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Law for Business

Knowhow - guidance - precedents

19 AUG 2012

Ten things every director needs to know - Part 2

This is the second in a series of articles in which we explore the role of a director from various angles, some of them slightly unconventional.  Each article identifies a fact of which directors need to be aware - whether concerning their duties, their relationship with other key players or their responsibilities under the Companies Act 2006 - and uses it as a starting-point to illuminate a particular aspect of their role.

The articles are written with new directors in mind, and take a practical approach to the issues raised.  However, they also look at the underlying law, on the basis that a director who understands the foundations of his role will be in a better position to comply with his obligations, and so we hope that the series will also be of interest to those with more experience of running a company.

Topics which we will cover in future issues include:

  • a director's responsibilities concerning the company's accounts;
  • the importance of the articles of association;
  • whether it is acceptable to be a "sleeping director";
  • criminal offences under the Companies Act 2006; and
  • the board's role in relation to allotting shares.

This second article in the series, however, discusses a director's duty to promote the success of his company.

2.   The duty to promote the company's success affects every decision you make.

A director has a fundamental obligation to be loyal to his company.  Historically, this obligation took the form of a common law duty to act in good faith in the best interests of the company.  Since October 2007, it has taken the form of a statutory duty imposed upon a director to "act in the way he considers, in good faith, would be most likely to promote the success of the company", and in so doing to have regard to certain specified factors, including the long-term consequences of the action, the interests of the company's employees and the impact of the company's activities on the environment (section 172, Companies Act 2006).

As we noted in the first article in this series, the articles of association normally delegate management to the directors, but the board's freedom to exercise its powers is constrained by the fact that the shareholders retain ultimate control over the company's affairs, in the sense that they can amend the articles and remove directors from office.  The success duty fits into the complex relationship between shareholders and directors as a further constraint on the board's freedom, ensuring that directors' actions are motivated not by self-interest or the interests of a third party, but by the interests of the company.

Not surprisingly, given that it served as a shareholder-protection mechanism, the courts took the view that the common law version of the duty was of broad application.  In Item Software (UK) Ltd v Fassihi (2004), Arden LJ described the scope of the duty in the following terms:  "It is dynamic and capable of application in cases where it has not previously been applied but the principle or rationale of the rule applies.  It reflects the flexible quality of the doctrines of equity."  In Hawkes v Cuddy (Re Neath Rugby Ltd) (2009), Stanley Burnton LJ noted that a director's fiduciary duties "do not begin or end at the door to the (actual or notional) boardroom.  They apply to him whenever he is acting as an officer of the company or in relation to its assets or affairs."

There has not yet been time for a significant body of case law on section 172 to develop, but the courts are likely to conclude that it is as flexible and broad in scope as its common law predecessor.  From a practical perspective, this means that a director must act in such a way as to promote the success of the company at all times.  Most directors who are advised of their statutory duties upon taking office will instinctively appreciate that they must comply with section 172 when they take major decisions.  In voting on a proposed acquisition of another company, for example, or a proposed new line of business, clearly a director must consider whether the proposal would promote the company's success.  It may not be as obvious that he is subject to the duty even when he is taking rather less momentous decisions.  Take, for instance, an HR Director's decision to offer a summer job to a friend's son.  Such is the all-encompassing nature of the duty that, if the decision is motivated solely by a desire to do a friend a favour, he may be considered to have betrayed the company's trust, and may technically be in breach of section 172.

Although the success duty must, then, underpin a director's conduct at all times, this should not be regarded as an unduly onerous burden.  In the first place (and leaving to one side the obligation in section 172 to consider specified factors, including the long-term consequences of the decision), the duty will not be breached as long as the director genuinely believes that his action will promote the success of the company.  As the High Court noted recently in Re Coroin Ltd (2012), the test is subjective, rather than objective:  the question is whether the director was genuinely seeking to promote the company's success, not whether he acted reasonably.  As far as the specified factors are concerned, ultimately it will be for the courts to decide what is required of a director in order to ensure compliance.  In the meantime, whilst the biggest decisions will certainly require detailed consideration of each of the factors, it is difficult to see how, in relation to most day-to-day decisions, a director can be expected to do more than have the factors at the back of his mind, such that he can spot situations in which he needs to give any of them particular consideration.

For a director seeking to comply with section 172, the key is to appreciate that he occupies a position of trust and to act accordingly.  As long as he is loyal to his company at all times, he has little to fear from the success duty.

Nigel Banerjee can be contacted at nigel.banerjee@kcl.ac.uk.

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