UK Companies Act shackles Directors with statutes

LEGAL EYE

The new UK Companies Act, slated to be operative through 2007-08 is the biggest legislative event since Sarbanes-Oxley.

The Act has pioneered various measures, of which the most controversial is the codification of the Director's duties or the "enlightened shareholder value" provisions of Section 172, which seek to rationalise and statutorily classify the Director's fiduciary duties, rather than relying on common law principles.

Section 172 requires a Director to act in good faith to promote the 'success' of a company for the benefit of its members, with due regard to probable long-term consequences, interests of employees, suppliers and customers, implications for the environment and concerns of the community at large, combined with the desired objective of maintaining high standards of reputation in business conduct. True to the spirit of corporate governance, Sections 173 & 174 expect Directors to exercise independent judgement, as well as reasonable care, skill and diligence in discharge of their duties, commensurate with their functions, skill and experience.

The term 'success' which has replaced the existing concept of fiduciary interest being that of the company's best interests, is not defined, but understood as to constituting long-term increase in value.

This pluralist approach in Directorial decisions has caused considerable concern as to how the various considerations under Section 172 are to be applied, and what would be the outcome in the case of a conflict.

The trick is to ensure that the Board maintains detailed records of the process in which various factors were considered and evaluated in order to arrive at business decisions, till such time that such decisions get the go ahead or are rejected in the courts.

A deeper cause for the anxiety of Directors is that the Act envisages a greater ability for shareholders to bring derivative actions on behalf of the company against the Board. For the first time, a Director's duty has been put on a statutory footing.

There is increased apprehension that the derivative claims will become an increasingly common feature in the UK. The new law provides for statutory claims to be brought against a Director in relation to any act or omission involving negligence or breach of duty by such Director. Such a claim can be initiated by a member, in respect of a cause of action vested in the company, to seek relief on the company's behalf and cost. The member who initiates such claim has to apply to the court to establish a prima facie case for grant of leave to continue. Of course, the veracity of such claims would have to be established.

Notwithstanding probable downsides, the dedication and commitment in making the Act happen is worth emulation. The contrast of various amendments, the Naresh Chandra and Irani Committees reports, the draft Companies Bill 2004 all in cold storage, speak for itself.

Kumkum Sen is a Partner at Rajinder Narain & Co, and can be reached at kumkumsen@rnclegal.com