one of the directors of the company was a partner – by being represented on both sides of the bargain, the director was in too powerful a position for his duty to a company to be carried out fairly

‘A corporate body can only act through agents…the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature toward their principal’

  • At this early period the law’s position on conflict of interests was immutable and unflinching- directors were performing a public function NOT a negotiable contract + the company was a public body intrinsically connected to society

Directors duties to the company as assets (1910-1980)

Shareholders became increasingly detached from any personal involvement in the company- the doctrine of separate corporate personality (Salomon v Salomon) and its ramifications

Directors remained conceptually and practically bound to the management of its working assets- the relationship between director and shareholder is entirely severed and no longer mirrors the relationship that subsists between partners in a firm:

  • A director’s fiduciary duty is owed to an entity distinct from shareholders and no longer represents a fiduciary relationship owed to the shareholders
  • Percival v Wright is the leading case for ‘to whom does the director owe a fiduciary duty’
    • Swinfen Eady J held that directors owed a duty to act in ‘the best interests of the company as a whole’ and ‘directors were not trustees for individual shareholders’
      • The company is a legal entity quite distinct from the shareholders Salomon v Salomon; so that a sale by a mortgagee to a company in which he is a shareholder is neither in form or substance a sale to himself
    • Directors are the mere trustees or agents of the company- agents in the transactions which they enter into on behalf of the company (Great Easter Railway Co v Turner)
      • Directors are called trustees but not trustees of a debt due to the company- the company is the creditor
      • Because the fiduciary duty is owed to the assets of the company- it is necessary for strict rules on self-dealing under English law

KEY: sees a shift of emphasis from the previous pro-dividend approach

  • Director legally conceived as owing a duty to the company entity not to the shareholders when materially the company was a distinct being
  • West Mercia v Dodd- director held to be in breach of duty to the company for transferring some assets from one company to another whilst there was an outstanding debtà once a company was insolvent the interests of the creditors overrode the interests of the shareholdersà the transfer was against the best interests of company because it was against the interests of the creditors (Brady v Brady)

Self-profiting rules were developed – Conflicts of interests and corporate opportunities (exploitation thereof)

  • No-profit rules- a director could not personally benefit from his fiduciary position- a director remains a trustee for company assets including non-tangible assets such as business opportunities
    • Art 85 of Companies Act 1985- a director would only be accountable to the company for any personal profiting if failed to make full disclosure given that his company’s articles included art 85
  • Guiness plc v Saunders- It was contrary to the to the position of a trustee to profit from his position outside that allowed under the trust document + s. 317 made it a criminal office for failing to disclose n interest
    • This no-conflict rule arose in the trustee principles of 19th century so that disclosure will not relieve a director from liability if the equitable principle of good faith has no been met
  • Neptune ltd v Fitzgerald (No 2)- the company’s articles excluded the strict equitable rule against self-dealing but that did not entail that the director was relieved from his other obligations to the company including – his duty to act bona fide in the company’s interests
  • Movitex v Bulfield- the company’s articles could not exclude a director’s liability ‘which by virtue of any rule of law would otherwise attach to him respect of any negligence, default, breach of duty or breach of trust of which he may be guilty in relation to the company’
    • Conflicts of interests could be modified BUT not excluded, in the articles (art 85 and s320 of 1985 Act)

Corporate opportunities

  • Cook v Deeks –great emphasis on a director’s trustee like relationship to company assets

‘Men who assume the complete control of a company’s business must remember that they are not at liberty to sacrifice the interests which they are bound to protect, and while ostensibly acting for the company, divert in their own favour business which should properly belong to the company’

  • Regal (Hastings) Ltd v Gulliver- a director’s accountability for self-dealing did not rest upon the bona fides of his actions. The liabilities which arise from a fiduciary position did not depend on fraud or an absence of bona fides
  • Similarly in Cooley- it was not the bona fides of the directors action that was definitive in holding them accountable
    • Importance of a director’s act of resignation in determining whether the fiduciary duty ceased with the resignation
  • In IDC v Cooley and Canadian Aero Service v O’Malley- resignation would not sever the fiduciary relationship between director and company if resignation was prompted by desire to exploit a corporate opportunity which emerged whilst he was working for the company
  • This was furthered in Island Export Finance Ltd v Ummunna- no breach of duty because Mr Umunna’s resignation was not prompted by desire to exploit the business opportunity AND because IEF was not ‘maturing a business opportunity’
    • quite a departure from Regal (hastings) - contrast is that in Regal the company was not maturing a business opportunity and had no financial ability to make the disputed transactions WHEREAS in IEF- did contemplate future transactions but not ones that were sufficiently well formed at the relevant periods
      • IEF: intentions were not to act against the interests of the company or to deprive the company of a corporate opportunity which properly belonged to ità there was not a competition for a specific contract

The Company as competitor: a nexus of competitions (1980 onwards)

IEF v Umunna continued to reflect the judicial understanding of the company as a bundle of tangible and intangible properties to which the director owes a fiduciary duty à it reflected the growing importance of the director’s bona fides (central in Canadian Aero and significant in IDC v Cooley). KEY: it goes much further towards reconceptualising the company as a competitor

  • His resignation was prompted by bona fide reasons and it was not maturing a business opportunity
  • Entitled to personally profit from business contacts and knowledge acquired as a fiduciary as long as his resignation was not prompted by desire to usurp a specific maturing business interest

CMS Dolphin v Simonet- director entitled as a general principle, to benefit from associations and contacts made while a fiduciary à the question of liability lay in his intention in resigning NOT the act of resigning itself or the subsequent use of business connections

Plus Group Ltd v Pyke- director not be accountable for diverting a corporate opportunity because he was resigned from his position at time of breach à a move away from the strict liability approach in Regal (hastings): courts emphasis on factual details of the transactions and relationships

These cases reflected the decision in earlier Canadian case of Peso Silver Mines- a director was held not to be liable to account for profits made from a transaction of which he had become acquainted in his capacity as a fiduciary à liability arose not from breach of duty but ‘by reason of his relationship to the company of which he is a director’

American law in director’s duties is dominated by two questions- that of bona fides of the director’s actions and whether the director acted in actual competition with his principal

  • Globale Woollen Co v Utica Gas and Electric Co- breach of duty to avoid a conflict of interest because had caused the plaintiff to enter into a contract on unfavourable terms with another company for whom he was a director
  • Broz v Cellular Information Systems (1996)- supreme court held that Broz was under no formal duty to present the Michigan licence to the CIS board, the opportunity had come to Broz in his private capacity and CIS lacked both the interest and financial capacity to acquire the licence
    • Supreme court explained that used the principles laid down in earlier Delaware case (Guft v Loft Inc)
      • Director may not take a business opportunity for his own if the corporation was financially able to exploit the opportunity and if the opportunity was within the corporation’s line of business and if the corporation had an interest or expectancy in the opportunity

Company Law reform

The judiciary’s more recent leniency toward the no-profit rule has come together with the contractarian approach of the reform process. The Law Commission Consultation Paper of 1998 was the first significant statement on director’s duties in the reform process.

  • ‘unclear law creates unnecessary costs and inhibits decision making and therefore competitiveness’
  • Company law is ‘a functional area of law: it must facilitate commercial activity and enable, or at least not prevent, the delivery of benefits to all the company’s stakeholders’

Straight from the heart of CONTRACTARIANISM- commission declared agency costs to be key to law reform –‘the cost associated with having your property managed by someone else’

  • The purpose of law reform would be to provide mechanism which reduce agency à by making bargaining more effective thereby contributing to both technical and allocative efficiency
  • The commission recognized that the agent/principal model does not operate in law in the same way that economic concept requires- English law acknowledges that directors are the agents and the company is the principal – shareholders do not enter into this formulation except in their association with the ‘interest of company’
    • Undeterred by this bullshit unclarity the commission stated: ‘ the economic concept of agency is concerned with the costs which arise fomr delegation rather than the precise juridical relationship to which the delegation gives rise à in order to accommodate the more desirable economic definition, the precise juridical relationship can be disposed of (collaborates Jensen & Meckling)

Although this position is precarious, law reformers take it and continue further with the contractual model in which shareholders have assumed the role of principal

  • Like Easterbrook and Fischel –the commission holds the company contract to be more contractual precisely because it does not conform to the norms of contract lawà they conceptualise company law as merely a mechanism for perfecting the corporate contract

‘Company law plays an important role in supplying a set of background rules which fulfil a number of functions, including filling in the gaps in express contractual arrangements and facilitating bargaining between the parties

  • The contractual relationship between directors and shareholders is economically efficient: the fiduciary principle does have an economic rationale BUT economic argument for imposing a fiduciary relationship on directors are MIXED:
  • The resulting legislation which is the 2006 act creates a regime which largely similar to that under the 1986 Act- provides more facility for a director to pursue other commercial interests outside the interests of his company and attempts to codify the many varied judicial interpretations put upon the directors’ fiduciary duties
    • Explicitly inhibits judiciary from creating more duties and limits the interpretation of existing duties à a clearer regulatory regime in which directors may operate and largely removes the criminal penalties attached to directors activities

How important were the contractarian theories which informed the reformers to the formation of the final Act?

  • The removal of many of the prohibitions and their replacement with default rules such as disclosure and consent aligns with the Commission’s contractarian-informed notion of company law
  • A regime which describes the private contracting of players involved in a joint commercial endeavour
  • The importance of contractarianism lies not in its effect on actual legislation but in its ideology of the company as private NOT public, concern.

Concluding Points:

  • The reform process and resulting legislation on director’s duties have promoted the ideology of shareholder primacy
  • The provisions in s 172 makes all the duties which a director owes to the company to be exercised in such a way that primarily pursues shareholder interest
  • Contractarianism has facilitated a modern and sophisticated justification for focusing the ‘best interests of the company’ in this way
  • thinks that it is methodologically and morally wrong- the company is made of arrangements between people as the contractarians rightly asset but this makes it a social as well as an economic actorà should give it a broad public nature
    • Director’s duties should take proper account of the interests of all engaged persons and not simply privilege shareholders

The general duties

A director often deals with other people’s property- not just in the legal sense that he will be in control of the company’s assets but also:

  • Shareholder’s investments in buying of company shares -they have little to no control over what directors do and their investment will be lost if company becomes insolvent.
  • If goods or services are supplied to company on credit, the directors will be dealing with money which the creditors have a claim to until they are paid in full
  • Blatant need to control the behaviour of a person in such a position of power – impose upon him a standard of conduct which will protect those who will lose out if director is incompetent or dishonest
    • 3 major difficulties in imposing this standard:
      • Directors vary considerably in extent their involvement with a company-
        • Executive directors will be very closely involved with day to day affairs of company and amount of knowledge that they are expected to have about workings of company will far exceed that of non-executive members who are charged only with duty to take an overall view of company operation, lend expertise to making of policy decision and warn of suspicious behaviour in company
        • This separation is by no means universal -law sought to impose a standard of conduct on all directors regardless of level of involvement à difficult to formulate this standard to be fair to all types of directors
      • Different types of company vary from multinational giants to ‘single member companies’ –
        • difference in size and complexity makes formulating standard by which the performance of all company directors can be judged difficult
        • statutes draw distinction between directors of public companies and directors of private companies
        • case law here is very crucial –no formal distinction is made between different types of companies BUT they impose a sliding scale of responsibility depending on what can reasonably be expected from someone in that position
      • Nature of the decisions directors make- mostly business decisions on which contracts will be most beneficial for company to enter into
        • Very difficult for a court looking at events with hindsight to judge if that decision was commercial foolish at the time it was made
        • Courts do not wish to encourage directors to become too cautious by imposing too high a duty of care àwill lead to inefficiency

Duty owed to the company

Directors owe their duties to the legal person ‘the company’ and not to shareholders or potential shareholders à general rule that directors duties can only be enforced by the company suing directors

  • Percival v Wright (1902)- shareholders wrote to the secretary of company asking if he knew any potential purchasers for their shares. Chairman and two other directors purchased the shares at 2.50p per shareà shareholders discovered that prior to negotiations for the sale of those shares the chairman and directors had been approached by a third party who wished to purchase the company offering a price which values each share well over 2.50p à shareholders asked for sale of shares to be set aside by court on grounds that chairman and directors had breached a duty to the shareholders
    • Swinfen-Eady J: refused to set aside sale and firmly rejected idea that there was any duty owed by the chairman and directors to the shareholders – their duties were owed to the company
    • Although this situation may now be caught by the s 459 remedy, the fundamental principle that directors owe duties to company is unchanged
    • This principle may cause difficulties where there are several companies acting as a group

In circumstances where parent company holds majority of shares in its subsidiary companies, very tempting for directors appointed to the board of the subsidiary to look after interest of the parent and ignore interests of the subsidiary

  • Scottish Co operative Wholesale Society Ltd v Meyer 1959- Lord Denning emphasized that the duty of directors was owed to the particular company which had appointed them
    • Must not prejudice or favour parent over subsidiary or vice versa

Directors must regard the interests of the people who are actively involved in company’s affairs- which persons are entitled to have their interests regarded?

  • Members – does a dissenting minority of members have a right to have their interests considered? (shareholders rights, alteration of articles of association, bona fide test)
  • Employees- under s 172 of CA 2006: company directors are ‘to have regard’ to the interests of employees as well as the interests of members
    • This duty has no enforcement mechanism- a mere ‘window dressing’
  • Creditors- they have their money tied up in the companyà172 Companies Act 2006: interests should be important to the directors in making a decision
    • Lonrho v Shell Petroleum (1980) this factor was recognized by Diplock ‘it is the duty of the board to consider..the best interests of the company. These are not exclusively those of its shareholder but may include those of its creditors’
    • West Mercia v Dodd: Court of Appeal confirms this view BUT the interests of the company in this case were said to include the interests of creditors because the company was insolvent at the relevant time (Lonrho was not an insolvency issue)
    • Winkworth v Edward Baron (1987): Lord Templeman reffered to duty owed directly to creditors
    • Brady v Brady 1989: Nourse J regarded the interests of the company as synonymous with the interests of the creditors where the company was insolvent or ‘doubtfully solvent’ à clear that:
      • Where company insolvent the interests of creditors and interests of the company coincide to a considerable degree (Standard Charted Bank v Walked 1992)
      • Where a company is approaching insolvency, the interests of the creditors are important where an assessment of whether the directors acted in the interests of the company is made
        • BUT not clear precisely at what stage of ‘approaching insolvency’ the creditors interests become paramount or what test is applied to determine directors appreciation of the insolvency à if they ought to have known of insolvency but did not are they liable? Not clear from cases.

Common law duties were divided into ‘fiduciary duties’ which reflected the position of the director as a guardian of the interests of company and those concerned in it, and duties of care and skill.  The statute follows a similar layout- a separate section setting out the ‘duty to act with reasonable care, skill and diligence’ EASIEST TO UNDERSTAND SO START WITH THIS

Duties of care and skill

  • The Marquis of Bute’s case 1892- illustrates the difference in the degree of involvement of directors: became president of the Cardiff Savings Bank when he was six months old (inherited from rather), attended only one board meeting of the bank in 38 years
    • Judge held that he could not be considered liable as he knew nothing about what was going on –no hint that he ought to have kept himself informed
  • Dovey v Cory (1901) director was able to escape liability for malpractice on grounds that he had relied on information given to him by the chairman and general manager of the company
    • Standard applied here seems to be stricter than in the Marquis of Bute’s case- court held that the reliance on chairman and manager was ‘reasonable’ à standard one of negligence: the director must have acted as a reasonable man wouldà reasonable man would have been suspicious of the information that was given and would have investigated further thus if failed to do so would be liable for the loss caused by the irregularity
      • This standard may be higher than standard in marquis but no suggestion that a ‘reasonable man’ test should be used to judge the marquis’s inaction
    • Re City Equitable Fire Insurance (1925) a case where these issues fully explored- 3 important rules:
      • A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience
      • A director is not bound to give continuous attention to the affairs of his company à duties are of an intermittent nature to be performed at periodical board/committee meetings à not bound to attend all such meetings BUT ought to attend whenever he is reasonably able to do so
      • In respect of all duties- a director is in the absence of grounds for suspicion if had left properly the exigencies of business and articles of association to another officialà is justified in trusting that official to perform such duties honestly
        • These rules still regarded as important but courts have moved away from these subjective standards to a more objective standard
      • Dorchester Finance Co. Ltd v Stebbing (1989) affirmed these rules- also held that there was no difference in the duties owed by executive and non-executive directors
        • RULE 1: Standard here is not a ‘reasonable professional director’ standard but refers to the reasonable man with the skill and experience actually possessed by the particular director in question
        • This standard is capable of working quite well and has sufficient flexibility to be valuable in different types of companies for judging behaviour of different types of directors
          • Only seriously inadequate where a very inappropriate appointment has been made regardless of size of operation
        • RULE 2: Duty is to attend meetings and give attention to company affairs ‘whenever in the circumstances the director is reasonable able to do so’
        • RULE 3: director who absents himself or fails to keep himself informed on company matters so that he will not be aware of any ‘grounds for suspicion’ , so he can leave the running of company to others.
          • Taken in conjunction with rules 1 and 2- he is actually obliged to take proper part in the affairs of the company so that unless his appointment has been manifestly foolish (e.g. baby Marquis) à rules work together to provide a sliding scale of responsibility which will weigh heaviest on those most able to do the job, and whose expectations of reward from the job are probably
          • The DTI Company Law Review accepted that this objective standard has been adopted into the general law by analogy- s.214 Insolvency Act 1986
            • In re D’jan of London Ltd- Hoffman LJ: the common law duty of care owed by directors was accurately stated in s.214 Insolvency Act 1986. The Companies Act adopts this objective standard
            • S 174 CA 2006 Duty to exercise reasonable care, skill and diligence
              1. Director must exercise reasonable care, skill and diligence
              2. Means the care, kill and diligence that would be exercise by a reasonably diligent person with
                • The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director
                • The general knowledge, skill and experience that the director has
  • This means that there is a base level of reasonable expectation which appears to be related to the type of company in which the director finds himself and so imports some of the flexibility of Re City Equitable Fire Insurance BUT where the director is particularly experienced, he will not be permitted to perform to a lower standard (e.g. Bill gates as director of a chippy will not be allowed to be a lazy piece of ass)
  • The statute strikes a good balance- imposition of too high a standard might cause problems as experienced in the USA (Smith v Van Gorkom 1985 [supreme court of Delware 1985] ) –imposition of liability for negligence proved too strict and led to distinct reluctance to join boards as non-executive directors [Delaware Corporation law s 102 (b)(7)]
  • UK law- the excuse of incompetence is clearly unavailable

Fiduciary duties

A director is under one overriding duty- to act bona fide in the interests of the company ; the list of duties that grew out of the case law was in fact a list of situations where a director is most likely to be in breach of his fundamental duty

The Companies Act 2006 seems to partially accept this reasoning- a general duty to promote the success of the company BUT the statute also sets out a list of other duties which are formulations of the pre-existing case lawà the duty to promote the interests of the company is not separate from the list of duties not is it the first duty to be mentioned

  • Behaviour which is not bona fide for the benefit of the company cannot be condoned unless ‘the company’ agreesà where sole shareholders and directors took money from a company still regarded as theft despite fact that they clearly had the agreement of all the members (themselves) to do so
    • Re Attorney General’s Ref No2 of 1982
    • R v Phillipou 1989
    • These affirmed by HoLs in R v Gomez – The discintion between the overriding duty of good faith and the effect of putting oneself in one of the perilous situations varies with the seriousness with which the particular behaviour is viewed
      • g. a misappropriation of company property but the directors can still be held to have acted bona fide for the benefit of the company à can be excused by a majority of shareholders against the wishes of the minority
    • The bona fide fundamental duty appears at s.172 CA 2006

Duty to promote the success of the company

  • A director of a company must act in the way he consideres in good faith would be most likely to promote the success of the company for the benefit of its members as a whole and have regard in doing so to
    • Likely consequences
    • Interests of the company’s employees
    • Fostering relationships with suppliers customers and others
    • Impact on the community and environment
  • Directors are only required to consider the above listed matters in so far as they benefit the shareholders – not a pluralist formulation of the company +weaker in stakeholder primacy
  • Are the prohibitions absolute? – no, behaviour may be forgiven by the company with a varying degree of case depending on seriousness the court takes
    • Behaviour can be ratified under s239 Companies Act 2006 and the statutory statement regarding ratification retains the common law uncertainty about the limits of ratification
    • 239(7) – states that ‘this section does not affect any other enactment or rule of law imposing additional requirements for valid ratification or any rule of law to acts that are incapable of being ratified by the company’
    • Motvitex Ltd v bulfield and Others (1988) is an example of how this system works – held that the ‘self dealing’ duty (duty not to allow oneself to be in a position where duty and interest conflict) because likely that his behaviour would be seen as a breach of his fundamental duty of good faith

Categories of duties

Duty to act within powers- s.171

A director must –

  1. Act in accordance with the company’s constitution and
  2. Only exercise powers for the purpose for which they are conferred
  • This is one area where the courts are very often happy to permit the majority to excuse the action of the directorsà so that this is pherpas an area where a director is in least danger of being found to be in breach of his fundamental duty
    • g. the power to issue sharesàcourts have determines that where directors have this power, the purpose for which they were given this was to raise capital
      • It is a power which can easily be used to fend off a takeover or to prevent themselves from being removed from officeà diluting the voting capacity of a hostile element by issuing of new shares (Punt v Symonds & Co 1903 and Piercy v S mills1920 good examples of this)
    • Howard Smith Ltd v Ampol Petroleum Ltd – more complicated: company was threated with a takeover by two associates who between them held 55 percent of the company’s shares. Company needed more capital but proposed to obtain it by issuing over four million shares to members other than the takeover bidders àwould have reduced the takeover bidders to a minority à held to be a misue of directors powers
      • To raise capital (proper purpose), to defeat takeover (improper purpose)
        • Courts concluded directors would be acting within powers if the dominant or substantial purpose of the exercise of those powers was proper
        • Lord Wilberforce emphasised- the court would not simply accept a statement by directors that they acted for a particular purpose

‘When a dispute arises whether directors of a company made a particular decision for one purpose or another (where there is more than one purposeone or another purpose was the substantial or primary purpose, the court is entitled to look at the situation objectively in order to estimate how critical or pressing an alleged requirement may have been. It may have reason to doubt or discount the assertions of individuals that they acted solely in order to deal with it particularly when the action they took was unusual or extreme’

  • Criterion Properties Plc v Stratford UK Properties LLC (2004) two companies were parties to a joint venture governed by a partnership agreement. A supplementary agreement in 2000 effected to protect Stratford UK Properties LLC against a potential takeover and change of management by the introduction of a ‘poison pill’ (defensive measure against hostile takeovers).
    • The second supplementary agreement was signed on behalf of Stratford UK by one of its directors without approval of whole board à that managing director had come to an agreement with an important shareholder within the company context that required the company to buy out his shareholding at a high price if there was a change of control int he company or a removal of a director from the board
      • Company asked court to set aside agreement because signed for an improper purposeà claims that agreement not been a proper use of directors powers and could not be enforced against the company
      • Stratford would have to endure a heavy financial burden in the case of a breach of its terms à a potential bidder would have been discourage from trying to acquire it
      • HoLs viewed the case from different angle to that of the ‘proper purpose’ argument and focused more on the nature of the authority of the managing director in question who had entered into agreement on behalf of company
        • Agreement would be set aside and company not found bound to that only if the director was not under any authority to sign the agreement à HoLs stated: in order to resolve this issue the principles relevant to consider are those of agency
      • Re Looe Fish Ltd (1993) the failure by a director to exercise the power of allotment of shares for the purpose for which it was conferred led to disqualification under s. 8 Company Directors Disqualification Act 1986

(2) Duty to exercise independent judgement –S.173

  1. Director of a company must exercise independent judgement
  2. This duty is not infringed by his acting
    1. In accordance with an agreement duly entered into by the company that restricts the future exercise fo discretion by its directors or
    2. In a way authorised by the company’s consitituion
  • Statutory restatement of the common law prevention of ‘fettering discretion’ – merely another way in which directors have an interest in conflict with their duty to the company
    • If they bind themselves by agreement to act in a particular way à they have personal interest in fulfilling that agreement
      • This is in conflict with their duty to be able to act always int he best interests of the company
      • Fullham Footbal Club v Cabra Estates Plc (1994)- the directors of Fulham football club agreed to support planning applications for the development of land leased by the company and oppose different plans proposed by the local council à large sums of money paid because of this agreement
      • A number of planning applications failed and enquiries held: found that issue was whether the undertakings by the directors applied to new planning applications by the respondents whether the undertakings had been improper in fettering the discretion of the directors and whether the agreement was subject to an implied term that the directors would not require to do anything contrary to their fiduciary duties
        • CA HELD: agreement valid- was not improper deterring of discretion and not subject to the suggested implied term
        • Test to be applied was :’was the contract as a whole bona fida for the benefit of the company?’ If it was, directors entitled to bind themselves to do anything necessary to carry it out

Duty to avoid conflicts of interest- s.175

Companies Act 2006 takes a new approach to two situations dealt with together under the case law

  1. A director of a company must avoid a situation in which he has or can have a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company
  2. This applies to the exploitation of any property , information or opportunity (immaterial whether the company could take advantage of the property, info or opportunity)
  3. This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company
  4. This duty is not infringed-
    1. If the situation cannot reasonably be regarded as likely to give rise to a conflict of interst
    2. If the matter has been authorized by the directors
  1. The matter can be authorised by directors if it is possible under the constitution and the interested director does not vote on the matter

Duty to declare interest in proposed transaction or arrangement- s. 170

Where the transaction is made between the director and the company before the transaction is made- the declaration must be made to the directors (both duties now continue after a director ceases to hold office)

  1. A person who ceases to be a director continues to be subject=
    • To the duty in section 175 as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was a director
    • To the duty in section 176 as regards things done or omitted to be done by him before ceased to be director

This is one area where it is unclear if the statute changes the already uncertain case law

  • Preceding case law covered various situations where benefits were siphoned away from the company by directors (can be more complex than just taking money from company)
    • Mernier v Hooper’s Telegraph Works (1874) – Hooper’s company was a substantial shareholder int he European Telegraph company and had contracted with it to make and lay a cable to S American under certain concessions granted to the European company by governments concerned
      • Mernier a minority shareholder in the European company claimed that Hooper’s company had used its votes to procure the diversion of this business to a third company à to cause abandonment of proceedings brought by Euro company to assert its right to the concessions and to have it wound up – Court upheld Menier’s claim (minority should have nothing to do with it)
    • Cook v Deeks (1916) - the directors of a company were involved in negotiating a series of construction contracts with the Canadian Pacific Railway. The last series of contracts were negotiated in the same way as others but before completed, directors took contracts in their own names
      • Held that because the directors were acting for the company at time of negotiations- the benefit of the contracts belonged to the company -à directors could not take benefit of those contracts for themselves
      • Where there is a conflict of interest and duty there is clearly a breach of duty but it remains unclear when such breaches can be ratifiedà the more serious the courts see the conflict to be, the ess likely they are to permit a majority of the company to ratify the actions of directors (particularly where there is a dissenting minority)
    • Scottish Co-operative Wholesale Society Ltd v Meyer (1959)- situation where duty and interest can be in conflict: 3 directors were both directors of a parent co and directors of a subsidiary of that co. è as soon as the interests of these two companies conflicted, the directors were unable to fulfil their duty to both companies
  • Under case law the situation where a director contracts with his company was dealt with under the same heading –it is now separate under s176 but the general rule remains:
    • a director is in peril of being in breach of his overriding duty if he makes a contract in which he has a personal interest with his company
    • Aberdeen Railway Co v Blaikie Bros (1854) – Lord Cranworth:

‘it is a rule of universal application that no one, having fiduciary duties to discharge, shall be allowed to enter into engagements in which he has or can have a personal interest conflicting or which possible may conflict with the interests of those whom he is bound to protect’

  • This rule has been referred to as the ‘self-dealing’ rule (Movitex v Bulfied)
    • It is by no means absolute and is an area where company can readily ratify acts done in breach of the general rule

The most difficult area where interest and duty often conflict is where a director is alleged to have profited personally from an opportunity or information which came to him in his capacity as director

  • Regal (Hastings) Ltd v Gulliver (1942)- the directors of appellant company owned a cinema and were anxious to acquire two other cinemas. A subsidiary co was formed for this purpose, its capital was 5000 shares at 1 pound each. A lease of two cinemas was offered provided that the subsidiary co’s capital was paid up. It was the director’s intention that the appellant co should own all the shares in the subsidiary company BUT the appellant company could only afford to invest 2000 pounds à directors and company solicitor each took 500 shares 3 additional investors took 500 eachà these were subsequently sold and the new shareholders of company sought to make directors, solicitor and chairman liable to account for profit made in respect of subsidiary co’s shares
    • HoLs held: the directors were liable to account to the company for their profit
      • This is a case where the company was unable to make use of the opportunity which was then taken advantage of by its directors
    • Industrial Developments v Cooley (1972) -The principle from Regal (Hastings) was applied here – defendant was a managing director of the plaintiff company, while serving in that capacity came across valuable information à obtained release from company by dishonest representations for purpose of obtaining lucrative contract for himself
      • Despite the fact that the defendant made it clear to other party that he was contracting with them in personal not managing capacity, the court held that the defendant must account to company for profits from contract
    • Gencor ACP ltd v Dalby (2000)- consistent with this line of reasoning- a director cannot escape liability on the basis of a defence that his company would not have taken advantage of a particular business opportunity
      • BUT can escape liability if he manages to obtain the consent of the company’s shareholders for his actions
    • CMS Dolphin Ltd v Simonet (2002)- an advertising company claimed that former managing director breached fiduciary duty to act bona fide for benefit of company and his fidelity duty stemming from his employment contract
      • He resigned and created new company to which he transferred the principal clients and business from the company .
      • Held that the power of the director to resign was not a fiduciary power and that a fiduciary obligation towards the company does not continue to exist and operate beyond the end of the relationship which gave rise to ità a former director is not precluded to release himself from the company and use his personal kill and knowledge to compete with the company
        • HOWEVER: exploitation on the part of the director of a maturing business opportunity was regarded as a misuse of the company’s property in relation to which a fiduciary duty does exist – took advantage of information he had access to because of his previous position and status in the company which he chose to misuse
          • Breached his overriding duty to act bona fide for benefit of the company – personally liable for profits he made
          • He also breached contract since he gave no notice of his resignation
          • FOUND: liable for damages towards the company
        • Bhullar v Bhullar (2003) the issue was that the director had obtained access to information that was very useful from a commercial point of view – under a fiduciary duty to communicate it to the company (whether or not the company would have acquired the property is irrelevant)
          • What matters is that information relevant to the company was not passed to it by director who consequently was found to be in breach of his duty towards the company and therefore liable to account for his profits- Cooley was also applied in this case
        • Item Software (UK) v Fassihi (2004)- found the director to be in breach of duty because he failed to disclose his own wrongdoingà case law position: director was under a fiduciary duty to disclose his own wrongdoing to the company- part of the broad and well-established duty to act bona fide for the benefit of the company as a whole
          • Director not justified in believing that it was in the company’s best interest to keep his actions secret from it SINCE it had such an adverse effect on the company’s interests
            • Under this duty because he was not just an employee (who would not be charged with this obligation)

No breach cases

  • Island Export Finance Ltd v Ummunna (1986) is a contrasting case where no breach of duty found à accepted that a duty could continue after resignation but the facts in this case pointed to there having been no breach- the facts particularly important in drawing this conclusion are:
    • Company had only a vague hope of further contracts rather than an expectation and were not actively seeking new contracts at the time of the defendant’s resignation
      • Now appears to be irrelevant under s175(2)
    • Resignation was not prompted or influenced by desire to obtain contracts for himself
    • Information about contracts was not confidential- merely amounted to knowledge of the existence of a particular market à to prevent directors using such information would conflict with public policy on the restraint of trade
  • Framlington Group Plc v Anderson(1995) – Defendants were directors of and employees of the plaintiffsà free to set up or join a competing business and to take with them the plaintiff’s client if they left the employment of plaintiffs first
    • They were all private client fund managers – R Plc offered jobs to all three defendants at the same time R plc negotiated a transfer of funds from the plaintiff company. This was carried out by other members of the plaintiff company and defendants were told not to get involved
      • Defendants did not inform the plaintiff company of the employment packages they already negotiatedà the plaintiffs claimed that the benefits received by the defendants from R plc were secret profits and should be paid to the company
      • Held in favour of defendants –fact of the negotiations on employment had been known to plaintiff company which had taken deliberate steps to keep the negotiations separate and had told defendants they were not concerned with details of the employment packages being negotiated
    • British Midland Tool Ltd v Midland International Tooling Ltd (2003) –throws doubt on the continuance of directors duties after resignation
      • A conspiracy by four directors to set up new company and poach employees and business from plaintiff company
      • One of the directors resigned but was actively engaged int he conspiracy with the remaining directors for several months
      • The three who continued in office were found to be in breach of their duties but the director who resigned was held not to have breached his duty to the company he had left
    • In Plus Group Ltd V Pyke (2002) Levy J stated:

‘it is not a breach of a fiduciary duty of a director to work for a competing company in circumstances where he has been excluded effectively from the company of which he is a director’

‘the defendant’s role as a director of the claimants was throughout the relevant period entirely nominal in the concrete sense that he was entirely excluded from all decision making and all participation in the claimant company’s affairs. For all the influence he had, he might as well have resigned’

‘the unusual circumstances of the instant case seem to lead inescapably to the conclusion that the claim based on fiduciary duty fails.... had P resigned as a director in late 1996 his resignation would have done no more than reflect what has in practice already happened’

  • Thomas Marshall (exports) Ltd v Guinle (1979)- Megarry VC sought to identify the type of information which would be protected by the courts- would prevent the disclosure of it or prevent anyone owing a duty to the company who was entitled to the benefit of the information from profiting from it

‘Information must be information the release of which the owner believes would be injurious to him or of advantage to his rivals or others’

‘owner must believe that the information is confidential or secret- that it is not already in the public domain’

‘the owner’s belief under the two previous head must be reasonable’

‘the information must be judged in the light of the usage and practices of the particular industry or trade concerned’

KEY: CURRENT POSITION- emergent principles from statute and case law

  1. A director is in danger of being in breach of his fundamental duty to the company if he places himself in a position where one of his private interests comes into conflict with the company’s interests
  2. This duty continues after resignation
  3. Use of information or opportunity which comes to the director because of his position in the company will be very likely to be a breach of his duty to the company even if he tries to disassociate himself from the company by
    • Saying he is acting in a private capacity on this occasion or
    • Resigning for the purpose of exploiting the information or opportunity

Duty not to accept benefits from third parties –s 176

  1. A director of company must not accept a benefit from a third party conferred by reason of-
    1. His being a director, or
    2. His doing (or not doing) anything as director

This is a reflection of the general duty not to allow duty and interest to conflict

Consequences of a Breach

Section 178 of Companies Act 2006 refers to the preceding common law concerning the consequences of a breach of duty-

  • A director may be prevented from doing an action in breach of his duties by an injunction and if he has profited from the breach, will be obliged to return any profit made because of breach to company
  • A director may becomes a constructive trustee of money which has been mishandled
  • Additional to these remedies- a breach of directors duties may open up actions to shareholders or the company against them

Section 183 makes it a criminal offence to fail to declare an interest in a transaction with the company