Clause 144: Appointment of directors of public company to be voted on individually

288.     This Clause replaces section 292 of the 1985 Act and has exactly the same effect: the appointment of each proposed director of a public company must be voted on individually unless there is unanimous agreement to a block resolution. Without such consent, any appointment of a director that is not voted on individually is void. This clause ensures that members can express their disapproval of any particular director without having to reject the entire board.

Clause 145: Validity of acts of directors

289.     This clause, which replaces section 285 of the 1985 Act, provides that a director's actions are valid even if his or her appointment is subsequently found to have been defective or void.

Register of directors, etc

Clause 146: Register of directors

290.     This clause replaces part of section 288 of the 1985 Act. It imposes on every company a requirement to keep a register of its directors (secretaries are dealt with in Part 12). This clause requires the register to be kept available for inspection at the company's registered office. It must be available for inspection by members (without charge) or the public (for a prescribed fee, set under powers provided under clause 744). Refusal to permit inspection is an offence. In addition, the court may compel immediate inspection of the register if the company has refused.

Clause 147: Particulars of directors to be registered: individuals

291.     This clause replaces section 289 of the 1985 Act so far as it applies to individuals. It specifies the particulars that must be entered on the register of directors for each director who is an individual (as opposed to a company or similar entity). In fulfilment of a Government commitment given in March 1998, the particulars no longer include details of other directorships held. There are also changes to the requirement to provide the director's name. The requirement is now to include any name by which the individual is or was formerly known for business purposes. As recommended by the CLR (Final Report, paragraph 11.38), there is no longer an exception for a married woman's former name. However the clause retains a protective provision relating to the former names of peers.

Clause 148: Particulars of directors to be registered: corporate directors and firms

292.     This clause replaces section 289(1)(b) of the 1985 Act. It retains the requirement for the corporate or firm name and the registered or principal office to be recorded where the director is either a body corporate or a firm that is a legal person. In addition, as recommended by the CLR (Final Report, paragraph 11.38), it requires for EEA companies the register where the company is registered and its registration number; for all others, particulars of legal form of the company or firm, the law by which it is governed, and, if applicable, where it is registered and its registration number.

Clause 149: Particulars of directors to be registered: power to make regulations

293.     This clause is a new provision. It provides power for the Secretary of State to make regulations that add or remove items from the particulars that have to be entered in a company's register of directors.

Clause 150: Duty to notify registrar of changes

294.     This clause replaces section 288(2) of the 1985 Act so far as it applies to directors. It retains the requirement that the appointment of a director, or a director's ceasing to hold office, and any change in an existing director's particulars be notified to the registrar within 14 days; default is an offence. It also requires a notice of appointment to be accompanied by evidence that the appointee has consented. This provision ensures that the public record is kept up to date.

Clause 151: Application of provisions to shadow directors

295.     This clause replaces section 288(6) of the 1985 Act. It applies to shadow directors the requirements relating to a company's register of directors and to notifying the registrar of changes in directors.

Removal

Clause 152: Resolution to remove director

296.     This clause replaces, without change, section 303 of the 1985 Act. Subsection (1) provides that an ordinary resolution is sufficient to remove a director, but requires that it be at a meeting so as to ensure the director's right to be heard.

Clause 153: Director's right to protest removal

297.     This clause replaces section 304 of the 1985 Act. There is no change of substance.

CHAPTER 2: GENERAL DUTIES OF DIRECTORS

Clauses 154 to 164: General comments

298.     The general duties form a code of conduct, which sets out how directors are expected to behave; it does not tell them in terms what to do. More particularly, the duties address:

• the possibility that a director may put his own or other interests ahead of those of the company;

• the possibility that he may be negligent.

299.     The duties are derived from equitable and common law rules, and are not at the moment written down in statute.

300.     The Law Commission and the Scottish Law Commission recommended that there should be a statutory statement of a director's main fiduciary duties and his duty of care and skill in their joint report Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties. The CLR's main recommendations in respect of directors' general duties are summarised in chapter 3 of the Final Report.

301.     The CLR recommended that there should be a statutory statement of directors' general duties, and that this should, with two exceptions, described in the next paragraph, be a codification of the current law. In particular they wanted:

• to provide greater clarity on what is expected of directors and make the law more accessible. In particular, they sought to address the key question "in whose interests should companies be run?" in a way which reflects modern business needs and wider expectations of responsible business behaviour;

• to make development of the law in this area more predictable (but without hindering development of the law by the courts);

• to correct what the CLR saw as defects in the present duties relating to conflicts of interest.

The Government has accepted these recommendations.

302.     There are two areas, both relating to the regulation of conflicts of interest, where the statutory statement departs from the current law:

• under clause 159, transactions or arrangements with the company do not have to be authorised by either the members or by the board; instead interests in transactions or arrangements with the company must be declared under clause 161 (in the case of proposed transactions) or under clause 165 (in the case of existing transactions) unless an exception applies under those clauses;

• clause 159 also permits board authorisation of most conflicts of interest arising from third party dealings by the director (e.g. personal exploitation of corporate resources and opportunities). Such authorisation is effective only if the conflicted directors have not participated in the taking of the decision or if the decision would have been valid even without the participation of the conflicted directors. Board authorisation of conflicts of interest will be the default position for private companies, but public companies will need to make provision in their constitutions to permit this. Board authorisation is not permitted in respect of the acceptance of benefits from third parties (clause 160).

303.     Both reforms implement recommendations of the CLR, which noted that the basic principles in the current law relating to directors' conflicts of interest are very strict:

• they noted that in practice most companies permit a director to have an interest in a proposed transaction or arrangement with the company, provided that the interest is disclosed to his fellow directors. The statutory statement therefore reflects the current position in most companies;

• they also took the view that the current strict rule relating to conflicts of interest in respect of personal exploitation of corporate opportunities fettered entrepreneurial and business start-up activity by existing company directors. The statutory statement therefore provides for board authorisation of such conflicts.

Codification of common law rules and equitable principles

304.     Codification is not a matter of transposing wording taken from judgments into legislative propositions. Judgments are, of necessity, directed at particular cases. Even when they appear to state general principles, they will rarely be exhaustive. They will be the application of (perhaps unstated) general principles to particular facts. In the company law field, the principles being applied will frequently be taken from other areas, in particular trusts and agency. It is important that these connections are not lost and that company law may continue to reflect developments elsewhere. Frequently the courts may formulate the same idea in different ways. In contrast legislation is formal. It is not easy to reconcile these two approaches but the draft clauses seek to balance precision against the need for continued flexibility and development. In particular:

• subsection (3) of clause 154 provides that the statutory duties are based on, and have effect in place of, certain common law rules and equitable principles;

• subsection (4) of clause 154 provides that the general duties should be interpreted and applied in the same way as common law rules and equitable principles. The courts should interpret and develop the general duties in a way that reflects the nature of the rules and principles they replace;

• subsection (4) of clause 154 also provides when interpreting and applying the statutory duties, regard should be had to the common law rules and equitable principles which the general duties replace; thus developments in the law of trusts and agency should be reflected in the interpretation and application of the duties;

• clause 162 provides that the civil consequences of breach (or threatened breach) of the statutory duties are the same as would apply if the corresponding common law rule or equitable principle applied. It also makes clear that the statutory duties are to be regarded as fiduciary, with the exception of the duty to exercise reasonable care skill and diligence which is not under the present law regarded as a fiduciary duty;

• subsection (4) of clause 164 preserves the current law on prior authorisation of conduct that would otherwise be a breach of the duties.

305.     The statutory duties do not cover all the duties that a director may owe to the company. Many duties are imposed elsewhere in legislation, such as the duty to deliver accounts and reports to the registrar of companies (clause 419). Other duties remain uncodified, such as any duty to consider the interests of creditors in times of threatened insolvency.

Duties owed to the company

306.     Clause 154(1) makes it clear that, as in the existing law, the general duties are owed by a director to the company. It follows that, as now, only the company can enforce them. Part 11 (derivative claims and actions by members) describes the mechanism whereby members may be able to enforce the duties on behalf of the company.

Who are the duties owed by?

307.     The duties are owed by every person who is a director of a company (as defined in clause 229). They are therefore owed by a de facto director in the same way and to the same extent that they are owed by a properly appointed director.

308.     Certain aspects of the duty to avoid conflicts of interest and the duty not to accept benefits from third parties continue to apply even when a person ceases to be a director; this is necessary to ensure that a director cannot, for example, exploit an opportunity of which he became aware while managing the company's business without the necessary consent simply by resigning his position as director. The closing words of clause 154(2) provide that the duties apply to a former director subject to any necessary adaptations. This is to reflect the fact that a former director is not in the same legal position as an actual director.

309.     The statutory duties apply to shadow directors where, and to the extent that, the common law rules or equitable principles which they replace so apply (clause 154(5)). This means that where a common law rule or equitable principle currently applies to a shadow director, the statutory duty replacing that common law rule or equitable principle will apply to the shadow director (in place of that rule or principle). Where the rule or principle does not currently apply to a shadow director, the statutory duty replacing that rule or principle will not apply either.

The relationship between the duties

310.     Many of the general duties will frequently overlap. Taking a bribe from a third party would, for example, clearly fall within the duty not to accept benefits from third parties (clause 160) but could also, depending on the facts, be characterised as a failure to promote the success of the company for the benefit of its members (clause 156) or as an aspect of failing to exercise independent judgment (clause 157).

311.     The effect of the duties is cumulative, so that it is necessary to comply with every duty that applies in any given case. This principle is stated in clause 163. One exception relates to the duty to avoid conflicts of interest (clause 159). This particular duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company. In such cases the duty to declare interests in proposed transactions or arrangements (clause 161) or the requirement to declare interests in existing transactions or arrangements (clause 165) will apply instead.

312.     The cumulative effect of the duties means that where more than one duty applies, the director must comply with each applicable duty, and the duties must be read in this context. So, for example, the duty to promote the success of the company will not authorise the director to breach his duty to act within his powers, even if he considers that it would be most likely to promote the success of the company.

313.     As well as complying with all the duties, the directors must continue to comply with all other applicable laws. The duties do not require or authorise a director to breach any other prohibition or requirement imposed on him by law.

Relationship between the duties and the company's constitution

314.     Under clause 155 a director must act in accordance with the company's constitution.

315.     Companies may, through their articles, go further than the statutory duties by placing more onerous requirements on their directors (e.g. by requiring shareholder authorisation of the remuneration of the directors). The articles may not dilute the duties except to the extent that this is explicitly permitted by the clauses:

• clause 157 provides that a director will not be in breach of the duty to exercise independent judgment if he has acted in a way that is authorised by the constitution;

• clause 159 permits authorisation of some conflicts of interest by independent directors, subject to the constitution;

• clause 164(4) preserves any rule of law enabling the company to give authority for anything that would otherwise be a breach of duty.

316.     The company's constitution may also set out the purposes of the company, especially in the case of an altruistic company which has purposes other than the benefit of the company's members. It is very important that directors understand the purposes of the company, so that they are able to comply with their duty to promote the success of the company in clause 156.

Relationship between the duties and the detailed rules requiring member approval of conflicts of interest

317.     Under the provisions in Chapter 4 of this Part, the directors must sometimes obtain prior shareholder approval for the following types of transaction involving a director (or, in some cases, a person connected to a director): long service contracts; substantial property transactions; loans, quasi loans and credit transactions; and payments for loss of office.

318.     Clause 164 provides that:

• compliance with the general duties does not remove the need for member approval of such transactions (subsection (3));

• (subject to the exception set out in the bullet point below) the general duties apply even if the transaction also falls within Chapter 4 (because it is a long service contract, substantial property transaction, loan, quasi-loan, credit transaction or payment for loss of office). So, for example, the directors should only approve a loan to a director if they consider that it would promote the success of the company. This is so, even if the loan does not require the approval of members under Chapter 4 because it falls within a relevant exception, such as the exception for expenditure on company business in clause 185;

• if the transaction falls within Chapter 4 (because it is a long service contract, substantial property transaction, loan, quasi-loan, credit transaction or payment for loss of office) and approval of the members is obtained to the transaction in accordance with that Chapter, or an exception applies, so that approval is not necessary under that Chapter, then the director does not need to comply with the duty to avoid conflicts of interest (clause 159) or the duty not to accept benefits from third parties (clause 160) in respect of that transaction. All other applicable duties will still apply. For example, a director would not be acting in breach of the duty to avoid conflicts of interests if he failed to obtain authorisation from the directors or the members for a loan from the company in respect of legal defence costs.

Relationship between the duties and the general law

319.     Clause 164(5) provides that the general duties have effect notwithstanding any enactment or rule of law except where there is an express or implied exception to this rule. For example, clause 226 provides that directors may make provision for employees on the cessation or transfer of a company's business even if this would otherwise constitute a breach of the general duty to promote the success of the company.

Consequences of breach

320.     Clause 162 preserves the existing civil consequences of breach (or threatened breach) of any of the general duties. The remedies for breach of the general duties will be exactly the same as those that are currently available following a breach of the equitable principles and common law rules that the general duties replace.

321.     Subsection (2) makes it clear that the duties are enforceable in the same way as any other fiduciary duty owed to a company by its directors (except for the duty to exercise reasonable care, skill and diligence, which is not considered to be a fiduciary duty). In the case of fiduciary duties the consequences of breach may include:

• damages or compensation where the company has suffered loss;

• restoration of the company's property;

• an account of profits made by the director; and

• rescission of a contract where the director failed to disclose an interest.

COMMENTARY ON INDIVIDUAL DUTIES

Clause 155: Duty to act within powers

322.     This duty codifies the current principle of law under which a director should exercise his powers in accordance with the terms on which they were granted, and do so for a proper purpose. What constitutes a proper purpose must be ascertained in the context of the specific situation under consideration.

323.     This duty codifies the director's duty to comply with the company's constitution. The constitution is defined for the purpose of the general duties in clause 236. As well as the company's articles of association it includes:

• decisions taken in accordance with the company's articles; and

• other decisions taken by the members (or a class of them) if they can be regarded as decisions of the company, for example a decision taken by informal unanimous consent of all the members.

Clause 156: Duty to promote the success of the company

324.     This duty, which codifies the current law, enshrines in statute what is commonly referred to as the principle of "enlightened shareholder value". The duty has two elements:

• a director must act in the way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole;

• in doing so, the director must, so far as reasonably practicable, have regard to the factors listed in subsection (3). This list is not exhaustive, but highlights areas of particular importance which reflect wider expectations of responsible business behaviour.

325.     The decision as to what will promote success, and what constitutes such success, is one for the directors' good faith judgment. This ensures that business decisions on, for example, strategy and tactics are for the directors, and not subject to decision by the courts, subject to good faith.

326.     Subsection (2) addresses the question of altruistic, or partly altruistic, companies. Examples of such companies include charitable companies and community interest companies, but it is possible for any company to have "unselfish" objectives which prevail over the "selfish" interests of members. Where the purpose of the company is something other than the benefit of its members, the directors must act in the way they consider, in good faith, would be most likely to achieve that purpose. 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.

327.     Subsection (3) specifies certain factors to which the directors are to have regard:

• in doing so, their duty to exercise reasonable care, skill and diligence will apply. It will not be sufficient to pay lip service to the factors. In many cases they will need to take action to comply with this aspect of the duty;

• they are required to have regard to the factors "so far as reasonably practicable". This makes it clear that directors must do all that they reasonably can to have regard to the factors, for example by thinking through the long-term consequences of their decisions, and addressing potential risks. At the same time, directors are not required to do more than is practically possible in the circumstances of any particular business decision.

328.     In requiring directors to have regard to the interests of employees, this provision replaces section 309 of the 1985 Act.

329.     Subsection (4) recognises that the duty to promote the success of the company is displaced when the company is insolvent. Section 214 of the Insolvency Act 1986 provides a mechanism under which the liquidator can require the directors to contribute towards the funds available to creditors in an insolvent winding up, where they ought to have recognised that the company had no reasonable prospect of avoiding insolvent liquidation and then failed to take all reasonable steps to minimise the loss to creditors.

330.     It has been suggested that the duty to promote the success of the company may also be modified by an obligation to have regard to the interests of creditors as the company nears insolvency. Subsection (4) will leave the law to develop in this area.

Clause 157:     Duty to exercise independent judgment

331.     This duty codifies the current principle of law under which directors must exercise their powers independently, without subordinating their powers to the will of others, whether by delegation or otherwise (unless authorised by or under the constitution to do so).

332.     The clause provides that directors must not fetter the future exercise of their discretion unless they are acting:

a)     in accordance with an agreement which has been duly entered into by the company; or

b)     in a way authorised by the company's constitution.

333.     The duty does not confer a power on the directors to delegate, or prevent a director from exercising a power to delegate conferred by the company's constitution provided that its exercise in accordance with the company's constitution. Under the draft model articles of association for private companies limited by shares, the directors may delegate their functions in accordance with the articles.

Clause 158: Duty to exercise reasonable care, skill and diligence

334.     This duty codifies the director's duty to exercise reasonable, care, skill and diligence. Traditionally, the courts did not require directors to exhibit a greater degree of skill than may reasonably be expected from a person with their knowledge and experience (a subjective test). More recently, the courts have said that the common law standard now mirrors the tests laid down in section 214 of the Insolvency Act 1986, which includes an objective assessment of a director's conduct. This clause is modelled on that section.

335.     The clause provides that a director owes a duty to his company to exercise the same standard of care, skill and diligence that would be exercised by a reasonably diligent person with:

a)     the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as the director in relation to that company (an objective test); and

b)     the general knowledge, skill and experience that the director actually has (a subjective test).