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					       LLM (Master of Laws) in Business & Commercial Law




                   MANAGEMENT




                         BOOK 2




Seminar Guidance     Book 2

                                                           1
1 Where does managerial power reside in the company. What role does
Table A and the Articles play ?


2 What is the distinction between executive and non executive directors ?

3 Is there a formal process to appoint a director ? Should those not
formally appointed directors of a company yet having a direct
involvement at board level, like a parent company, be cautious ? If so,
why ?


4 What is meant by the phrase „separation of ownership and control‟ and
how does this manifest itself in the Ltd and plc companies ? How does
this relate to the corporate group ?


5 What is a fiduciary ? Go through each of the four duties identified
paying particular attention to: (a) what the duty involves; (b) the issues
surrounding its legal application and how they would apply to a director
and corporate director.

Under good faith and interests of the company why should a director be
wary of taking into account the interests of those outside the company –
possibly the employer of that director or a parent company ?


6 On the duty of care and skill: what is the relevance to the statutory
provision of s214 of the Insolvency Act 1986 and the Company Directors
Disqualification Act 1986 ?


7 Explain the changes brought about by the Companies Act 2006 as they
affect a company‟s constitution and directors.

Can you see any problems in saying that directors should owe a duty to
others apart from shareholder/ members ?




                                                                             2
Reading:



Mayson, French & Ryan Company Law 23nd Edition 2006-2007 Chs 15
&16

OR

Company Law 2nd Edition Ben Pettet Ch 8,9 &10
Digman & Lowry Company Law 4th Ed Chs 13 & 14
Cases & Materials on Company Law Hicks & Goo 5th EditionCh 11 & 12

Articles

Finch, V. „Company Directors: Who Cares about Skill and Care‟ (1992)
55 MLR 179.
Trebilock, MJ. „The Liability of Company Directors for Negligence‟
(1969) 32 MLR 499.
Mackenzie, AL. „A Company Director‟s Obligations of care and Skill‟
(1982) JBL 460.




                                                                       3
                 MANAGEMENT OF COMPANIES 1



Managerial Power


The location of managerial power resides with the board of directors
(Table A article 70).

Table A

Table A (SI 1985/805) is a set of standard form articles of association –
the articles are a formal document required to be registered by all
companies which set out the internal workings of the company, for
example, shareholder rights, appointment and removal of directors etc.
Table A is a model which companies are free to adopt or not and to
modify. If a company does not adopt Table A or has a modified version,
in the event of a dispute the court will refer to Table A for clarification.
Fully customised articles, in which Table A is excluded in its entirety, are
often adopted for the first time when a company becomes a public
company in order to raise capital from the investing public. Whatever
form of articles are used most companies provide that the management of
the business will be by the board.


Companies Act 2006 section 20 confirms the position above but also
provides for:

      1. new simpler Table A to be drafted by Secretary of State one for the
         Ltd. one for the Plc.

      2. Re entrenchment S22 – a company‟s articles may contain a
         provision (“provision for entrenchment”) to the effect that certain
         provisions of the articles may be altered or removed only if certain
         conditions are met, or certain procedures complied with that are
         more restrictive than the usual process of alteration – a special
         resolution (75% majority). These may be the requirement for
         approval by a parent company or certain shareholder.

1
    Based on Ferran, E, Company Law and Corporate Finance (1999) Oxford.


                                                                            4
      This is acceptable provided:

      Entrenchment is contained in original articles or after
      incorporation, where all members agree to an amendment to
      existing articles to bring in an entrenchment clause.

      Such clauses cannot stop in the future a unanimous decision to
      remove any entrenchment clause and alter a clause or an alteration
      ordered by the court.


Managerial power given to boards may not reflect reality. In large
companies for example, the board will be a formal body that meets at
periodic intervals; a body such as this can set and refine the strategic
direction of the company and can supervise its management, but it cannot
itself perform the function of managing the company on a daily basis.
That task has to be devolved to the individual senior managers of the
company, some of whom may be, but none of whom need be, directors of
the company.

Executive and non executive directors

Directors‟ duties fall on all directors both executive and non executive.
An executive director is one who is actively engaged, usually full time, in
the affairs of the company.

A non-executive director (NEDs) has only an occasional involvement.
They tend to be of four types: (a) retiring directors kept on in a semi
consultancy basis; (b) persons with status that will enhance the corporate
image e.g. Earl, Duke, Lord, leading politician etc., for the CLG a high
profile celebrity might well enhance the image of the charity thus
increasing potential fund raising; (c) experts in a particular field e.g.
corporate strategy, marketing, finance etc.(d) a more recent role in the
larger company that has been developed for non execs. linked to
corporate governance; particularly plcs on the Stock Exchange.
Following various reports - starting with the Cadbury Report - a need for
some independent authoritative monitoring of board activity was thought
to be needed; this followed various scandals, most notably; Guinness,
Maxwell, and Polly Peck. Leading business men and women in the role
of non executives were seen as being ideal to fulfil such a role.
(Developed further in the core Corporate Governance module)



                                                                         5
As there is no requirement of a formal appointment for directors, other
persons, even companies, who are involved in the affairs of a company,
may find themselves inadvertently being classed as directors - shadow
directors thereby incurring duties to the company.


For under various statutes - Company Directors Disqualification Act
1986 section 22(5), Companies Act 2006 section 250, Insolvency Act
1986 sections 213,214 and 251 and Financial Services Act 1986 section
207(1) - excluding advice given in a professional capacity;

                  any person(s) in accordance with whose directions or
                  instructions the directors of a company are accustomed to
                  act, shall be deemed to be shadow directors.

There is no requirement that the board be shown to be subservient to the
outsider:

          „Advice on its own would not do and it was only relevant if it was
          given and accepted so as to amount to a direction or instruction,
          coupled with a pattern of the board being accustomed to act on it.‟
          (Morritt LJ in Secretary of State for Trade and Industry v Deverell
          and Another [2000] Times, C.A - a case on director
          disqualification)


There is a possibility that a parent company might find itself a shadow
director of a subsidiary when the level of control which it exercises is
such that the directors of the subsidiary are accustomed to cat in
accordance with its directions or instructions and it will be a question of
fact in each case as to whether this level of control exists. For the parent
company there is an exemption for the general fiduciary duties (see later
notes) a director or shadow director may be required to fulfil, a corporate
shadow director does not owe such duties.2 Any controlling shareholder
is potentially at risk of being classified as a shadow director and it is a
question of considering the particular facts to see whether that person has
exercised real influence in the conduct of the company‟s affairs.3




2
    S251 (3) C.A. 2006.
3
    Hannigan, B. Company Law (2003) page 142.


                                                                              6
As the focus moves away from the large company with many
shareholders and a large management team towards, the one-person
quasi-partnership style of company where most, if not all, of the
shareholders are also involved in management, the formal constitutional
vesting of managerial functions in the board becomes increasingly
unimportant. An individual who is the sole shareholder and director of a
company is unlikely to pay much attention to whether decisions about the
running of the company are constitutionally made as a „shareholder‟ or as
a „manager/director‟. Equally market mechanisms for controlling
managerial power become increasingly irrelevant as the company under
consideration shrinks in size.

Separation of „ownership‟ through membership/ shareholding and control

This phrase is said to describe the process whereby control of the
company has passed from the hands of the „owners‟ of the company – its
shareholders/ members, to its directors or managers.

          With larger corporate size comes a greater dispersion of stock
          ownership, a steady reduction in the power and interest of the
          shareholder, and gradual enhancement of managerial authority,
          that is a separation of ownership from control. 4

Because investors, in the larger company, typically acquire only a tiny
proportion of the shares in any company as part of a portfolio of
investments, no one shareholder is in a position to exercise effective
control through the formal process of the general meeting. Further,
shareholders in public companies have little incentive to monitor the
management closely since they have limited liability and they can protect
themselves against company-specific risks by portfolio diversification.
The cost to an individual shareholder of monitoring management would
normally exceed the benefit to that person, and any benefits attained
would benefit all shareholders – the free-rider problem. If investors are
unhappy with the performance of the management, the capital markets
provide an exit since they can simply sell their shares and invest
elsewhere. Managerial autonomy in the larger company leads to a
structure which gives scope for the managers to use the sums invested
more for their benefit than for the benefit of the shareholders (conflict of
interest) or they may not give the care and attention to the management
of it that they would to their own money (managerial shirking).

4
    Herman, ES, Corporate Control, Corporate Power (1981) 5.


                                                                           7
Company law seeks to control management in a variety of ways: by
giving the shareholders in general meeting the right to vote on certain
matters including the appointment and removal of directors; by requiring
disclosure of financial information and imposing requirements for an
independent audit of accounts; and by imposing fiduciary duties
including one of care and skill.

Director fiduciary duties


Directors, by virtue of their office, owe fiduciary duties (of trust and
confidence) to the company but they do not owe duties to shareholders,
employees, or creditors. This was established in:

Percival v Wright [1902] 2 Ch 421

Where it was held that the relationship between directors and
shareholders was not fiduciary and that directors therefore had no duty to
inform shareholders of an impending takeover bid for the company prior
to the sale of shares to the directors.

This has important implications with regard to enforcement because it
follows that it is for the company to decide whether or not to sue
directors for breach of duty (Shaw v Shaw [1935] 2 KB 113, CA).
Litigation is normally a managerial function (Edwards v Halliwell [1950]
2 All ER 1064, CA) but, if the wrongdoers are in control of the
management, the decision whether to pursue directors through the courts
for breach of fiduciary duty may devolve to the shareholders in general
meeting. Shareholders often suffer from serious informational
disadvantage compared to the board and they may simply not be in a
position to judge accurately the strength of a potential claim. At most
shareholders may hope for some increase in the share price as the result
of a successful action which may be outweighed if bad publicity about
the case has previously caused the share price to fall; also there is a
strong disincentive in that any benefit will go to all shareholders.




                                                                           8
The Fiduciary Duties

   1. Duty to act bona fide and in good faith in the interests of the
      company; including a requirement not to fetter their discretion or
      delegate it.

   2. Duty to exercise their powers for the proper purpose they were
      give.

   3. Duty not to put themselves into a conflict of interest situation or
      make secret profit.

   4. Duty to exercise care and skill in the management of the company.


1. Good faith and in the interests of the company

The directors have a statutory duty to consider the interests of the
shareholders collectively in discharging their duty to act in the interests
of the company. (s172(1) Companies Act 2006). However it is a duty that
means little in that it is not enforceable by the shareholders individually
and the directors are not obliged by the statute to give priority to the
shareholders‟ interests. The courts tend to treat the interests of the
company as being the same as in the interests of shareholders.


Lord Greene MR stated in Re Smith and Fawcett Ltd [1942] Ch 304, CA,
306;

      Directors must exercise their discretion bona fide in what they
      consider – not what a court may consider – is in the interests of
      the company.

The duty to act in good faith in the interests of the company is an
essentially subjective obligation but with a minimum threshold of
genuineness. Directors who are positively dishonest will clearly be in
breach of duty, and oppressive or extravagant conduct by directors may
cast doubt on their honesty (Shuttleworth v Cox [1927] 2 KB 9, CA).




                                                                            9
The interests of the company for purposes of the duty are normally
equated with the long term interests of its shareholders. As seen, under
statute, the directors are required to consider employees‟ interests, but
this does not oblige, or permit, the directors to give preference to the
interests of employees; also employees cannot enforce the statutory
requirement. The identification of a company‟s interests with those of its
shareholders breaks down when a company‟s solvency is in doubt
because creditors‟ interests intrude at that point and, if the company does
become insolvent, they eventually eclipse shareholders‟ interests.


Directors of Subsidiary Companies and „interests of the company‟


There is a particular problem in respect of acting in the interests of the
company where a company is part of a group or wholly owned
subsidiary. However much in practical terms the various companies
within a corporate group are run as one enterprise, as a matter of law the
directors of each company within the group are required to act in the
interests of the company to which they are appointed rather than in the
interests of the group as a whole (Lindgreen v L & P Estates [1968] 1 Ch
572). Yet, if the interests of the company are treated as being
synonymous with the interests of its shareholders, then, at least in
wholly-owned subsidiaries, the duty of the directors of the subsidiaries
should translate simply into a duty to act in the interests of the parent
company. This is not the position under English company law case
law. Instead, it has been held that where the parent company wants a
subsidiary to do something which is outside the normal run of business
matters and which does not represent a profit enhancement opportunity
for the subsidiary – intra-group loans or guarantees being obvious
examples – the directors of the subsidiary, even if it is a wholly-owned
subsidiary, must act in the interest of their company, meaning the
economic entity distinct from its shareholders, and must not sacrifice its
interests in favour of the parent or the group.




                                                                         10
 The only concession to the group structure is that although, strictly,
directors should specifically direct their minds to their company‟s
interests;

       „in the absence of actual separate consideration … [the proper
      test] must be whether an intelligent and honest man in the position
      of a director of the company concerned, could, in the whole of the
      existing circumstances, have reasonably believed that the
      transactions were for the benefit of the company.‟ (Charterbridge
      Corpn Ltd v Lloyds Bank [1970] 1 Ch 62, 74.)

This concession is a fallback which may have some use in limited cases,
but properly advised directors should direct their minds specifically to
the subsidiary‟s interests rather than risk being judged to have failed in
their duty on the basis of an objective test of what the intelligent and
honest director could reasonably have believed. Directors of subsidiary
companies can also seek to protect themselves by having the parent
company authorise or ratify their conduct.

The substantial risk for directors of wholly-owned subsidiaries is that
actions which are taken for the prosperity of the group as a whole but
which are loss-making for the acting subsidiary may jeopardise its
solvency and prejudice its creditors. Shareholder ratification will not
protect the directors when the company‟s solvency is in doubt because
(as seen) creditors‟ interests intrude at that point. Looked at in this way,
the rule which obliges subsidiary-company directors to consider the
interests of the company as distinct from the group becomes, in
substance, part of the wider principle which treats the company‟ s
interests as being synonymous with those of its creditors in the event of
insolvency.




                                                                           11
In Facia Footwear Ltd v Hinchcliffe [1998] 1 BCLC 218, where a cash-
rich subsidiary had entered into cross-guarantees whereby the subsidiary
guaranteed the debts of other companies in the group. Massive payments
were made by the directors of the subsidiary to other companies in the
group two months before the subsidiary went into liquidation. The claim
(by the liquidator) was that the directors made these payments in
disregard of the subsidiary‟s creditors‟ interests. The directors argued
that the payments were in the normal course of implementation of group
treasury arrangements; and there was no suggestion that the payments
were for private purposes or in breach of any statutory or other obligation
or were otherwise than for the trading purposes of the recipient
companies. Most importantly, if the group of companies collapsed, the
subsidiary would collapse also under the weight of the cross-gurantees;
moreover, the directors were intent on keeping the group afloat as they
believed a refinancing scheme was a serious possibility.

The Court acknowledged the difficult position of the directors of the
subsidiary. It was clear, the judge said, that in continuing trading in those
final months, the directors were taking a risk; clear too that given the
parlous financial state of the group, the directors had to have regard to
the interests of creditors. But, he noted, the creditors of the group, and of
the subsidiary in particular, would clearly have been best served by a
refinancing that could support a continuation of profitable trading. The
cessation of trading followed by the disposal of the assets of the
companies on a forced sale basis would, it was always realised, lead to
heavy losses for the creditors. The creditors‟ only chance of being paid
in full lay in a continuation of trading. The Court found that it was not in
the least obvious that in continuing to trade in those final two months the
directors were ignoring the interests of the creditors of the subsidiary.




                                                                          12
Observation

This is an interesting approach to creating and developing UK company
law. Unlike other countries – e.g. Germany, Portugal, the approach is not
to have specific laws for groups of companies but instead recognise the
group relationship within general company law.

A fundamental issue relates to this UK approach to law making and UK
company law which states that a directors within interlinked groups of
companies can only fulfil their fiduciary duty to act in good faith if they
do so in the interests of the company of which they are a director and
NOT for what might benefit the group as a whole. Some argue that it is
a fact of life, a fundamental economic principle, that where you have
groups of companies individual decisions taken within each subsidiary
within that group may not be for the benefit of that particular subsidiary
– for example, guarantee a loan of another company within the group,
transfer assets cheap, have work taken from it and relocated in another
company etc. Some countries – most notably Germany – recognise this
reality and the law states that provided the parent or holding company
agrees to pay for any losses incurred by the subsidiary, directors can
consider the interests of the group. The EU also sees this as a valid
approach. This was put forward in the recent Company Law Review but
was rejected as being un-necessary and un workable.




                                                                        13
Directors must also make their own decisions

They are in breach of duty if they simply follow another‟s instructions
without considering and deciding whether what is proposed is in the
interests of the company.5 Nominee directors can prove a difficult
instance in this respect. Nominee directors are directors elected onto a
board at the behest of a major creditor, majority shareholder, parent
company, local authority or major benefactor etc. In reality they are
installed to look after the interests of those who got them elected, who
may be their employer. However, under company law they must act in
the company‟s interests even if this goes against their appointor. The rule
is also an obstacle to the development of employee representation at
board level; employee appointees would naturally incline to representing
and promoting employee interests but the law, as it currently stands,
would not permit them to do so.6 And in Kuwait Asia Bank EC v
National Mutual Life Nominees Ltd [1991] 1 AC 187, PC where nominee
directors appointed by their employer bank, Lord Lowry stated;

        In the performance of their duties as directors … they were bound
        to ignore the interests and wishes of their employer, the bank.
        They could not plead any instruction from the bank as an excuse
        for breach of their duties.


Directors must, therefore, not be fettered to their sponsor or appointer,
e.g. a parent or holding company.




5
 Re Englefield Colliery Co [1878] 8 Ch D 388, CA
6
 There are indications of a more flexible approach in Australian and New Zealand case law; see Boros,
EJ „The of Nominee and Multiple Directors‟ (1990) 10 Co Law 211 and (1989) 11 Co Law 6;
Crutchfield ,P, „Nominee Directors: the Law and Commercial Morality‟ (1991) 12 Co Law 136.


                                                                                                  14
The Court of Appeal qualified the no-fettering rule in Fulham Football
Club Ltd v Cabra Estates plc [1992] BCC 863, by drawing a distinction
between;

        i)    a fetter on the future exercise of their discretion – not
              permitted, and,

        ii)   a decision by directors to bind themselves to do whatever
              was necessary to effectuate a contract which, at the time
              when the contract was negotiated, they genuinely believed
              to be in the interests of the company as a whole.

Facts

The case concerned a lengthy dispute between a local authority and the
owners of the freehold of Fulham Football Club‟s ground concerning the
future use of the site. The club was the lessee of the property and, as part
of a package of arrangements including the payment of considerable
sums to the club, the directors of the club undertook to support the
freeholder‟s plans for redevelopment of the site. Some two and a half
years later, the directors of the club had a change of heart and objected to
the plans for redevelopment, in defence to the freeholders‟ claim that they
had breached their undertaking by so doing, they claimed that the
undertakings were implicitly qualified by their fiduciary duty to act in the
interests of the company. The Court of Appeal disagreed. The directors‟
undertakings were not contrary to public policy, nor were they subject to
a term implied by law qualifying the promise by reference to fiduciary
duty. At the time when the arrangements between the freeholders and the
club had been negotiated, the directors had genuinely believed that the
arrangements were in the interests of the club; accordingly , they could
validly bind themselves to do whatever was necessary to effectuate those
arrangements.




                                                                          15
The case goes against earlier decisions (Rackham v Peek Foods Ltd
[1990] BCLC 895 and John Crowther Group plc,[1990] BCLC 460,
Dawson International plc v Coats Paton plc [1991] BCC 276, Ct of
Sess., where undertakings given by directors‟ were found to be subject to
the fiduciary duty, it now appears that Fulham is the preferred route; if
directors‟ find themselves bound by earlier promises that have
subsequently become less attractive, they cannot be allowed to escape
their „poor bargains‟ by pleading fiduciary duty. Rather than relying on
the possibility of a qualification being implied from the facts, a safer
course for directors is to insist upon covenants being expressly qualified
by reference to their overriding fiduciary duty to act in the interests of the
company.


Closely linked to the no-fettering rule is the requirement that directors
must not delegate their decisions. In practice this requirement is often
overridden by a provision in the company‟s articles allowing the directors
to delegate powers and discretions either to committees or to individual
agents. The rule remains of significance to the extent that, where
delegation is not provided for, any purported exercise of power which is
vested in the directors under the articles by their „delegate‟ will be invalid
and will not bind the company. (Guiness plc v Saunders [1990] 2 AC
663, HL) Note the requirement that directors keep themselves informed
of delegated activities and actively supervise – see earlier case Re
Barings.




                                                                           16
2. Directors must exercise their powers for proper purposes


A director must exercise fiduciary powers for the purposes for which they
were conferred. 7 This can be a problem in that frequently directors‟
powers contained in the articles and memorandum of association are
drafted in general terms and do not expressly state the purposes for which
they can be exercised; nor can such purposes be easily inferred merely
from the documents themselves. The leading authority for determining
the purpose behind directors‟ powers is:

Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821, PC

Lord Wilberforce said the task of the court is:

          To start with a consideration of the power whose exercise is in
          question and assess the nature of this power and determine the
          limits within which it may be exercised… the court should seek to
          identify the substantial purpose for which it was exercised.

The courts‟ are reluctant to get involved in questioning business
decisions bona fide made. We can see here that, unlike the duty to act in
the best interests of the company – which is essentially subjective
assessment with a minimum threshold of genuineness – here the courts
can more readily review an improper exercise of power.

The Howard Smith case, like many of the reported decisions on the
exercise of director power, concerned the issue of shares. Clearly to
issue shares to raise capital is a legitimate purpose but there may be other
circumstances equally legitimate e.g. making a bonus issue, promoting an
employee share scheme, forming a link with another person or business
for financial stability purposes, or seeking a valuable business
opportunity. There are however, certain purposes which can be described
as improper: directors must not issue shares simply to remove a previous

7
    Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821, PC, 834.


                                                                          17
majority and create another,8 that is a matter for shareholders. Thus,
using a takeover bid as an example, if directors genuinely believe that a
bid is not in the interests of the company they may consistently with their
subjective duty of good faith advise the shareholders to reject the bid, but
because of the proper purpose rule, they cannot exercise their power to
allot shares so as to distort the operation of the market for corporate
control by allotting shares to a favoured bidder and thereby thwarting a
hostile bid, or issue shares simply to keep themselves in power.

An interesting illustration of improper purpose relating to share issues
was an investigation carried out into a scheme implemented by the Savoy
Hotel group whereby in order to stop a potential bidder from succeeding
and closing down an important hotel with a view to re develop the site,
the hotel was sold to a newly created company controlled by the trustees
of the Savoy‟s employees‟ pension scheme and then leased back to the
group with restrictive covenants attached as to use. The investigation
concluded that although the directors had proceeded in the genuine belief
that it was in the interests of their companies, the directors had exercised
their fiduciary powers of management for an improper purpose.9

More recently in Lee Panavision Ltd v Lee Lighting Ltd [1991] BCC 620,
CA, the Court of Appeal held that it was unconstitutional for the
directors to purport to tie up the management of the company by way of a
management agreement at a time when they knew that the shareholders
were intending to change the managerial control of the company by
removing the old board and appointing new directors. The decision of
Hoffmann J in Re a Company [1986] BCLC 382, further supports the
proposition that directors who seek to use their powers in a way which
prevents shareholders from accepting an offer from a particular bidder
are acting for an improper purpose. Conduct designed to frustrate a bid
would also infringe the Takeover Code where that applies.10

The proper purpose requirement has also been applied to other powers
vested in directors, for example, common power in the articles of private
companies entitles directors to refuse to register the transfer of shares.
This reflects the resemblance between some private companies and
partnerships: where a company is, in effect, an incorporated partnership,
the shareholder – partners are likely to be concerned about the identity of

8
  Punt v Symons [1903] 2 Ch 506
9
  The Savoy Hotel Ltd and the Berkeley Hotel Company Ltd. Investigation under Section 165(b) of the
Companies Act 1948 (HMSO, 1954).
10
   City Code on Takeovers and Mergers, general principle 7 and r21.


                                                                                                18
transferees of the shares, and the directors‟ power to refuse to register
transfers provides a way of monitoring this and preventing the
registration of unwelcome persons.11 (The same principle underpins the
requirement that members of a CLG may not transfer their shares, nor
may any new members be permitted without board approval) A provision
restricting the transfer of shares would be unusual in a public company
and in the case of a listed company, could be incompatible with Stock
Exchange requirements concerning the transferability of shares. 12

As far as directors are concerned, if they use their powers for an improper
purpose and, as a result, the company loses out, they will be liable to
indemnify the company for its loss.13 If the directors benefit personally
from their breach of duty, they will be liable to account to the company
for the benefits that they receive. In Bishopgate Investment Management
Ltd v Maxwell (no 2)14 a directors was held liable to compensate the
company for the loss resulting from the transfer of some of the
company‟s assets (in the form of shares) for no consideration, in
circumstances where the execution of the share transfer forms amounted
to an improper exercise of the director‟s fiduciary powers. The Court of
Appeal held that the burden of proof was upon the directors to
demonstrate the propriety of the transaction, and that it had not been
discharged.

The fact that a director has misused fiduciary powers may be a factor to
which the court attaches importance when considering whether to
disqualify that person from being involved in the management of a
company. Also, it may form the basis of a petition under the Companies
Act 2006, s994 for relief from unfairly prejudicial conduct.




11
   Re Smith and Fawcett Ltd [1942] 1 Ch 304, CA, 306 per Lord Greene MR.
12
   The Listing Rules, Ch 13, app 1, paras 6 -8.
13
   Re Lands Allotment Co Ltd [1894] 12 ACLR 118, NSW CA, 139, per Kirby P.
14
   [1994] 1 All ER 261, CA.


                                                                             19
3. Conflict of Interest

Note: no requirement that any profit/ benefit has occurred; just to be in a
conflict of interest situation is in itself enough.

A fiduciary should not be swayed in his actions by considerations of
personal interest or interests to third parties.

The starting point here is that a director may not enter into a contract
with the company or have an interests in any of the company‟s contracts,
for example by being a partner in, or holding shares in, another firm with
which the company contracts. (Aberdeen Rly Co v Blaikie Bros [1854] )
The court will not examine the fairness, or otherwise, of the terms of a
contract between a director and the company and will treat the director as
having infringed the rule even though the deal may be entirely favourable
to the company. Clearly economic necessity means that there must be a
qualification to such a rule otherwise directors couldn‟t enter into
contracts of service with their company. The qualification that makes
this rule practically operative is that a director can contract, or have an
interest in a contract, with the company where either this is authorised by
the company‟s articles or the interest has been properly disclosed to the
company and the company has consented to the director‟s participation.
The „company, for the purposes of disclosure and consent means the
shareholders in general meeting but this requirement can be, and
normally is, modified by the articles to provide for the board to act
instead of the general meeting for this purpose.

Articles of association tend to follow the Table A model with respect to
the procedure for permitting directors to contract with, or to have
interests in contracts with the company. Under Table A, a director is
permitted:

   (a) to be a party to, or otherwise interested in, a transaction or
      arrangement with which the company or in which the company is
      otherwise interested; and


                                                                           20
   (b) to be a director, officer or employee of any body corporate
      promoted by the company or in which the company is otherwise
      interested; the director may also be a party to, or be interested in,
      any transaction or arrangement with such a body corporate

provided that, in either case, the director has disclosed to the directors the
nature and extent of any material interest. (Table A Art 85) In addition, a
director who has an interest in any matter must not count in the quorum
or vote at any board meeting where the matter is considered, (Art 94)
though this requirement of Table A is frequently amended to allow such
directors to count in a quorum and vote. Compliance with the procedure
in the articles ensures that the director is then not accountable to the
company for any benefits derived from any such transaction. An interest
of which a director is unaware is deemed not to be his interest provided it
was unreasonable to expect the director to have that knowledge.

Statutory disclosure is also required in respect of interests that a director
may have in company contracts – s182 Companies Act 2006. The section
requires disclosure to the board, and does not limit itself to material
interests or, unlike Table A, exempt a director who has no knowledge of
any conflict. Failure to disclose under s182 renders a director subject to
the criminal sanction of a fine.(s183)

The consequences of a failure to disclose render any contract voidable at
the option of the company provided; there is no significant lapse of time,
no intervention of third party rights, that it is possible to substantially
return the parties to their pre contractual positions.




                                                                           21
4. Director Fiduciary Duty of Care and Skill

Those who take it upon themselves to act on behalf of or advise others
may have an equitable duty to exercise care and skill in doing so.

This duty relates to the standard of competence that it is reasonable to
expect of directors. Individual contracts of directors may well contain
terms as to performance, in their absence, common law and statute has
recently evolved a basic threshold of duty - „a floor‟ - which directors are
required to meet. Following Re Barings plc (No5) [1999] 1 BCLC 433
(discussed later) and statute - namely the Company Directors
Disqualification Act 1986 (CDDA) and the Insolvency Act 1986, a higher
standard is now required of directors as to the extent to which they are
required to:

           know the business,
           participate in its affairs,
           verify information, and,
           monitor the activities of co-directors and subordinates,
           i.e. be proactive.

The classic statement of the standard of care and skill required of a
director by virtue of his office in that of Romer J in Re City Equitable
Fire Insurance Co. [1925] 1 Ch 407. He stated that:

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.

This requirement is essentially subjective. Although the standard is what
can be reasonably expected of a director , this is tested by reference to
the director‟s own knowledge and experience15 rather than by reference
to the functions which he performs as a truly objective test would
require. Some older cases representing the traditional view hold that a

15
     Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392, CA


                                                                           22
director need bring no particular skills to his office – „he may undertake
the management of a rubber company in complete ignorance of
everything connected with rubber.‟16 With whatever level of skill he has,
the director must then, according to Romer J, take such care in the
conduct of the company‟s affairs as an ordinary man might be expected
to take in the circumstances on his own behalf.

The problem with the duty formulated as in Re City Equitable is obvious,
incompetence is its own defence. Highly qualified and skilled directors
are judged by their own standards and may be liable accordingly; but the
ignorant and unskilled are also judged by their own standards and,
provided they do their best, they will not be held to have failed to satisfy
their legal duties. The problem is there is no one typical director, all are
different.17

Wrongful trading and director skill and care

Wrongful trading liability in the Insolvency Act 1986 s214 has turned out
to be an important step forward in the resolution of this difficulty. The
immediate background to the introduction of wrongful trading liability
was the Report of the United Kingdom Review Committee on Insolvency
Law and Practice18 which accepted that a balance had to be struck
between not discouraging the inception and growth of businesses, even
though they were inevitably attended by risks to credit, and discouraging
irresponsibility and ensuring that those who abused the privilege of
limited liability could be held liable for the consequences of their
conduct. The committee recommended, which was accepted that a
person should be held to be personally liable to contribute to the assets of
an insolvent company if, on broadly objective standards, he is considered
to have been guilty of wrongful trading.




16
   Re Brazilian Rubber Plantations and Estates Ltd [1911] 1 Ch 425
17
   Leading articles are:Trebilock, MJ, „The Liability of Company Directors for Negligence‟ (1969) 32
MLR 499; Mackenzie, AL, „A Company Director‟s Obligations of Care and Skill‟ (1982) JBL 460;
Finch, V, „Company Directors: Who Cares about Skill and Care ?‟ (1992) 55 MLR 179.
18
   Cmnd 9175 (1984).


                                                                                                  23
S214

The section applies to directors upon a company going into insolvent
liquidation; this give the section a rather narrow application but the
criteria contained in the section has been taken and used in a far broader
general context. The section provides for liability where;

A director carries on trading when he knew or ought to have concluded
that there was no reasonable prospect of the company avoiding insolvent
liquidation.

Shadow directors are also included; which may for example, hold a
parent or holding company liable.

It is s214(4) that is interesting in its setting out of a standard for director
liability:

The facts which a director of a company ought to know or ascertain, the
conclusions which he ought to reach and the steps which he ought to take
are those which would be known or ascertained, or reached or taken, by
reasonable diligent persons having both;


       (a) the general knowledge, skill and experience that may
           reasonably be expected of a person carrying out the same
           functions as are carried out by that director in relation to the
           company, and (OBJECTIVE)

       (b) the general knowledge, skill and experience that the director
           has. (SUBJECTIVE)

   (a) represents a significant departure from Re City Equitable in that it
       imposes an element of objectivity. This is in addition to the
       subjective standard which is embodied in (b) with the consequence
       that, whilst inexperience or lack of skill is not a defence a director
       who is highly skilled and greatly experienced will still be judged



                                                                             24
      by his own personal standards. (Re Brian D Pierson (Contractors)
      Ltd [1999] BCC 26)




Fraudulent s213 and Wrongful s214 Trading


Critical comment

The two are part of the general obligation placed upon directors upon
insolvency, to take account of the interests of creditors. Both sections
can lead to contribution orders being made by the court against those
running the company (veil lifting).

The Cork Comm stated that the purpose of s214 was to, „improve the
standards of competence and conduct among directors.‟ The section
requires „reasonableness‟ on the part of directors not simple „optimism‟,
it therefore introduces a degree of objectivity to the conduct of directors.

Another aim of s214 has been said to be to motivate directors to face up
to a financial crisis before it is too late: with the result of at least
reducing losses to creditors.

Weaknesses of the sections is the defining of the point in time when
insolvency was an obvious outcome – the prediction point. Liability
begins when all reasonable hope of recovery is gone. This can lead to a
closure that is too early to avoid liability or action that is too defensive eg
delivering the company into the hands of the banks: this is a particular
temptation for non executive directors.

Where disqualification of a director is sought (s6 CDDA 86) it is rare to
also go for wrongful trading by a liquidator: even though the most
common ground for director „unfitness‟ is trading while insolvent. One
reason for this may be cost. Only liquidators can bring s214 actions so
they wont pursue an action unless success is highly likely also a
contribution order has to be of some value – ie directors have funds to
pay. Also creditors are reluctant to fund actions because any benefit
goes to all creditors primarily preferential creditors and the floating


                                                                            25
charge holder at the expense of the unsecured creditor. It is also possible
that costs may be awarded against a liquidator where an action fails
which may be expensive – e.g. getting reports from expert witnesses. It
is generally felt that the risks outweigh the rewards.



It has been suggested that s214 be amended to allow a judge to direct
funds to a particular creditor. It is felt that this might lead to many more
funded s214 s.

By referring to „function‟ the minimum objective standard imposed by (a)
addresses the challenge of imposing an objective standard on directors,
bearing in mind the variety of activities which persons answering to that
description can in practice perform. A director is to be judged by the
general knowledge, skill and experience that may reasonably be
expected of a person carrying out the same functions as are carried out
by that director in relation to the company. This directs the court to have
regard to particular company and its business: in Re Produce Marketing
Consortium Ltd (No 2) [1989] BCLC 520, 550, Knox J noted that the
general knowledge, skill and experience postulated will be much less
extensive in a small company in a modest way of business, with simple
accounting procedures, than it will be in a large company with
sophisticated procedures. The reference to function should also allow the
court to distinguish between the various activities carried out by the
directors within a given company so that, for example, its non-executive
directors may be judged by a different objective standard from that which
applies to its executive directors. However, certain minimum standards
will be expected of all directors irrespective of their particular function.

Two cases put forward a more general application of the criteria
contained in s214, an approach favoured by the Law Commission19

Norman v Theodore Goddard [1992] BCC 14

Here Hoffman J held that a director had not been negligent in relying
upon information provided by a professional adviser in circumstances
where that information later proved to be untrue. Hoffmann J went on to
enunciate the extent of the skill that a director was required to show in
managing the company‟s affairs:
19
 Company Directors: Regulating Conflicts of Interest and Formulating a Statement of Duties: A Joint
Consultation Paper (Law Commission Consultation Paper No 153 (1998).


                                                                                                 26
      „A director … need not exhibit a greater degree of skill than may
      reasonably be expected from a person undertaking those duties.‟

He went on to state that in deciding the standard to be expected, s214 (4)
of the Insolvency Act 1986 accurately stated the means of determining
that standard.

In Re D‟Jan of London Ltd [1993] BCC 646 Hoffman J re stated the
approach in Norman. For both care and skill, on the basis of these two
decisions it would appear that the general duty is shifting in favour of a
more objective standard, albeit on that is sensitive to the functions that
the director is expected to perform.

(Note here the strong link between the duty of care and skill and
Corporate Governance)


The second aspect of the duty of care and skill is the extent to which it
requires a director to devote himself to the affairs of his company.
Romer J in Re City Equitable stated:

      „a director is not bound to give continuous attention to the affairs
      of his company. His duties are of an intermittent nature to be
      performed at periodical board meetings. He is not, however,
      bound to attend all such meetings, though he ought to attend
      whenever he is reasonably able to do so.‟

The most notorious example of a director escaping liability for non-
involvement was in Re Cardiff Banking where a director attended one
board meeting in 30 years. He was held justified in relying on the active
managers of the bank and incurred no liability for his own non-
participation.

The position today is somewhat more exacting for directors. A director
who fails completely to participate in his company‟s affairs would be
exposing himself to the risk of being held liable for breach of the duty of
care and skill. In Dorchester Finance Co Ltd v Stebbing [1989] BCLC
498, to non-executive directors left the running of the company in the
hands of a third director. They did not attend board meetings or monitor
the company‟s accounting records, signing blank cheques for the
executive director; they were held liable.


                                                                            27
Liability for wrongful trading is judged by reference to what a director
knew or ought to have known; if the director would have known that the
company had no reasonable prospect of avoiding insolvent liquidation if
he had familiarised himself with the company‟s financial position, he will
be liable.

The degree of devotion to his company that a director ought to display in
order to escape censure cannot be stated in absolute terms. It will depend
on the circumstances and relevant variable factors, including the type of
organisation and the role that the director in question can reasonably be
expected to play. The role of non-executive directors of a public
company is necessarily an intermittent one since if non-executive
directors became actively involved in the day to day running of the
company they would lose the very independence and detachment for
which they were appointed. But in smaller companies where the
monitoring function of the board is less important, all directors may be
expected to play a more active part in the company‟s affairs.20

Note the strong link here to corporate governance, often at the centre of
corporate scandals are directors doing things they should not be doing or
not doing things they should be ! Both linked to this key fiduciary duty.

The Impact of the Company Directors Disqualification Act 1986 on
Standards of Care and Skill of Corporate Management

Under the CDDA a person can be disqualified from acting as a director of
a company and from being involved in the management of a company
(directly or indirectly) for a specified period.21 There are a number of
grounds on which a disqualification order may be made including:

           conviction of offences
           persistent breaches of companies legislation
           fraud and participation in wrongful trading




20
     Re Burnham Marketing Services Ltd [1993] BCC 518, 527.
21
     s1


                                                                       28
A director of a company which has become insolvent may be disqualified
under the Act if the court is satisfied that that his conduct as a directors;

        Makes him unfit to be concerned in the management of a
        company22

What level of incompetence as opposed to deliberate or reckless
wrongdoing, will constitute unfitness is a difficult assessment. The
underlying purpose of the disqualification legislation is to ensure that
those who make use of limited liability do so with the proper sense of
responsibility and to protect the public against the future conduct of
companies by persons whose past records as directors of insolvent
companies show them to be a danger to creditors, employees and
investors.23 But overly rigorous standards could inhibit the formation
and expansion of new business ventures and could constitute a
substantial, and arguably unwarranted, interference with the liberty of
individuals who want to participate in the management of companies.24
In 1962 the Jenkins Committee on Company law Reform had
recommended that incompetent management should be a ground of
unfitness, 25 but when an opportunity for reform arose in the Insolvency
Act 1976, the government felt that this went too far. Now under the
CCDA s6, the court is specifically directed to consider a number of
matters in determining whether the conduct of a director makes him unfit
to be concerned in the management of a company. These are set out in
Sch 1 to the Act and include;

        any misfeasance or breach of any fiduciary duty

        the extent of a director‟s responsibility for failure to comply with
        specified accounting and other provisions of the companies
        legislation

        the extent of the director‟s responsibility for the causes of the
        company becoming insolvent.



22
   s6
23
   Re Grayan Building Services Ltd [1995] BCC 554, CA, 577.
24
   Re Rolus Properties Ltd [1988] 4 BCC 446.
25
   Report of the Company Law Committee, Cmnd 1749 (1962) para 85 (b).


                                                                            29
Certain patterns of misconduct tend to feature in disqualification cases,
such as:

           persistent failure to comply with the accounting requirements of
           companies legislation;
           trading whilst insolvent;
           diversion of corporate property or other benefits to directors
           personally;

On the accounting requirements the courts are prepared to take into
account any lack of accountancy experience of directors, but treat
insolvent trading harshly as this is viewed as taking unwarranted risks
with creditors‟ money and is an abuse of limited liability. Where directors
engage in conduct that benefits themselves, such as by continuing to pay
themselves remuneration whilst at the same time defaulting on
obligations due to creditors, diverting corporate opportunities to
themselves or transferring company assets to themselves at an
undervalue, this too is the type of conduct that can lead to
disqualification.26 Ordinary commercial misjudgement in itself is
insufficient to justify disqualification. The conduct complained of must
display a lack of commercial probity (integrity) or commercial morality
or incompetence or negligence in a very marked degree. The correct
approach is for the court to consider whether, as a matter of fact, the
conduct complained of comes within the words of the statute.

Recent illustration

Re Continental Assurance Co of London plc [1996] BCC 888

This case concerned an insurance company which had gone into
liquidation with debts in excess of £8 million. All three directors of the
company were disqualified , including a non executive director who had
been appointed to that position at the request, and on behalf, of a bank
which had provided finance to the parent company to enable it to acquire
the now insolvent subsidiary. The court accepted that the non-executive
director had not known of the misconduct in relations to the company‟s
affairs, in particular the fact that it was\lending money to its parent

26
     Re Firedart Ltd [1994] 2 BCLC 340, and others.


                                                                              30
company to enable it to finance its bank loan in breach of the ban on
financial assistance contained in the Companies Act 1985, s151. (now
s678 CA 2006).
Nevertheless the court held that any competent director in his position
would have known what was going on and that his failure to know
displayed serious incompetence or neglect in relation to the affairs of the
company that was sufficient to justify disqualification:

      “He was a senior employee of a major bank, who was lending his
      name and respectability associated with his employer bank to the
      company. Persons dealing with the company were entitled to
      expect that external directors appointed on the basis of their
      apparent expertise will exercise the competence required in
      relation to the affairs of the company.”

It now appears that in public limited companies non-executive directors
cannot safely assume that lack of involvement in a company‟s affairs will
be a defence; there will be a general expectation on such persons by
creditors and others to monitor and oversee.

The disqualification legislation is regarded by the judiciary as playing a
real and significant role in raising the standards expected of corporate
managers. The disqualification legislation provides a more effective
enforcement mechanism than that of the general duty of care and skill
and s214.

Remuneration of Directors

Directors are fiduciaries - they enjoy a similar status to that of a trustee,
hence, they have no right to be remunerated for any services they have
performed except that which is expressly approved within the company‟s
constitution (Dunston v Imperial Gas [1832] KB ER 47)- there is no
application of the equitable remedy of quantum meriut:-

In Guiness v Saunders [1990] 2 AC 663, the articles provided that
remuneration for directors be determined by the Board. No
determination was made and the Court held that a director was not
entitled to payment for work undertaken.

Directors may enter into contracts of employment with the company, and
as such acquire rights - one being payment for work done. In addition,
the Articles of the company frequently provide for payment. Art 82 Table


                                                                           31
A provides: directors shall be entitled to such remuneration as the
company may be ordinary resolution determine. If no such resolution is
given, directors have no entitlement to payment.

It is not necessary for a full general meeting to take place provided all
those entitled to vote assent (Re Duomatic [1969] 2 WLR 114)


Statutory Statement of Directors‟ Duties.

Contained in the Companies Act 2006 ss171 to 177

The Approach:

 Think small first i.e. concentrate on the private company with additional
requirements for the plc. At the moment company law concentrates on
the plc with exemptions for the Ltd, this makes the law complex and over
formal.

There is a need for an inclusive, open and flexible regime of corporate
governance.

A new body, the Company Law & Reporting Commission CLRC be set
up to oversee reforms.

A new Highway Code for directors which is statute based has been
recommended; statute law is preferred in that it will give a clearer and
more accessible guidance for directors to rely on. It will reduce the role
of the courts in developing the law by being binding on them and giving
greater consistency.




                                                                            32
On the duty to act bona fide for the benefit of the company

Contained in s172 Companies Act 2006 (the Act)

Duties should be owed, as at present, to the company (2. of the Code),
however in taking account of what directors believe to be in the best
interests of the shareholders as a whole, they should wherever possible
take account of all material factors. These will include:-

      the need to foster business relationships with employees, suppliers
      and customers;
      the impact on the community and the environment;
      the reputation of the company;
      the need for fairness between the majority and minority of
      shareholders.


Note: the link to the „stakeholder debate‟ in corporate governance and the
problem of realistically taking such often conflicting interests into
account; are directors managers or social arbiters ? Also appears to put
forward some apparently statute influenced duty owed to minority
shareholders.

It is here where the link to EU based employee participation
mechanisms:- the Draft 5th Directive, Works Councils, Supervisory
Boards, employee consultation etc can be brought in to possibly
reconcile these conflicting interests.

During reform proposals a Review Group supported the Law
Commission‟s recommendation that there should be a statutory based
minority right of redress for shareholders and others against directors for
breach of duty allowing an action to be brought in the name of the
company. At the moment enforcement is by 51% of the members
passing a resolution instructing the company to act, or directors acting
under the company‟s constitution. Current s172 offers no right to
employees to enforce. This has not been enacted.




                                                                          33
On the no conflict of interest or secret profit duty

S175 of the Act

Exploitation of corporate property and opportunities belonging to the
company must not take place without disclosure and authority. At the
moment disclosure to shareholders or the board - with later shareholder
approval - is required. In the Act the board alone can ratify provided:
for a private company, there is nothing against this in its articles and the
director who is in conflict abstains; for the public company, there must be
a provision to that effect in the articles (note this would require initially
75% of the members to agree to the addition).

Note: a slight de regulation here, removing some authority from
shareholders.

On the Duty of Care and Skill

S174

As suggested in D‟Jan of London Case, S214 of the Insolvency Act there
is now a statutory definition of the requisite standard of care and skill a
director should exhibit i.e.

       (a) that expected by a reasonably diligent person with the
           knowledge, skill and experience which may reasonably be
           expected of a director in his position AND

       (b) any additional knowledge, skill and experience which he has
          (this will heighten the basic duty set in (a))


Note; this duty will often lie at the centre of corporate governance, i.e.
the conduct of directors.




                                                                             34
S172

The new Companies Act 2006 broadens beyond shareholders who
directors should take account of and the scope of company law has been
broadened to give greater weight to employees, suppliers, customers and
the local community, who have long term relationships with the
company. The issue is commonly referred to as the „stakeholder‟ debate.

The argument is that company law should adopt a pluralist approach so
that directors would have an obligation to serve a wider range of
stakeholder interests without the interest of a single group i.e.
shareholders, being overriding. The Act comes down in favour of a
pluralist approach but keeping the basic rule that directors should operate
companies for the benefit of the shareholders but with that duty being
framed in an „inclusive‟ way. This would require that directors:

       „take proper account of all relevant considerations including a
       proper balanced view of the short and long term; seeking to sustain
       effective ongoing relationships with employees, customers,
       suppliers and others along with considering the impact of its
       operations on the community and the environment.‟

And for the plc s listed, greater disclosure obligations.


Comment

The framing of the director duty in such broad inclusive terms with its
clear irreconcilable interests, will make enforcement extremely difficult
if not impossible. Employee representation on boards of companies
appears to be the only way that employee interests in particular, can be
promoted. Such employee involvement is very much resisted in the UK
in contrast with other Member States such as Germany.




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