Local Government - May 2009
Directors' Liability
The biggest changes under the Companies Act
2006 are arguably those to directors’ duties. But then, directors
have always owed a duty of care to their company, so what is the
difference?
The key difference is that where a director’s
duty of care previously derived from common law and a case by case
basis of fiduciary trust, such duties are now codified into a
binding set of statutory rules. These ‘golden’ rules include a duty
to promote the success of the company; to act within the powers of
the company’s constitution; and to exercise independent judgement
and reasonable care and skill.
Of course, many directors will feel that they
have successfully run their company before the Act came into force
and are in no doubt that they can continue to do so. Fortunately,
for most companies this will be the case. However, in an age of
increasing litigation, some directors would be well advised to
review their managerial roles and take heed. Sections 171 & 172
of the Act (duty to act within powers; duty to promote the success
of the company) do go someway to providing guidance but the true
test will be the advent of case law.
The Court has yet to extend its definitive
view in this area however there have been a few instances that
indicate the path ahead.
For example, inCommonwealth Oil & Gas Company Ltd v
Baxter & Anor [2007], Lord Reed confirmed that the new
statutory duties apply to executive and non-executive directors
without any distinction. Significantly, Commonwealth saw
an appellant non-executive fail to defend the Court’s imposition of
a statute despite the fact that he carried out no managerial role
and received no payment.
In proceedings issued by West Coast Capital (Lios)
Limited against Tesco, Lord Glennie concentrated on s.171(b)
(the duty to exercise his or her powers) and has established that
the key to interpretation is ‘power’only for the
purposes for which it is conferred. The initial test is a
subjective one, and one of the director’s motivation (in this case
a disputed share issue). The Court found ‘improper motivation’ in
an attempt to block a minority shareholder. The same was confirmed
by an objective assessment. This case has determined that where an
abuse of power can be identified it will not only judged as
‘unfairly prejudicial conduct’ but it will breach s.171 of the
Act.
Although its early days, the Act appears to provide a more
‘measurable’ yardstick against which to judge a director’s
‘success’ within his or her company. Going forward, we now await a
definitive judgment which more directly addresses the “enlightened
shareholder value” underlying s.172 as exposure here will be
heightened by the advent of ‘derivative actions’.
Under Part 11 of the Act, shareholders have for the first time a
statutory right to sue a director on behalf of the company.
Previously, the circumstances under which such claims could be
brought were extremely limited (due to the general rule known as
the Foss v Harbottle rule) as the ‘proper’ person to bring
the claim was the company itself. A claim was restricted to a
director’s actions that were tantamount to fraud; could not be
ratified by an ordinary resolution, or finally, were outside the
company’s objects and therefore ultra vires.
Now, a shareholder can bring a claim for
‘actual or proposed act or omission involving negligence, default,
breach of duty or breach of trust’ which opens up a host of
potential ‘wrong doing’. Further, a claim for negligence can be
made even where the director concerned has not benefited.
We can still only speculate as to how ruthlessly the courts
might intervene in the running of a company and the level to which
a director exposures him or herself to liability once taking
office. However, perhaps the recent case of Franbar Holdings
Ltd v Patel and others [2008] provides some clarification. The
Court confirmed that in any ‘derivative action’ under Part 11,
proposed negligence evaluated against the ‘hypothetical’ or
‘notional’ director; any claim should not be more akin to ‘unfair
prejudice’ (in this case breaching a shareholder agreement), and a
remedy could not be achieved by an alternate action. In the context
of issuing litigation against the instant directors, permission was
denied.
So how can a director reduce his exposure?
The ideal answer is to never fall foul of the
‘golden rules’. However, as mentioned above, it is difficult to
ascertain how far the Court will measure a director’s performance
against the Act and the consequences and reality of everyday
commercial decision-making.
In practical terms, the new changes to the
Companies Act will affect commercial contracts; credit agreements;
letters of engagement, and crucially, relationships with
shareholders and employees alike.
It may be possible for a director to negotiate
an indemnity into his/her service contract in respect of any
negligence and breach of duty. A company may also agree to provide
a director with funds in order to defend any civil proceedings. The
fact of the matter is, and in weary anticipation of the future,
more and more company directors are running for the cover of
officer’s liability insurance when renewing or commencing new terms
of employment in 2009.
If you wish to discuss any of the issues
raised above or you would like to discuss how Weightmans Corporate
can help your business, please contact Lynne Rathbone on lynne.rathbone@weightmans.com
or Chantel Clague on chantel.clague@weightmans.com.