The Common Law Directors Duties Law Company Business Partnership Essay

Published Date: 02 Nov 2017

Introduction-

It is a well-established notion that directors’ duties arose out of the fiduciary relationships they owed to the companies which they govern. The most understandable definition of the director’s fiduciary relationship with the company can be put as:

"a fiduciary duty … in respect of a company's director means the relationship between the director and the company which gives rise to an obligation of loyalty, trust and confidence on the part of the director." [1] 

The term fiduciary does not have an exact definition, but Dr Finn in his work Fiduciary Obligations gave the overarching definition of a fiduciary relationship, of which directors are a sub-category, as:

"the distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal." [2] 

Prior to the directors’ duties being codified by Parliament in the Companies Act 2006, the duties which the court recognised at common law on a director were that directors owed the company were the duty to act in good faith in what the director considers to be the best interests of the company; the duty not to fetter any of his discretions; the duty to comply with the company’s constitution; the duty to account for a benefit he receives as a result of a transaction entered into by the company in which he has an undisclosed interest; the duty not to make secret profits; the duty of care skill and diligence; the duty to have regard to the interests of employees; and the duty to act fairly as between different shareholders. [3] 

The duty to act in good faith in what the director considers to be the best interests of the company

For the purposes of this paper duty is shortened to the title of the duty of good faith. The words given in Re Smith and Fawcett [4] to define what a director’s duty of good faith are that directors "must exercise their discretion bona fide in what they consider - not what a court may consider - is in the interests of the company." In the case Scottish Co-operative v Meyer, [5] Lord Denning stated that the requirements of a director in relation to good faith arise because the duty of a director is "to do their best to promote its business and to act with complete good faith towards it," [6] although not explicitly stating what good faith is due to the subjective nature of good faith.

This duty is regarded as being a subjective duty as, "whether a director had breached his or her duty came down to a consideration of the director's state of mind and provided that directors believed in good faith that they were acting in the best interests of the company they could not be said to be in breach." [7] The reason for the courts implementing the good faith requirement is that it should be what a director believes is in the interests of the company, and not what the courts consider to be in the best interests of the company. [8] In the case Regentcrest v Cohen, [9] Jonathon Parker J stated "the question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company" [10] demonstrating that it is a subjective test and that a director’s actions should not be taken objectively. To further this belief the courts have a long standing policy regarding directors conduct, and if directors act in what they consider to be in the best interests of the company at the time of making a decision, and the decision was made in good faith, the courts will not place their view about how the directors ought to have acted in place of the board's own judgment. [11] 

The duty to comply with the company’s constitution

A director must comply with a company’s constitution, the memorandum and articles, and prior to codification Section 35A of the Companies Act 1985 protected third parties by granting them the ability to deem that when dealing with a director, the director’s power was free of any limitation under the company’s constitution. A continuation of this duty is that a director must act for a proper purpose. The common law position was that a director must act for a proper purpose in the exercise of his powers. This duty was examined in the Australian case of Howard Smith Ltd v Ampol Petroleum Ltd [12] a Privy Council case. The Privy Council judgment is only a persuasive authority on the UK law, however it had been adopted into the UK law common law. The Court decided that before a director exercises his power, the purpose for such use had to be investigated. This must be done on an objective basis to "to examine the substantial purpose for which it was exercised, and to reach a conclusion whether that purpose was proper or not." [13] In doing so, the belief of the directors in the exercise of their power is scrutinised, and so long as it was exercised in a bona fide belief, the director’s judgment as to matters in question will be taken. This is due to the court distancing itself from imposing their own opinion on what is right in the interest of a company as mentioned above. The issue more frequently arises in relation to allotment of shares [14] , to prevent a director exercising his powers to entrench himself in office [15] , and deprive an existing majority of shareholders of their majority position. [16] The case of Howard Smith v Ampol was concerned with a director attempting to defeat a hostile take-over by the release of new shares, as a result Ampol’s take-over bid was defeated but it was held that the directors had not acted for a proper purpose even though they had been acting in good faith, demonstrating the strict approach which the court takes to this duty.

The duty not to fetter any of his discretions

Directors are forbidden from entering into agreements which fetter their discretion, or enter into an agreement with a third party in relation to how their discretion is exercised. This duty existed to ensure directors maintained independent judgement. However there exists an exception where the directors negotiate a contract "on behalf of the company, [and] the directors bona fide think it in the interests of the company as a whole that the transaction should be entered into and carried into effect they may bind themselves" [17] from the Australian case Thorby v Goldberg [18] which was confirmed to be the UK law approach in the case of Fulham Football Club Ltd v Cabra Estates Plc. [19] 

The duty to account for a benefit he receives as a result of a transaction entered into by the company in which he has an undisclosed interest

This duty is more commonly known as the no-conflict rule. Along with the duty of loyalty, it is the no conflict and no profit duties which are arguably the most important duties on a director. The no conflict rule arises where a director places himself into a position where his duty as a director conflicts with his personal interests or a duty to another person. More succinctly put, per Lord Herschell in Bray v Ford [20] :

"It is an inflexible rule of a court of equity that a person in a fiduciary position . . .

is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict. [21] "

The exception to the strict rule is where such a conflict is ratified by the company when it has informed consent. [22] This rule has such strict enforcement which can be seen through-out the case law, [23] and this resulted in the duty applying in situations where there is no detriment to the company [24] , or the directors were acting in good faith. [25] The duty goes further and applies to the directors even if the company could not take advantage of the benefit. [26] A more flexible approach which contrasts that taken by the UK law has evolved in the Commonwealth, the main countries implementing the less rigid approach being Australia and Canada. The Canadian case of Peso Silver Mine Ltd v Cropper, a Privy Council case, has been commended for the judgment which Jei Li believes, "achieved fairness and complied with the aims of justice better than the application of the absolute strict approach." [27] The decision reached in this case was explained by:

"Morse et al [ [28] ] in their annotation to subs (4) (a) of s.175 that "It may now be the case that if a company considers a new venture and concludes, on a properly informed and bona fide basis, that it will not pursue the venture, then the company's directors will be free to pursue the venture on their own account." [29] 

In contrast to the above, the UK law is considered a "crude mechanism to deal with the problem of corporate opportunities without considering the ‘fairness facts" by Jei Li.

However, there are several reasons for the strict application of this rule. The Law Commission in their consultation document Company Directors: Regulating Conflicts Of Interests And Formulating A Statement Of Duties [30] which was published with an aim to consider "the case for a statutory statement of the duties owed by directors to their company under the general law, including their fiduciary duties and their duty of care, [31] " puts forward that "the economic justification is that severe liabilities imposed by law operate as an incentive to directors to comply with their duties to convey information to shareholders. [32] " Andrew Keay in his paper The Authorising of Directors’ Conflicts Of Interest: Getting a Balance [33] puts forward 3 reasons; first, it acts so as to deter directors "from allowing themselves to be placed, or putting themselves, in a conflict situation. Secondly, it prevents directors from exploiting opportunities to make profits. Brenda Hannigan identifies another reason for the rule, [ [34] ] namely that it comprises an efficient method for dealing with the agency problem in companies, as it makes monitoring less onerous. [35] "

The duty not to make secret profits

This rule is a logical progression from the no-conflict rule and commonly referred to as the no-profit rule. The no profit rule relates to the fact that a director cannot keep any profits they receive as a result of any information, property or opportunities which belong to the company. This duty was discussed in the case Parker v McKenna, [36] and it was held, per Sir W. M. James, L.J, that "no agent in the course of his agency, in the matter of his agency, can be allowed to make any profit without the knowledge and consent of his principle; that rule is an inflexible rule." [37] 

The duty of care

The duty of care is a duty which if a director breaches he may accrue liability in the tort of negligence where his/her conduct or management of a company fall below such a standard that they ought to be liable to an action in the tort of negligence by the company. The starting point for such a duty was set at a low threshold, with a test of "ordinary prudence" being formulated in the case of Overend, Gurney & Co v Gibb. [38] The test was set so low that an action against a director whom was appointed the position of director at an age of 6 months, and failed to attend a board meeting for the following 38 years failed. [39] The case failed on the grounds that a director could be excused if he "was not cognisant of relevant facts by reason of inattention to the business of the company and avoidance of situations where they would have been made known to him." [40] 

However this duty has developed over time and is now a stricter duty than it originally was. The common law duty has been held to be the same as the duty contained within section 214(4) of the Insolvency Act 1986. In Re D’Jan of London Ltd [41] Lord Hoffman applied this formulation of the duty in a case by stating "a reasonably diligent person 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 (b) the general knowledge, skill and experience that that director has." [42] 

The duty to have regard to the interests of employees

This duty is contained within section 309 of the Companies Act 1985 and was introduced to reverse the case of Parke v Daily News. [43] This issue in this case was whether a director could give profits of his company to benefit former employees rather than to the company and the judge held that he could not take interests of employees into account and could only give regard to the company’s interests. [44] This was a controversial decision and resulted in s 309 to ensure that directors take into account the interests of employees when exercising their powers. Subsection (2) provides that if a director fails taking such interests into account the duty is enforceable against the director in the way that all fiduciary duties are enforceable and will have the same consequences. However, the case Fulham Football v Cabra Estates [45] questioned the effectiveness of such section on the grounds that as employees are not shareholders, and therefore they do not have the required locus standi to bring a claim against a director. Thus, section 309 was effectively toothless as it gave the employees no right of recourse where their interests were not considered by a director, as the position in law is that only shareholders can bring a claim against the company and unless and employee was a shareholder they could bring no claim as only shareholders have the authority to bring a derivative claim on behalf of the company against a director.

The duty to deal fairly as between different shareholders

This duty was given in the case of Mutual Life Insurance v Rank Organisation Ltd. [46] The case concerned directors of the Defendant company allotting shares to other shareholders, and not the North American shareholders. The directors conducted themselves this was to avoid compliance with registration requirements of the Securities and Exchange Commission in the United States. The directors believes that interests of the company they should not join the above and the North American shareholders brought an action alleging the directors had breached the company’s articles y breach of the membership contract contained within the articles. The shareholders argued that their shares entitled equal treatment with other shareholder categories, without discrimination. However, Goulding J disagreed, he concluded that there was no unfairness by the director allotting shares between the two groups of shareholders. He went on to state that a director must take two things into consideration when exercising his powers to allot shares, "first, the time honoured rule that the directors’ powers are to be exercised in good faith in the interests of the company, and secondly, that they must be exercised fairly as between different shareholders. I doubt whether it is possible to formulate either of these stipulations more precisely because of the infinity of circumstances in which they may fall to be applied." [47] 

This summarises the duties which a director was subject to before codification through the Companies Act 2006. The duty to act fairly between shareholders did not become codified, but still exists as a common law duty. Additionally the duty to have regard to the interests of employees did not receive codification but was incorporated into section 172 of the Companies Act 2006; within the list of interests a director must have regard to in promoting the success of a company.

Reform of the Common Law Directors’ Duties

Codification of directors’ duties had begun to gain traction again in the late 1990s after the Department of Trade and Industry (DTI) held a number of consultations on areas for company law which it considered may be in need of reform during the 1980s and 1990s, which proved to be unsuccessful. [48] It then turned to the Law Commission to undertake the task of providing recommendations on the reform of company law where it had failed. The two reports produced by the Law Commission were Shareholder Remedies [49] and the Directors’ Duties reports. [50] Both reports were important in the formation of the Companies Act 2006, and many of the recommendations contained within both reports were incorporated into the final document. After the Law Commission released its reports the DTI decided to undertake another report on the issue of company law reform again. This report was undertaken by the Company Law Review Steering Group, and their final report is known as the "Modern Company Law for a Competitive Economy: Final Report." [51] 

The Steering group in its final report made 2 key recommendations which were implemented in the Companies Act 2006. The first was to change which category of companies the new law was most applicable to. It took the form that the law was to operate mainly with a focus on private companies, as opposed to the previous focus on public companies. [52] The second of those recommendations was that corporate governance needed improving. The main way it identified to do this was through codification of directors’ duties. [53] 

Following the publication of this report in July 2001, a government White Paper was created a year later, incorporating most of the recommendations which were put forward, including the codification of directors’ duties. The Company Law Reform Bill was placed before Parliament in November 2005, and the following year it became the Companies Act 2006.

Arguments against codification

An argument against codification is that codification would increase the amount of legal advice directors would have to seek as a result of the new law. [54] Their reasoning being that the interpretation of the act if often determined on how the lawyers interpret the statute, arising from their positions as advice givers.

H. R. Hahlo’s article ‘Here Lies the Common Law: Rest in Peace’ [55] argued, in 1967, against the considered codification of contract law. The points he raises are just as relevant to the codification of directors’ duties and the points he raised were often repeated in opposition to the idea in the numerous discussions before the 2006 Act. [56] 

With the main aim of codification being to make the law clearer and more understandable to the lay director, the support for the argument that this aim is unobtainable is numerous and difficult to ignore "one of the things which codification, contrary to a widely held view, cannot do, or can do only very imperfectly, is to bring law closer to the layman." [57] This argument is agreed with the views of Lord Lloyd who states "it is an illusion that a code can be complete in itself, solve all problems and dispense with judicial interpretation, it is equally chimerical to suppose that a code can be reduced to such simplicity that any layman could obtain a reasonably clear solution of his legal problems by being referred to the appropriate sections of the code." [58] 

With the eminent company law Professor Gower also agreeing that "it is a fallacy to suppose that codification can ever bring the law within the comprehension of the uninstructed layman." [59] 

This inherent confusion surrounding the law arises with the blame falling "on the lawyers, who have made it one for their own, selfish purposes, [as] men since times immemorial have dreamt of a simple and straight forward code, couched in language the man in the street can understand, which would make it possible for every reasonably intelligent person to be his or her own lawyer." [60] 

Codification is inherently a huge commitment to the law, as Hahlo identifies that with codification "there is no turning back once the law is codified... Like the sorcerer’s apprentice, the codified is forever pursued by the spirits he evoked from the deep. [61] " This causes further difficulty for a layman to understand as that once the law is codified it can further become less accessible to the lay person after the court has begun to interpret and create a backlog of case law in relation to it.

In the report on Fiduciary Duties and Regulatory Rules [62] the Law Commission came to the conclusion that it would be impractical to codify the duties since there were many unanswered questions which may arise within the law. Each case has various different circumstances which require the flexibility which only judicial decision on the common law can give. However it is important to note that report was on fiduciary duties in general, not just those imposed onto directors. Yet two further Law Commission Papers have rejected the notion of directors’ duties codification- the Jenkins [63] and Greene Reports [64] . The Greene Report emphatically stated "to attempt by statute to define the duties of directors would be a hopeless task." [65] The Jenkins Committee agreed with the statement "We think that any attempt to define the duties of directors more clearly would involve the risk that, since it would be impossible to define such duties exhaustively, there would be inevitable lacunae which might well make it more difficult to determine in any particular set of circumstances what these duties were." [66] 

Why codify Directors’ Duties now?

The Rt Hon Lady Justice Arden DBE states "the climate of opinion had changed [67] " as regards to the idea of the codification. This was due to the amount of reports and empirical evidence showing that there was widespread support for the codification of directors’ duties. The empirical evidence was gathered by ESRC Centre for Business Research on behalf of the Law Commission in relation to its report on directors’ duties. The research showed that there was widespread support for the codification of the duties and is contained within Directors’ Duties: Empirical Findings. [68] This was partially reflected in the Company Law Review Steering Group’s statements that times had changed regarding the effectiveness of company law, and LJ Arden whom was involved in both the Law Commission’s and the DTI’s reports, puts forward that the "codification of directors’ duties had previously been seen as the search for the Holy Grail, on the grounds that it would be virtually impossible to express in the words of a statute all the intricacies and nuances of the general law. [69] "

It was said that if the law was to be codified it should be with the aim that it would make the law more accessible to directors of small businesses who lacked the professional in-house lawyers to give advice, such as with many of the large companies. The rationale behind such an aim is that if directors are aware of the duties they are subject to it will "guide all directors towards higher standards. [70] " The codification should clarify the law by giving a proper, understandable statement of the duties directors in statute form, which would play an "essential part in making positive improvements in corporate governance. [71] "

How should the duties be codified?

The Directors’ Duties report explores 5 possibilities for codification a comprehensive codification; a partial codification; a statutory statement for guidance only and not replacing the general law; a non-binding statement of the main duties under the general law to be used in certain prescribed forms or authoritative pamphlets. [72] 

Arguments against a comprehensive codification were raised in the Directors’ Duties report. The Law Commission identified that "codification is a difficult process and successful codification may not be achieved [73] " echoing Hahlo’s argument of the sorcerer’s apprentice. The Law Commission followed this with the acknowledgement, "a risk that codification may be a lengthy exercise and differences of opinion may emerge as a result of which it is impossible to achieve a consensus. [74] " The inherent issue with comprehensive codification is that that the directors’ duties: "cannot be codified without either being stated in detailed terms in which case there will be a loss of flexibility, or being stated in general terms in which case the statute may have to be interpreted by the courts and the result is that the law may not be much more accessible than it is at present. [75] "

A big fear regarding the duties was that there may be a loss in flexibility once the change from the judge lead common law occurred. The law before codification was considered dynamic and adaptable to each new situation arising in a case before the Courts, whereas with the implementation of a code where a situation arises which is not covered, or partially covered, by the code then the code may be unfairly applied due to the court being bound by the statutory law. This highlights the issues discussed above, that the more a court interprets and passes judgment on the code, the more convoluted the law becomes, thus contradicting the sole purpose of codification- accessibility to the lay directors or laymen.

Partial codification would be based, in the same form as the codification enacted in Australia, or the manner put forward by the Jenkins Report. The argument the Law Commission levels at this form of codification is that the lay person would be confused to find that all the duties he is subject to are not in the statute. A partial codification would only create partial accessibility. [76] 

The middle ground of the options for codification would be to have a statutory statement which does not replace the general law, and thus would "make part of the law more accessible but yet would not cause the law to lose any of its flexibility since it would always be open to the court to use the general law." [77] However the introduction of this would cause the director to be under two regimes, the common law and the statutory law, and thus may be confusing as a lay person is more likely to give higher priority to the statute law. This proposition is an unusual practice in the law, and as the law develops through the Courts the statutory law will need constant revision.

The fourth suggestion is the creation of a statement of duties which the Secretary of State has power to apply to certain specified prescribed documents. The main problems with this initiative would be how to bring such duties to the attention of directors, and the Secretary of State would have to have the power to create such a statement of duties.

A fifth suggestion which would be an option if 2-4 were implemented would be an authoritative pamphlet giving a summary of the duties and having the backing of the sector. This would have the same problem as above, the raising awareness with directors, although Australia has been successful in implementing this method.

In whose interests is the company ran?

With the codification being decided upon, a further obstacle stood in the way before the creation of the bill: in whose interests are the companies run? This is one of the biggest historic questions in company law, and was known as the "stakeholder vs. shareholder" debate. The debate has been running since the Berle vs Dodds dialogue from the early 1930’s. [78] The ideas they raise have been extended and developed, and in the discussion of codification the terms which they originally used have evolved into "pluralism" representing the stakeholder argument, and "enlightened shareholder model" based on the shareholder theory.

The pluralism approach is that the company is not solely run in the interests of the shareholders, but the interests of the wider community, or stakeholders, must be taken into account by directors. Examples of stakeholders include employees, the environment, and the community.

The enlightened shareholder model, which was favoured over pluralism by the Company Law Review, and carried into the new Act, was that the company is run in the interests of creating value for the shareholders. The addition of the word "enlightened" is to signify that the directors of a company should take into account the long term activity of the company and attempt to foster relationships with the employees, suppliers and other stakeholder groups.

Criticisms during the second reading of the Company Law Reform Bill

During the second reading of the Company Law Reform Bill, which went on to become the Companies Act 2006, when it was presented to the House of Lord recorded in the Parliamentary brief, contained "strong criticism of a number of provisions within the draft legislation" [79] with regards to the proposed codified duties. The criticisms which were levelled at the bill were fundamentally aimed to "question the desirability or effectiveness of important areas of the bill. [80] " The Law Society, in relation to the aims for the codification of directors’ duties considers that "although the Law Society is in favour of these aims, we do not believe they have been achieved. [81] " The Law Society went further and casted doubted that the aims were even achievable by the codification and put forward that it would have preferred the duties to be codified the publishing of non-statutory guide to directors’ duties. [82] 

The Law Society criticise the Company Law Review Bill, agreeing with earlier arguments against codification, that as a result of the codification "the new code is inflexible [83] ." The Law Society feels that the judge lead common law had freedom to develop and expand the duties on a case by case basis and the new code would stifle such development. They believe that the law will become progressively more inaccessible due to the interpretation and application by the courts. The Law Society adds that the codes "meaning will over time become less and less clear to a reader who does not also understand how it has been interpreted and applied by the courts. [84] " It is asserted by the Law Society that the codification "will result in new uncertainty, increased costs and legal bureaucracy. [85] "

With regards to what became the duty to promote the success of the company, under s 172 it argued that as a result of the new duty, any breach of duty will "be much less flexibly dealt with by the code than by the common law." [86] In relation to the list of stakeholders given for a director to have regards to when promoting the success of the company, the Law Society’s opinion was these raise "the possibility that this will give the courts jurisdiction to review, by reference to objective tests, business decisions taken in good faith by directors. This could have serious implications for the management of companies by their directors." [87] The serious implications arise as it is contrary to the courts history of not involving itself in commercial decisions of companies which have been taken in good faith.

A fear has arisen in relation to directors whom are inactive within their company, and it is believed that will place the directors in a harder position when they are not being successful in the management of their company. In the article, "Woe to the inactive director" [88] it states that "the relative clarity of the duties will inevitably lead to even more focus on how directors executed their office when things go wrong." [89] The director will have this statutory code highlighting to all duties the he was under in an one accessibly place and thus will have no-where to hide. The author believes that the codification is the latest in a developing a stricter approach to the conduct of directors, as seen through the activity in applying the duties to cases such as Re D'Jan of London, [90] and Re Barings. [91] 

Codification

After much deliberation it was decided that codification was to go ahead. Despite the shortcomings and apprehension prophesised in relation to codification, it appears the time was perfect for the codification to go ahead. The historic opinions of past were dismissed, or simply not heeded, and with overwhelming empirical support for codification the time was right.

The codification took the form of an extensive statement of principles, and to avoid the court having to start anew with the building up of the case law, provision was made to allow previous case law decisions to be consulted through s170 (4) which provides that "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. [92] " The inclusion of this sub-clause is to allow the duties to develop alongside other developments in the law. [93] 

Main Body

The product of the research and deliberation for the preceding two decades leading up to 2006 came finally to fruition, resulting in the Companies Act 2006. Parliament opted to codify the duties substituting the old general duties and principles, whilst keeping the duties existing on a director which did not receive codification, the main one being the duty to act fairly between different classes of shareholders. The new duties are to be interpreted with s170 (4) taken into consideration.

This provision is not without issue; LJ Arden believes that it may cause "strained interpretation" [94] due to the requirements on the courts to uphold the doctrine of primacy of European Union law, and with section 3 of the Human Rights Act [95] requiring the courts to interpret the law, so far as possible, in accordance with the law of the European Convention on Human Rights. She continues that "a problem of interpretation the newly codified duties will be to identify the relevant common law rule or equitable principle" which the courts themselves created.

The codified duties

The duties have been codified into Part 10 of the Companies Act 2006. Each duty which received codification is contained within sections 171-177. The application of the duties is cumulative in effect, and "more than one of the general duties may apply in any given case [96] " as provided for by section 179.

Section 171

Section 171 is the duty that a director must act within the company’s constitution and only exercise his duties for the proper purpose. The main authority for this duty was discussed above, the case of Howard Smith Ltd v Ampol Petroleum [97] , and the judgment of that case is essentially put into statute. Goddard feels that the duty failed to "explain the criteria to be used in deciding whether powers have been improperly exercised. [98] " This is due to the Company Law Steering Review Group being reluctant to base it on the common law’s approach of basing it on the company’s articles. [99] 

The purpose of such a duty is generally to limit the powers conferred onto directors as it "it is common for the articles of large companies to confer extremely broad discretionary powers upon the boards. [100] " The most applicable cases where this duty applies was discussed earlier as where a director attempts to defeat a takeover bid, where such exercise of power would be an improper purpose. The cases discussed appear to conflict with the case law relating to the next duty.

Section 172

Section 172 is the duty to promote the success of the company; it replaces the common law duty of loyalty to the company. It has been stated that this is the "the core fiduciary duty owed by directors. [101] " The act clarifies that the duty is owed solely to the company, and replaces the duty to act in good faith for the success of the company with the creation of the enlightened shareholder value. The section enshrines the enlightened shareholder value through the words "for the benefit of its members as a whole [102] " and including the provision that directors must give regard to stakeholders in the company. Now, directors, in promoting the success of the company, must now have regard to a variety of stakeholders, including employees, suppliers, customers, community and environment.

The previous Companies Act 1985 contained section 309 which provided "the matters to which the directors of a company are to have regard in the performance of their functions include the interests of the company's employees in general, as well as the interests of its members. [103] " How much regard is given by each director is a matter for personal decision of the director, and LJ Arden believes, contrary to the worries of serious implication in "Woe to the inactive director [104] ", that "it seems unlikely that the courts are to be required to substitute their views on such matters for those of the directors. [105] " LJ Arden identifies that in having regard to relevant matters "does not mean that a director must act with the aim of furthering those matters. [106] "

It is argued he must do more than merely pay lip service but the act fails to identify how much a director should give regards to each interest. [107] Yet if he believes that he should not take into account an interest group’s regards, with the precaution that this belief is in good faith, he can choose not to give regard to such interests. The main way a director can do this is through board meeting minutes to show that each regard was given consideration but it was felt that a decision contrary to such opinion was necessary.

This section includes s172 (3) which creates a further group which a director must have a regard to, and that is "in certain circumstances, to consider or act in the interests of creditors of the company." This will apply usually where the company is entering difficulty and the director should have in mind whether or not the company should be wound up. If breach this duty may carry liability for fraudulent or wrongful trading under the Insolvency Act.

The list of stakeholder interests listed in s 172, it has been argued are as ineffective as s 309 Companies Act 1985, as discussed above, which with regard to employees is echoed in s 172. Daniel Attenbrough states that it "seems that the wording of the Act allows directors to pay lip service to the factors listed in s.172 and that the requirement to consider these additional six factors will make very little difference to how boards make decisions. [108] " Professor Birds, in agreement, believes that the stakeholder element of s 172 will have little practical relevance, saying "on the whole it is thought that the effect of s 172 is more likely to be educational rather than in any sense restrictive and that business decisions taken in good faith will not be any more easily challengeable than they were before this provision existed. [109] " Alistair Alcock believes there is further confusion to arise on the behalf of a director, as list of stakeholders in section 172 "may almost give rise to a Catch-22 for directors [110] " due to the conflicting nature of directors having to pay attention to the interests of stakeholders and as a result may liable for breach of the primary duty towards shareholders.

This inconsistency may cause confusion on behalf of the directors and when considered alongside the widened derivative actions available to aggrieved shareholders, while running a company under the new s 172 may have a negative effect on directors. There are fears that "the perception of such increased exposure to litigation may have wide-ranging effects, from the willingness of individuals to accept appointment as directors, to the likely impact on directors' and officers' insurance. [111] " This impact arises as if a director fails to give the correct regard to an interest group, or breaches his duty to correctly promote the success of the company in the eyes of a shareholder then a derivative claim may be "used to seek judicial review, in effect, of a commercial decision of management [112] " where it is in fact simply a challenge to the director exercising his powers as director, which a shareholder merely disagrees with.

A recent case on the stakeholder issues contained within s 172 is the case of People & Planet v HM. [113] It was ruled that the claimants should not be allowed to appeal on the grounds that "company law is not the appropriate vehicle for the achievement of environmental or human rights objectives beyond what the law requires generally." [114] As a result, the argument for the ineffectiveness of the stakeholder element of section 172 is strengthened on basis that "the case demonstrates that s.172 has raised expectations that it cannot deliver and would be better replaced with a traditional statement of a director's fiduciary duty of loyalty." [115] This may lead to s 172 being brought into actions as an additional strengthening element of a claim, instead of being brought as an action on its own.

The aspect of good faith a director must act with under s172 was considered in Keay’s article "Good faith and directors' duty to promote the success of their company [116] ". The good faith element of the section is uneasy to ascertain due to the lack any definition, clarity or meaning being given in the Act. Keay analysed the case law under the common law where the test was a subjective one and debated whether the statutory requirement for good faith requirement would be in the same vein. He concluded that "there is nothing to suggest that the new provision will be interpreted any differently. [117] " Essentially, that the subjective test will continue to be used and "there does not seem to be room to enable one to assert that there will be the employment of a reasonable director test in relation to s.172." He puts forward that if the shareholder is bringing a claim for breach under s 172, yet the director has acted in good faith; it is more suited that he brings a claim for breach of duty of care established by s 174.

An Australian Joint Parliamentary Committee on Corporations issued a report in 2006 entitled Corporate Responsibility: Managing Risk and Creating Value [118] considered the incorporation of the enlightened shareholder model of management of a company into Australian law. This was their preferred approached to the codification of directors’ duties, and after consideration they rejected the implementation in their own legislation. The Australian committee, although agreeing with the idea of enlightened shareholder value, were still highly critical of the approach taken by the UK Parliament.

Their first argument is that s172 "appears to introduce great uncertainty into the legal expression of directors’ duties [119] " due to the involvement of the court in deciding what purposes were for the benefit of the members. They continue this argument onto that until the court gives a declaration on what the purposes other than those of the members of the company are, the directors themselves may "not even be sufficiently equipped with basic knowledge about those to whom they owed a duty." The Committee raises an additional argument that the inclusion of the various stakeholder groups in a company and the requirement that a director must give each group regard under s 172(3), yet fails to give "clear guidance as to whom the duty is owed, and how it is to be discharged" and states emphatically, "a law which does not is bad law." [120] As it stands, "in part, the s.172 duty is confusing in terms of how success is to be measured in the context of shareholders' interests. [121] "

LJ Arden believes "it is likely that at least when the Act is first brought into force there will be a number of challenges to decisions made by boards of companies in circumstances where such challenges would not previously have lain [122] " due to the provisions in s 172. The reasons for such challenges giving rise to an increase in litigation, is based on the section being likely to "encourage people to challenge board decisions on the grounds that the board has failed to take into account all relevant considerations. [123] " LJ Arden continues onto the counter-point to this argument that there will be an increase in litigation, as under company law doctrine, it is the company itself which brings a claim against the directors in breach of their duties and she identifies that "if there has been no change in management or insolvency, the company itself is unlikely to want to sue, even if the directors negligently failed to take into account the interests of some particular group. [124] " An addition to this argument is that when proceedings are brought by a company it is the directors themselves whom authorise the proceedings on behalf of the company; they are unlikely to bring proceedings against themselves, however this is where deviatory action can be used, yet getting permission from the courts for a derivative claim may be difficult due to the hurdles involved in a derivative action.

A further Australian report, ‘The Social Responsibility of Corporations [125] â€™, published in December 2006 concluded along the same lines as the report above, although it concluded changes to adopt the Companies Act 2006 approach "may not necessarily be appropriate for corporate decision-making in the future." [126] This argument arises due to the inclusion of the various stakeholder categories yet with little guidance being given on how such inclusion would benefit the directors.

LJ Arden does not agree with the Australian Committees proposals, and in relation to their argument of uncertainty by the section believes that the Australian Committee has misunderstood the provision and that the Explanatory notes published with the Bill sufficiently clarify what the purpose of the section is. The Explanatory note provides that "Subsection (2) addresses the question of altruistic, or partly altruistic, companies… It is a matter for the good faith judgment of the director as to what those purposes are, and, where the company is partially for the benefit of its members and partly for other purposes, the extent to which those other purposes apply in place of the benefit of the members. [127] " LJ Arden counters the second argument that in failing to provide clear guidance on how the duty is to be exercised with is simply something legislation cannot sensibly do, as it is ultimately "for the directors to do that which in the circumstances is appropriate. [128] "

Arguments have arisen in those less cynical, and they have argued "that s.172 has opened the way for an important norm to be embedded in corporate governance, in that it has, at the very least, crystallised the important status of stakeholder." [129] 

Section 173

Section 173 codifies that a director has a duty to exercise independent judgment. This section "is a newly formulated fiduciary duty, although it may have fallen into a window of the previous conflict of interest rule." [130] The section provides that a director can still fetter his own discretion via a contract with a third party if it is in accordance with the company’s constitution. This duty does not seem to have as wide an application as some of other wide ranging duties codified, and "may be relevant in the cont