Duties of directors in new Companies Act 2006: legal Q&A

One of the many company law changes made by the new Companies Act 2006 is to define, for the first time in legislation, directors’ duties. The new provisions come into force on 1 October 2007.

Among the new statutory requirements under the Act are duties to:

  • promote the success of the company

  • exercise independent judgement

  • exercise reasonable care, skill and diligence.

Q What has changed?

A Many of the new duties are similar to the current common law duties. There is one significant change, however, which is the duty to promote the success of the company (section 172). In doing so, the director must consider a number of factors, including:

  • the likely consequences of any decision in the long term

  • the interests of the company’s employees

  • the need to foster the business relationships of the company with suppliers, customers and other organisations

  • the impact of the company’s operations on the community and the environment

  • the desirability of the company maintaining a reputation for high standards of business conduct

  • the need to act fairly as between members of the company.

Coupled with the duties to exercise independent judgement and take reasonable care, many directors have been left wondering how they can meet their obligations and what risks they run if they get it wrong.

Q Is there any conflict between the duties of a director as an employee and the new directors’ duties?

A Employment agreements often require a director “to use his best endeavours at all times to promote and protect the interests of the company” but do not usually permit directors to take into account the interests of others in reaching their decisions on behalf of the company. There may, therefore, appear to be a potential conflict.

The new duty is owed to the company and not to its employees or customers. So directors must take a broad and socially responsible view of what they do, consistent with promoting the success of the company.

For example, a company with a large fleet of delivery vans will have an impact on the environment. A director is not expected to let the environmental impact override the needs of the company to conduct its business efficiently. However, corporate social responsibility might dictate considering the use of environmentally friendly delivery systems where possible, such as green fuels or energy-efficient vehicles.

Provided that the directors can show they considered the relevant factors, it is unlikely they will be in breach of the new duty – or their employment contracts – even if they do not ultimately decide to take the most environmentally friendly approach.

Q Are there any circumstances where the requirement to take into account the external factors could lead to a different decision?

A One example may be where a company can make a quick profit by the sale of a business which, if not sold, is likely to be highly profitable in the longer term. A director who ignored the long term and focused solely on the immediate profit to be made might be found to be in breach of duty by ignoring a relevant factor.

Q What should you take into account when drafting directors’ employment contracts?

A From an employment point of view, you should ensure that the director is entitled to promote the success of the company and consider the external factors.

To make the position clear, you could word the director’s obligation thus: “to use his/her best endeavours at all times to promote and protect the interests of the company in accordance with section 172 of the Companies Act 2006 and all or any other duties he/she may have as a director of the company or any company in the group of which he/she is a director”.

From a corporate governance point of view, this also draws the director’s attention to the duties that are owed to the company. Like many companies, you should now be considering what arrangements should be put in place to ensure that future decisions of directors are appropriately recorded in case a subsequent challenge arises.

Q How will this new duty be enforced?

A By the company itself. However, there is the possibility of what is known as a ‘derivative action’, under which a shareholder (rather than the company) takes action against a director, even though a majority of shareholders may not be in favour. The shareholder will, however, need the permission of the court to take it forward.

By Peter Cooke, head of the European employment practice, Covington & Burling

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