Even more rules for directors?

The Company Law Reform Bill is now before Parliament. It is likely to become law in the autumn and covers many things including setting out the rules on the duties of directors in statute for the first time. The DTI says that the new Act will simply codify existing common law and best practice. However, the Confederation of British Industry (CBI) has other views.

According to the CBI: “business is worried the Bill’s definition of directors’ duties will cause uncertainty and increased litigation, undermining the common law principle that the courts do not overturn business decisions taken in good faith by the directors.” (Financial Times - 3 February 2006). The new duty to ‘promote the success of the company’ is causing particular concern. The new rule says that:

“A director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.”

So far so good. Putting the rule another way, the director is required to act in the best interests of the company’s shareholders. This is how directors see their role and they would not have a problem if it stopped there. The new rule also preserves the current requirements that in certain circumstances (for example if the company is in financial difficulty) the directors must consider or act in the interests of creditors of the company.

But things get more complicated. In fulfilling the duty to promote the success of the company a director must (so far as reasonably practicable) have regard to:

a   the likely consequences of any decision in the long term
b  the interests of the company’s employees
c   the need to foster the company’s business relationship with suppliers, customers and others
d   the impact of the company’s operations on the community and the environment
e   the desirability of the company maintaining a reputation for high standards of business conduct
f    the need to act fairly between members of the company.

The requirement that, where reasonably practicable, the directors should follow the principle of ‘enlightened shareholder value’ noted above brings in wide social responsibility factors to the issues that directors must consider when making their decisions. What is more, the list of factors is not exhaustive. The problem that directors face is how they are expected to balance the different factors they are required to consider. For example, if an offer is made for the company the directors will need to balance the interests of the shareholders in getting the best price for their shares against the range of factors in the list.

At a recent QCA (Quoted Companies Alliance) Legal Committee meeting the DTI explained that, in their view, the new duty goes no further than the current law. They said that they are not expecting pages and pages of board minutes recording directors’ decisions reciting compliance with the requirement to consider the various factors listed on a ‘tick in a box’ basis.

But against that we suspect, for example, that the requirement that directors should consider the impact of their decisions on ‘the community’ will come as a surprise to many directors.As will the requirement to foster the company’s business relationships with suppliers, customers and the mysterious ‘others’.

In our view, the new Act will indeed add to the burden on directors as the CBI has complained. What are the practical implications? As a matter of commonsense, if a director (who must exercise ‘reasonable care, skill and diligence’) is to have regard to the consequences in a) to f) that flow from his proposed decision, the first thing he will need to know is what the consequences are likely to be. If he doesn’t know or can only guess he may need to commission an impact assessment. When he has done that he will need to consider the likely consequences and decide what weight to give them. And, if he is to be able to justify his decision later on, he is likely to be advised to make a record of his review.

For more information, please contact tom.shaw@speechlys.com.   Tom Shaw is a member of the Legal Committee of the Quoted Companies Alliance (QCA), the only organisation dedicated to representing the interests of quoted companies outside the FTSE 350. He is a contributing author of Butterworths Financial Regulation Service.