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Director’s Duties -

171-179 sections mix statute and case law

Directors duties where corporate governance fails The codification of directors’ duties under the companies act ss171-177 • The Main Duties (ss. 171-177): • Section 171: Duty to act within powers • Section 172: Duty to promote the success of the company • Section 173: Duty to exercise independent judgment • Section 174: Duty to exercise reasonable care, skill and diligence • Section 175: Duty to avoid conflicts of interest • Section 176: Duty not to accept benefits from third parties • Section 177: Duty to declare interest in proposed transaction or arrangement • Supporting Sections: • 170 (Interpretation); 178 (Enforcement) and 179 (Overlapping of Duties) Section 170 – interpretation – scope and nature of directors duties - based on certain common law rules and equitable principles - both statute and common law apply - codification exercise - all duties are fiduciary in origin (except 174) - section 174 – duty of care, skill and diligence based on common law negligence

Directors duties – statute and case law Section 178 – enforcement - Breach of s 171-177 – same as common law or equitable principle apply - Section enforceable same way as fiduciary duty owed to company by its directors Section 179 – several duties can apply at once - More than one duty can apply in any given case Re Bradcrown 2001 - Were disqualified for breaching: - s179 Section 172: the duty to promote the success of the company - He considers good faith – success of company – for the BENEFIT of the member as a WHOLE

What is the standard of the duty? -

Subjective duty Not about what the court thinks - NOT hindsight –COURTS DO NOT want to step in too much

Re Smith and Fawcett 1942 – AFFIRM THE SUBJECTIVE STANDARD

CoA -

Not questioning genuine management decisions Did the director act in way that he, in good faith, believed to be best for company? Court is not going to intervene – for the existing director to decide – not for the court to decide

Item Software (UK) Ltd v Fassihi [2005] 2 BCLC 91 - Best interest of the company – general terms - ‘Reflects the flexible quality of the doctrines of equity’ Regentcrest v Cohen [2001]: - Honestly believed it was in interests of company Held: - Subjective test. - Not about whether action was best for company but whether directors believed it was best for company. - so manifestly unreasonable as to cast doubt on director’s stated belief Charterbridge principle Charterbridge Corporation Ltd v Lloyds Bank [1970]: - Test is subjective, still as - minimum level of objective consideration - Is it feasible that a reasonable person would consider it to be in the best interests of the company? - Standard – subjective but with a little objective

WHO – members, stakeholders, members collectively? S.172 1. Duty to promote success of the members collectively? yes - Directors to act ‘in interests of the company’ - Gaiman v National Association for Mental Health [1971] - dual duty to both the company and the members collectively “Benefit of members” still flexible o Section 172(1)(a) - long-term consequences – potentially not good for short term - Additional objective in companies constitution – aware of this Stimpson v Southern Landlords [2009] - Where company established for more than one purpose, director must conduct balancing exercise -

2. Owed to members individually? – unless special circumstances - Protect their interest Percival v Wright [1902]: High Court: No duty owed to shareholders directly, but to the company as a whole - Don’t have to give a benefit to them personally

Hawkes v Cuddy [2009]: Court of Appeal - The director’s duty should be to the company only - Don’t owe to that shareholder

Duties - “special factors” Coleman v Myers [1977]: - Relationship of trust – advice from D to members – obligation individuals owed Re Chez Nico – in general do not owe fiduciary duties to members – certain special circumstances – duty of disclosure - Duty always to the company Peskin v Anderson [2001], - No general duty to shareholders - Percival v Wright - arise in appropriate/specific circumstances - need special factors s. 172(1)(f) - directors - need to act fairly between members of a company 3. Duties owed to wider stakeholders (employees, creditors, communities)?

- Only indirectly through shareholders Section 170(1): Duties owed “to the company” (i.e., separate entity)

Where do you focus? Shareholder Primacy: Directors run the company for the benefit of shareholders OR Stakeholder Pluralism: Directors run the company for the benefit of all stakeholders S. 172 (1): - When considering how best to promote success of company for benefit of members, directors must have regard to 172 duties Duties owed to employees? -

CA 1985 – interest of employees – didn’t work CA 2006 - S. 172 - b) the interests of the company’s employees …. Take into account and only so far as promotes success of company Duty is owed to company, NOT to employees

Duties owed to creditors? – only in insolvency s214 IA 1986

Multinational Gas Co v Multinational Gas Ltd [1983]: - no duty when solvent West Mercia Safetywear Ltd v Dodd [1988]: - main case - When company is insolvent – CREDITORS ABOVE SHAREHOLDERS

Shareholder value approach adopted – obligation owed to the company Directors ------ company and members -------- stakeholders Through this direction – duty to company will effectively help the stakeholders

Section 173 – duty to exercise independent judgment Boulting v Association of Cinematograph, Television and Allied Technicians [1963] 2 QB 606 - Duty to not restrict future decisionmaking Fulham Football Club v Cabra [1994] (following Thorby v Goldberg): - Cannot rely on s173 if they change their mind

Section 171: act within powers 1. Constitution 2. Purposes – for what they were intended Constitution – articles - Liability for failure but may still bind the company with third parties Purposes – conferred Punt v Symons & Co [1903]: Origins - “Proper Purposes” rule - Improper use of the power to issue shares Howard Smith Ltd v Ampol Petroleum Ltd [1974]: leading case for improper purposes Held: 1. Identify power and ascertain limits within which it may be exercised 2. Identify “substantial” purpose for which power was exercised 3. Is that substantial purpose within the limits of a proper purpose? • Court will give credit to bona fide (good faith) opinion of directors and respect judgment as to matters of management • But court will look at situation objectively and discount assertions where appropriate Applying the Proper Purpose TEST Hogg v Cramphorn Ltd [1967]: - Share issue to prevent hostile takeover

CoA - Proper purpose of power to issue shares is to raise capital, not to prevent a takeover Extrasure v Scattergood [2003]: - Transfer of assets from one company to another in group CoA - substantial purpose was to benefit other company in group, so improper purpose. Eclairs Group v JKX Oil [2015] – Director’s power was NOT exercised for a proper purpose Re OS3 Distribution Ltd [2017]: - Proper test is still Ampol Petroleum – not eclairs Interaction of S 171(b) and 172 Can breach s. 171 despite acting in good faith to promote success of company o Provides objective back-stop, even where directors acting in what they considered best interests of company (E.g. Eclairs Group v JKX Oil; Hogg v Cramphorn Ltd ) o Hogg v Cramphorn Ltd [1967] Ch 254 - Can breach s. 172 even if acting within scope of powers, if not acting to promote success of company

Section 174 – care, skill and diligence -

subjective and objective test - fiduciary duties subjective standard imposes an objective minimum – transitioned in pre 2006 case law

Hannigan, B., Company Law (OUP): focus on function of individual Breach of duty or just a bad decision? - BALANCE Burland v Earle [1902] AC 83 – Court wont interfere with internal management – within powers – no jurisdiction Re Bugle Press [1960] 2 WLR 658 – commercial matter – company better judge

The Standard of skill and care – S174 – formed in common law Re Brazilian Rubber [1911]: - Serious errors by D - RELAXED – reasonably expected from him – not responsible Expectation has strengthened;

Wrongful trading (s. 214 Insolvency Act 1986): Norman v Theodore Goddard [1991]

Re D’Jan of London Ltd [1994] – dual objective and subjective approach

Director disqualification: Re Landhurst Leasing [1991] - dual objective (minimum) and subjective test (dependant on your skills) 1. Subjective standard of knowledgeable director 2. Objective standard of someone in the directors position 3. Subjective standard of an incompetent director

Level of attention of directors – directors must pay attention to decisions being made Dorchester Finance v Stebbing [1989]: failed to attend meetings and pre-signed cheques - Clearly negligent Re Barings plc (No. 5) [2000] 1 BCLC 523 – collectively and - Collectively and individual – duty to acquire sufficient knowledge of the company’s business – so they can discharge duties as directors

Delegation – entitled to rely on others in principle Re City Equitable [1925] - justified in trusting that official to perform such duties honestly Dovey v Corey [1901] - : business would not work without trusting those in position of trust Norman v Theodore Goddard [1991] - However, director retains a supervisory role even when relying on others - They cannot abdicate responsibility Disqualification cases  Re Barings plc (No 5) [2000] – 3 directors disqualified – allowed rouge trader to gamble bank finances – bankrupted the company  Re Queens Moat Houses [2005]  Re Bradcrown [2001] – asked no question, no advice – did what he was told and abdicated all responsibility

Section 175 – duty to avoid conflicts of interest -

Fiduciary duty

Aberdeen Railway Co v Blaikie Bros (1854) - Chairman and director in both companies HoL Agreed - conflict of interest - voidable HISTORY

Bray v Ford [1986]: fiduciary position – not allowed to make profit – where interest and duty conflict Two related rules 1. no conflict – not allow conflict of interests 2. no profit – not profit from position

Judicial development Cook v Deeks [1916] - They have a fiduciary obligation to the company – opportunity came as directors Regal (Hastings) v Gulliver [1942] - Landmark House of Lords House of Lords – clear bright line rule - Directors used knowledge and opportunity gained through position and made profit therefore liable - Strict application means no need to consider motive; clear deterrent to self-serving behaviour by directors - Irrelevant that: o Directors had acted in good faith o Company could not take advantage of opportunity o Company could have ratified actions o New shareholders obtained windfall

*This is now reflected in s175(2) Industrial Developments v Cooley [1972] - Cooley managing director sub co – co contract wanted to work individually with Cooley - resigned - then took on contract High Court: Irrelevant that company unlikely to have been able to take on opportunity; still breach of fiduciary duty

Exceptions to No conflict duty Where s175 may not apply; (3) in relation to transaction or arrangement with company – refer to ss177 and 182 (4) a) cannot reasonably be regarded – rise to conflict b) authorized by directors

‘cannot reasonably be regarded as likely to give rise to a conflict of interest’ s175(4)(a) -

Broad and open for directors to argue

Boardman v Phipps [1963] “a real sensible possibility” of conflict of interest between the solicitor’s control and the trust.

‘if the matter has been authorized by the directors’ s175(4)(b) Section 175(5) Private company – board can authorize unless otherwise provided in the articles Public company – articles need to allow for board authorization - no breach if Board authorised director to pursue opportunity Queensland Mines v Hudson [1978 – Recognised by statute - If authorised, then no requirement of shareholder approval (Section 180(1)(a))

Strict approach to the no conflict duty - notes Regal (Hastings) v Gulliver [1942], - Balance to be drawn – strict rule and directors as professionals who are free to develop their own skills

Flexible Approach? Canadian Aero Service v O’Malley (1973) - Canadian case – looked more at the facts - director liable on fact Island Export Finance Ltd v Umunna [1986]: - directors should be able to exploit new position – public interest Peso Silver Mines v Cropper (1966) [Canadian case]: - good faith

UK COURTS = strict approach Bhullar v Bhullar [2003] CoA – obliged to communicate – disclosure is key O’Donnell v Shanahan [2009] - ‘possibility’ within the interest of the company CoA – not for director to make own decision that Co will not be interested – so proceed for himself – duty is UNDIVIDED LOYALTY Item Software v Fassihi [2005] - Didn’t disclose conflicting interests CoA – S 172 duty to promote interests of the company – disclose conflicting interests

No conflict duty following resignation Section 170(2)(a): - cease to be director – subject to s175 – exploitation of information/ opportunity - aware of as a director of company IDC v Cooley [1972] - Cannot avoid breach by simply leaving and then taking up opportunity BALANCE – cannot stop directors moving on in career  depends on director’s conduct and intentions prior to departure. CMS Dolphin v Simonet [2001] -> Breach - intention create competing business - took clients Balston Ltd v Headline Filters [1990] -> No breach - Nothing wrong with considering conflicting business ideas and later competing. - Defendant only using knowledge and skills obtained while director.  depend on whether director took any steps towards conflicting opportunity while still in work Shepherds v Walters [2006] and Colman Taymar v Oakes [2001] -> Breach - Took active steps, such as preparing business plans Foster Bryant v Bryant [2007] -> No breach - barred from being involved in management of the company – no use of information

Section 176: Duty to not accept benefits from third parities Boston Deep Sea Fishing v Ansell (1888): commission / bonuses for two companies Bribes – intended to prevent bribes - Section 176(4): No breach if benefit NOT reasonably regarded as likely to give rise to conflict of interest -> Would exclude trivial benefits, e.g., small gifts - Section 170(2): Duty continues notwithstanding resignation Authorised - NOT provide for authorisation by board - Remains possibility of ratification if breach is ratifiable

Section 177 and 182 – duty to declare an interest in a proposed and existing transaction with the company Section 177(1) – directly or indirectly – interested in transaction with company – declare nature and extent of interest with other directors -

Director interest in contract with the company - clear conflict of interest: “selfdealing”

Aberdeen Railway v Blaikie Bros (1854): - Co and partnership – same director/patner - Voidable – conflict of interest

Subsections -

Section 177(1): declare - nature and extent of that interest to the other directors.” Section 177(2): declaration - board meeting or in writing Section 177(3): further declarations - if circumstances change Section 177(4): prior to transaction Section 177(5): No declaration needed if director is not aware of conflict, unless they ought reasonably to be aware Section 177(6)(a): No declaration needed “if it cannot reasonably be regarded as likely to give rise to a conflict of interest” Section 177(6)(b): No declaration needed if other directors are already aware of interest, or ought reasonably to be aware

Effect of declaring interest • •

If director discloses interest - Section 177 = NO breach of duty: If director fails to disclose interest under Section 177: - Contract voidable – Cannot avoid if due delay, restitution impossible or third party rights have intervened. - Director liable for their profits, or losses incurred by company, as a result of failure - Ongoing duty to disclose continues - Section 182

Section 182 – Existing transaction or arrangement - Section 177 - ‘proposed’ transactions or arrangements - Section 182 – requires if D directly or indirectly interested – that has been -

entered into by the company – nature and extent manner of notice and exceptions to rule – similar to 177 Section 183: Failure to declare interest is a criminal offence If director has made declaration under s. 177, they do not need to make further declaration under s. 182

Section 190 – substantial property transactions (SPT) - company cannot enter into an arrangement where a director of company will -

acquire substantial non-cash asset or company acquires non cash asset from the person so connected UNLESS there is shareholder approval

S. 190 shareholder resolution, it must be shown that there is: 1) Acquisition or sale of property or interest 2) Between company and a director or “connected person” (defined in Sections 252-266) 3) Relating to a “substantial non-cash asset” (defined in Sections 191 and 1163)

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2- Between company and director or ‘connected person’ Section 252 – connected person definition Section 253 – directors family definition

3- Relating to a ‘substantial non-cash asset’ - Section 1163: “In the Companies Acts ‘non-cash asset’ means any property or interest in property, other than cash.” - Section 191: “An asset is a substantial asset in relation to a company if its value— (a) exceeds 10% of the company’s asset value and is more than £5,000, or (b) exceeds £100,000.”

What does s190 require? - director must obtain approval of shareholders - Disclosure to the Board is insufficient - British Racing Drivers Club v Hextall -

Erskine [1996] Shareholders must approve all important terms - Demite v Protec Health [1999]

Re Duckwari plc [1999]: - Conflict of interest – accepted an offer even though it was not approved by shareholdes CoA - C other directors of Duckwari, and Offerventure Ltd all liable for full loss

Breach of 190 Section 195(2): Transaction voidable unless - Restitution not possible - Company has been indemnified

- Third party rights would be affected Section 196: If transaction subsequently affirmed by general meeting “within a reasonable period”, then transaction no longer voidable. Effect on liability: - Section 195(3): Director/connected person liable to account for any profits made and indemnify company for any loss - Section 195(7): Unless connected person can show he did not know the relevant circumstances constituting the contravention - Liable for full loss, even that caused by depreciation (e.g. Re Duckwari)

Exceptions to Rule in Section 190 (ss. 190-194): Transactions; - group - holding company and wholly-owned subsidiary or 2 wholly-owned subsidiaries - company and person in his capacity as member of the company - Recognised investment exchange through independent broker - Relating to entitlements under director’s service contract or for loss of office - Where company is in winding-up/administration

Loans, Quasi- Loans and Credit Transactions These transactions also all require the approval of members: Section 197: Loans to a director or giving of security/guarantees Section 198: Quasi-loans to director/connected person (public co) - Section 199: Quasi-loan is an arrangement where company meets some financial obligation of person on understanding that it will be reimbursed later Section 201: Credit transactions to director/connected person (public co) - Section 202: Credit transactions include hire-purchase, conditional sale agreements, etc  Effect of breach (same SPTs) Section 204 – 209 – exceptions to the loan and credit rules