‘The 2006 Act has certainly made directors’ duties more accessible but difficulties remain.’ (Goddard, 2008). Discuss.
The aim of this essay is for firstly to conduct an in depth analysis as to whether there was a real need or the codification of directors’ duties, this will involve a consideration of the problems that arose as a result of relying on an set of rules to be sourced from the case law – this will be conducted within part 2 of this essay. Under part 3, the essay will then consider some of the duties that have been codified and whether this codification has worked in substance as well as form to eradicate the problems that arose through a lack of accessibility to a coherent set of rules. The final section of this essay offers some concluding remarks.
The case and need for codification
Looking back to around 200 years ago, the history of company directors was wholly different. Cultural attitudes towards directors were different and their role within a company was not as complex as can be seen today.4 In fact most company directors were just regarded as individuals who helped start a company up by raising the needed amount of start-up capital and, for this reason, they were often only recruited because they had some standing and respect in society that would encourage and promote investment for the company.5 This is very different from the situation today where a separation of ownership and control within a company, as a result of the separate legal identity principle, means that directors have a much more control over a company.6 The old attitude was visible in the old case law. Important cases such as Brazilian Rubber Plantation and Estates Ltd, Re 7 saw Neville J make it clear that when a court was evaluating the duty owed by a director and his liability for his acts and a breach of any duty, this should be limited to his subjective duties and the courts should avoid using an objective standard of assessment, also Neville J went on to add that running a company in “complete ignorance” was not deemed to give rise to any liability and it was the fault of the shareholders for picking a bad director.8
The present day duty owed by directors is very different from that that was described by Neville J in 1911. Hoffman LJ made it clear that public attitudes to corporate governance had changed and that the law on directors’ duties needed to change to show this.9 The old subjective duty of care has given way to a new hybrid duty which is both subjective and objective together10 and s.174 of the CA 2006 reflects this position which the law stands in today. The reason a wholly objective duty has not been favoured is that this would alienate worthy directors who may lack certain business qualifications from taking part in the worthy activity of conducting business.11
However, along with directors’ duties there has come a regime for punishing and sanctioning directors when they breach their duty. The Company Law Disqualification Act 1986 allows the court to prevent a director from occupying the office of a company director for up to a maximum of 15 years.12 There are claims that the disqualification regime is too strict as it further imposes a mandatory minimum disqualification period of two years13 as is prescribed for directors of insolvent companies.14 Indeed, the research of Hicks in this area of law (directors’ disqualification) shows a deeply worrying problem. Hick’s interviewed company directors who had been disqualified and found that a large majority of these directors were not aware of the either the disqualification regime or the duties that they had to think of and comply with in order to avoid disqualification.15 The problem here comes from a lack of understandable, clear and accessible director’s duties; there is an arguably harsh disqualification regime that allows directors to be stripped of their job and their future job prospects to be diminished, but the directors are unlikely to be able to comply with their duties as such duties have been described as complex and inaccessible; this makes the directors vulnerable to disqualification.
The Law Commission was clear that codification was important to promote business efficiency; after all, directors are not lawyers and will most likely lack the skills to quickly, properly, and efficiently find the duties they owe through centuries of case law.16 Without knowing the nature of the duty that is owed, it is very unlikely that the director will be able to comply with this duty satisfactorily if at all.
The next section of this essay examines the process and end result of the codification task that came about in the CA 2006 and critically analyses whether it has worked well at removing the worrying problems that existed whereby a director was unable to easily access the duties he owed and walk away comfortable that he was clear as to how to comply with these duties.
Has the codification of directors’ duties worked?
As we saw above, the lack of clarity with regards to directors’ duties was not favourable to any of the parties involved in business with a company. The directors were particularly vulnerable to harsh sanctions as a direct result of not knowing which duties they were to discharge, and those to whom the duties were owed, were deprived of enjoying the benefits as they were rarely discharged correctly. What must be decided here is whether codification was the right step and whether such a step has in fact done what it had set out to achieve.
One of the problems with the codification process was whether to have a very specific set of duties that would in reality direct directors, or whether to have a more general set of duties that would allow many situations to be covered by the duties and allow small differences to be catered for and apply differently where the contextual situation required. The Law Commission’s consultation had revealed that a code that was too restrictive with regards to the duties owed by directors could stop and slow down development as company law is always changing and the regulation of duties would need to change in order to cope with things like the new stakeholders that enter the situation which would mean that some duties are still changing.17 On the other end of the scale is a general set of duties that were preferred by the CLRSG.18 The problem with a general and broad set of guidelines is that it is too open ended and does not address the reason for which the reform and codification were intended. This is the argument is supported by Worthington; though she does not approve of the more specific alternatives of being too restrictive, she says that: “If the primary function of the statutory statement is to make the law clearer and more accessible, then there are some potential flaws in the proposed regime. The heading to the proposed statutory statement, ‘The general duties of a director of a company’, is intended to reinforce the idea that there are other specific duties imposed o directors of companies. This is counter-productive. It seems preferable to collect together (at least) the Companies Act provisions which impact on the duties of the directors, whether the provisions affect the existence or the exercise of their authority”.19
There is another problem along the same lines which reduced the clearness of the statutory codification of duties. Section 170(4) of the CA 2006, relating to the scope and nature of a director’s duties, states the following:
“The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.”
As can be seen here, the CA 2006 is saying that directors or anyone using the statute to try to understand directors’ duties should still have regard to the common law and what it has to say on the matter. The problem here is obvious, if the aim of the reforms was to add clarity and certainty to a set of rules that were inaccessible and difficult to understand because they were imbedded in centuries of case law, the general nature of the statutory duties discussed above along with the need to keep common law in mind when you are thinking about duties as directed by s.170(4) means that the case law will continue to play a big part in deciding directors’ duties and the same inaccessibility will exist that always did.20 The truth of the matter is that, if the directors still have to refer to case law, all the general statement of statutory duties will have done is to categorise the chaos but let it remain in reality.
The other problem is does the codification of duties make it clear who the directors owe their directors’ duty to? In other words, can a director look at the CA 2006 and be clear who the duties are owed to? Section 172(1) CA 2006 reads:
A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—
(a) the likely consequences of any decision in the long term, (b)the interests of the company's employees,
(c) the need to foster the company's business relationships with suppliers, customers and others,
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.
Some spectators could argue that this is very difficult for the directors to really understand. By looking at the term, it would seem directors owe a duty to many other people other than the company, including employees, the community and environment, suppliers, customers, etc. This is not true, because only the company can enforce the duty only the company is really owed the duty.21 Andrew Keay also interprets s.172 in a restrictive way. He states that because the provision talks about what the directors believe to be in the best interests of the company this gives the directors a lot of discretion and freedom to make choices that think will promote the success of the company.22 From this discussion it is very clear that things are not clear. A director who is reading this section of the CA 2006 will be more likely to think that the duty is owed to lots of different people, including employees and suppliers for example. But the truth is not this, the duty is only really owed to the company and the directors have discretion in how they are to apply it. As was mentioned before, the aim of the codification process was to make the law clearer and more accessible, it is true that law about who the directors owe a duty to is now very accessible but the law is not clear and is not what it seems when the section is first read.
Though Section 171(b) lays down that the directors can utilize the powers conferred upon them for the same purpose for which the powers were given. This power was a codification of the common law position regarding purpose rule that was adopted in the case of Howard Smith Ltd v Ampol Petroleum Ltd.23 The Act however fails to explain the yardstick for measuring if the powers were not properly exercised. When this clause was drafted, the CLRSG was not comfortable with limiting the proper purpose rule as can be seen from the wordings of S. 171 (b) thereby leaving the option for the courts to develop this area further.
Above we talked about the directors having low duty of care in cases like Re Brazilian Rubber Plantations, the new position on directors duty of skill and care has been codified by s.174 CA 2006: (1) A director of a company must exercise reasonable care, skill and diligence.
(2)This means the care, skill and diligence that would be exercised by a reasonably diligent person with—
(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
(b) the general knowledge, skill and experience that the director has.
Hsaio says here that just looking at the statute it is not clear what is mean specifically by the duty of skill and care, and because of this it is important to look at the case law to understand the meaning of the statute.24
Section 175 of the CA 2006 requires company directors to avoid situations where conflicts of interest will arise. This section is from the idea that directors owe a primary duty to their principal companies. The codification of the conflict of interest requirement is a problem because the requirement does not make clear what situation will give rise to a conflict of interest, the CA 2006 does not give any test that the courts or directors can apply.25 This means that the directors who wish to avoid a conflict of interest will not be able to know how just by looking at the CA 2006 but they will also have to look back to the case law that had many problems and was the reason that the reform took place.
The aim of the reforms was to make directors duties more easy to access and clearer so that directors, who are not lawyers and do not understand case law like lawyers, can easily understand what their duties are and then can perform in the company in relation to those duties. This codification was very important; when important case law started hundreds of years ago directors did not have much responsibility, they just raised money for the company; now the situation is different, and directors have many duties and responsibilities. Also, directors who breach these duties are also in danger because they can be disqualified. Given the extra duties and the punishment of disqualification, codifying directors’ duties is very important. The problem is that because the case law still needs to be used and the provisions are not clear about who the directors owe duties to. This essay shows that codification was important to company law so that directors can perform and perform well, but, the CA 2006 still has some problems that mean accessibility and clarity are still not complete.
1 Law Commission and Scottish Law Commission, Company Directors: Regulating Conflicts of Interest and Formulating a Statement of Directors Duties, (Law Com No 261 and Scot Law Com No 173, 1999).
2 Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Developing the Framework (2000) para. 3.14.
3 See Hansard, Grand Committee Official Report, 6/2/2006; coll GC125.
4 Chris A. Riley, “The Company Director’s Duty of Care and Skill: The Case for an Onerous but Subjective Standard” (1999) 62 Mod. L. Rev. 697, 698.
5 Leonard Hoffman, “The fourth annual Leonard Sainer lecture: the Rt Hon Lord Hoffman” (1997) 18(7) Comp.Law, 194, 194.
6 Adolf A. Berle and Gardiner C. Means, The Modern Corporation and Private Property, (2nd Ed, Harcourt, Brace and World,  1967).
7  1 Ch 425, p.437.
9 Bishopsgate Investment Management Ltd v Maxwell (No 2)  BCLC 814.
10 Norman v Theodore Goddard  B.C.L.C. 1028 Ch D. and D’Jan of London Ltd, Re  B.C.C. 646 Ch D.
11 Chris Riley, op. cit, 698.
12 S.6 Company Directors Disqualification Act 1986.
13 Vanesa Finch, “Corporate Insolvency Law: Perspectives and Principles”, (Cambridge University Press, 2002) 521, 524.
14 S.6 Company Directors Disqualification Act 1986.
15 Andrew Hicks, “Disqualification of Directors: No Hiding Place for the Unfit?”, ACCA Research Report 59 (Certified Accountants Educational Trust, 1998), 68-69.
16 Law Commission, Company Directors: Regulating Conflicts of Interest and Formulating a Statement of Duties (Law Com CP No 153, September 1998).
17 Law Commission and Scottish Law Commission, (1999), op. cit, para.4.27. 18 CLRSG, op. cit, para. 3.14.
18 CLRSG, op. cit, para. 3.14.
19 Sarah Worthington, ‘Reforming Directors’ Duties’, (2009) 64(3) M.L.R. 439, 455-456.
20 Len Sealy, ‘The Statutory Statement of Directors’ Duties: The Devil is in the Detail’ (2008) 228, Co.L.N. 1, 4.
21 Fraser Dobbie, ‘Codification of Directors’ Duties: An Act to Follow?’, (2008) 11 Trinity.C.L.Rev, 13, 19.
22 Andrew Keay, “Section 172(1) of the Companies Act 2006: an interpretation and assessment”. (2007) 28(4) Comp. Law. 106, 107-109.
23  AC 821
24 Mark Hsaio, ‘A Sprouting Duty of Honest and Loyalty: Companies Act 2006’,(2009) 20(9) I.C.C.L.R. 301, 301- 302.
25 Barney Hearnden, and Simon Howley, ‘Director’s Conflicts Under the Companies Ac 2006 Considered’, (2008) 239 Co.L.N. 1, 1.