UNIT 3 - DIRECTOR'S DUTIES 1: S172 DUTY TO PROMOTE THE SUCCESS OF THE COMPANY; ENLIGHTENED SHAREHOLDER VALUE AND CORPORATE GOVERNANCE

Remember the importance of the statutory factors of s172, what is important in relation to bigger companies? -

- Bigger companies must abide by certain criteria of corporate governance i.e. those companies traded on the Stock Exchange

What was held in West Mercia v Dodd? (1988) -

- CA (reversing judge at first instance) held this was a preference and a breach of duty - Reliance was placed on Australian case Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) - When a company is solvent, the proprietary interests of the shareholders entitle them to be regarded as the company, but where a company is insolvent, the interests of the creditors intrude

What is another case to be considered in regards to s.172 and DDs? -

- Charterbridge Corp Ltd v Lloyd's Bank Ltd (1970). This involved a case of ultra vires which is now referred to in relation of s.172 and s.173. - Mr and Mrs Pomeroy were the only shareholders and director of Castleford Limited. - Mr P owned a number of other companies, including Pomeroy Ltd. The business of the companies was property investment. - Castleford took a lease of land, guaranteed by P Ltd. P Ltd paid the rent and developed the land.

To what extent has s172 changed the law? -

- Solidified the law, has it changed it? - Shareholders still ultimately only have rights to do something about a breach

What is under s.172 of CA 2006? -

- " A director of a company must act in the way he considers, in good faith, would be most likely to promote th success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters)..." - Does amongst other matters infer shareholders? - This is the duty of a director to promote success. This area holds numerous debates of corporate governance and question how success is measured. Is it financially? - This includes 2 things, the element of subjectivity and the meaning of company.

What provides academic analysis of corporate governance? -

- "Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment" (A Shleifer and R W Vishny) - "A whole set of legal, cultural and institutional arrangements" which determine the activities and control of listed companies and who bears the risk and takes the rewards of such activities (M Blair) - "the issue of the relationship between the stakeholders in a company and those who manage its affairs (the board of directors)" (D D Prentice)

What are a few definitions of corporate governance? As there is no single definition? -

- "the system by which companies are directed and controlled" (DTI Consultation Doc, March 1998) - "sets out standards of good practice in relation to board leadership and effectiveness, remuneration, accountability and relations with shareholders" (FRC) - "involves a set of relationships between a company's management, its board, its shareholders and other stakeholders [it] provides the structure through which the objectives of the company are set, and the means of attaining those objectives of monitoring performance are determined". (OECD Principles of Corporate Governance)

What occurred after 1999 in the case of Extrasure? -

- 17 Aug 1999, S and B instructed Extrasure's bank to transfer £200,000 to IHL and then on to Citygate and hen to a creditor of Citygate. - Use of financial reserves from Extrasure to Inbro to Citygate to the creditor of which Citygate owed money. - 13 Sep 1999, Citygate is insolvent, receivers are appointed. - Extrasure's business sold and E Ltd, a new owner of business brings proceedings for a breach of duty based on the transfer not being in the best interest of Extrasure and on improper purpose. This was based on the £200,000 transfer prior not being for the proper purpose.

What happened after September 1990 in Regentcrest plc v Cohen? -

- 5 Sep 1990, there was a board meeting to waive claims under the clawback provision by DR and RR alone voting in consideration of the provision of services by MC, Scott and Farley. DR and RR choose to waive rights of clawback for help given in difficult period. - 17 Sep 1990, petition for winding up of R. - 21 Nov 1990, compulsory winding-up order made and the company went into liquidation. - Claim against DR for breach of fiduciary duty in relation for voting to waive clawback claim. - The liquidator claimed: insolvent company, no assets, debts. Could have had £1.5 million agreement under clawback provision.

What was the decision in Re Smith & Fawcett 1942 in relation to subjectivity of the duty to act in the best interest of the company (prior to duty s.172 of CA 2006)? -

- Articles in the case provided that the director may at any time in their absolute and controlled discretion refuse to register any transfer of shares - Principle to be applied where articles confer a discretion on directors regarding acceptance of transfer of shares: they must exercise discretion bona fide in what they consider - not as a court may consider - is in the interests of the company, and not for collateral purpose - Director NS did not have to give reason for his 'no' decision, unless it was proved that he acted in bad faith for improper purpose to the courts discretion but there is no evidence from just merely wanting to purchase shares. The transfer article in speculation was agreed by original shareholders. - Director NS was entitled to his decision. This case is a demonstration of an unfair end result?

Consider elements and nature of duty in s172, in particular the evolution of the duty to promote success of the company prior to CA 2006 -

- Before 2006, the law of directors' duties was not codified but common law duty, fiduciary duty. The law recognised duties of directors but there was no legislative reference. The duty was to act in good faith and best interests for the benefit of the company as a whole (subjective). CL test: bona fide, benefit (profit, growth, security (future), long term value, provision of needed goods/services, reputation, ethical/moral. Court will have mainly used PROFIT as a determinant.) company as a whole (stakeholders, shareholders, creditors become important in insolvency demonstrated by West Mercia, directors, employees (s309 CA 1985, employees are an interest group). Court will have mainly used SHAREHOLDERS as a determinant. - Once the company is insolvent and cannot pay debts, the interests in the company are dominated by what is in the best interests of the creditors - A subjective test, clear from the beginning

What was the result of Regentcrest plc v Cohen 2001? -

- Consider was the director in breach for that decision? - Court examined factual background in some detail and viability of company at 5 September. This was the date of the board meeting waiver for the clawback agreement. -"The central issue in the case is whether... DR honestly believed that he was acting in the best interest of Regentcrest". - Law: the duty is subjective, the director's state of mind is relevant, not that of the court. - When considering evidence, there is a danger of applying hindsight.

What is a broader overview to consider of s172? -

- Consider: has the duty has been changed due to the wording of the Act to change the underlying duty of a director to act in the best interests of the company? - This has generated considerable academic debate and practitioner/business concern, s172 appears to focus the extent of the need to consider other matters, the nature of the company and the meaning of success - Most commentators think that the section does not really alter the common law position and does not and has not changed from the intro of s172. - D's must be more specific when considering their decisions under s172. Any rational board would take factors into account - Judicial reaction to s172: Re Coroin Ltd [2012] approved the assessment of subjectivity in Regentcrest; s172(3) raising prominence of duty to creditors

What did the court decide in Regentcrest plc v Cohen 2001? -

- Court estimated that they would have secured £50,000 on the date of 5 Sep, which is a loss but not the 1.5million that was claimed by the liquidator. - It was held to be of honest thought, no breach of duty occurred. - Court avoid using hindsight for company history. The Ds were unsure of end result when taking the decision at the time of taking the decision. When questioning whether the decision was in the best interests, the court held that it was in the best interest of the company.

What needs to be remembered in relation to duties? -

- Duties are cumulative, actions or behaviours can result in a breach of a number of duties/decisions are made on a case pleaded - it is the company decision of which director has breached which duty and an attempt to amend this (i.e. duty of reasonable skill and care)

When looking at all cases remember -

- Duties are cumulative; - An action/behaviour can breach a number of duties - Decisions are made based on the case pleaded - Company decision of which duty has been breached by the director and whether they attempt to amend this

What are the origins of the duty under s.172? -

- Duty involve reasonable skill, reducing conflicts of interest, multiple duties to consider. - Previously a duty under common law to act bona fide in the best interest of the company. - Remember to consider subjectivity

How is s172 duty enforced and by whom? -

- Duty is enforced by the company's constitution and the articles of association. It is owed to the company and is enforced by all members of the company including stakeholders. The duty is owed to the company, not the stakeholders. Directors owe a duty to the company, if the company thinks there is a breach they sue the director. It is difficult to sue directors as a difficulty of director duty involves directors generally deciding who sues. Shareholders in a small plc, the directors, the same situation applies unless there is a min. shareholder that is at odds with the maj. shareholder then an action could be brought in that case. Reasons for shareholders not suing directors for a remedy (damages/accounted profit) for breach of duty: money; counter productivity; reputational damage Liquidators/Administrators exercise full power of board of directors, when the company is insolvent company damages etc doesn't matter. Breaches have been committed and the suing can commence. Restraints do not apply in insolvency, this is why most of the cases are insolvency. i.e Regentcrest - insolvency as the liquidator tries to recover as much as possible but nothing left to lose in terms of the reputation, the company The duty is owed to the company, the company decides who to sue. Directors are often dismissed, could resign.

Has there been a change in the nature of the duty under s172? What is the purpose of a company? -

- Has/will the wording of s172(1) changed/change the nature of the statutory duty? - the matters listed in s172(1)(a) to (f) reflect the concept of "enlightened shareholder value", which recognises the effects of a company's actions on constituencies beyond the shareholders - however, the primary duty is framed in the terms of the members - what is the purpose of a company? shareholder primacy/enlightened shareholder value/pluralism

What are the possible duties owed to creditors? -

- If the company is solvent, and there is no indication of it becoming insolvent, there is no directors' duty to creditors - If the company is already insolvent, then duties are owed effectively to the creditors, through the liquidator - In situations of doubtful solvency, the position is not so clear: it seems the law may, in certain circumstances, impose a duty on the directors to act in the interest of the creditors of the company - insofar as there is such a rule, CA 2006 preserves this position as demonstrated in West Mercia Safetywear v Dodd

What occurred in Regentcrest plc v Cohen from 1990? -

- In early 1990: General collapse of commercial property market, R was in serious financial difficulties. The interest exceeded rent, the banks were concerned about value/security. The board planned a rights issue Half yearly results showed significant decline in value Events of default - In May 1990, DR and RR acquired remaining shares in R. DR and RR injected own (unsecured) resources to assist company R meet its cash flow needs: £2 million in June 1990, £3 million in Aug 1990. - Directors were now DR, RR, MC, Scott and Farley. (vendors of land became directors.)

What are the parties to consider? -

- In order: Shareholders, Directors, Managers, Employees, Creditors (bondholders, secured, unsecured), Gatekeepers (auditors, lawyers), The community/society

What is to be considered from the case of Extrasure? -

- Issues to consider include: - whether the directors did in fact consider that the transfer was in the best interests of the company - Was it in the best interests of Extrasure because it had the effect of discharging a debt owed to IHL? (for the better of the company group) - Was it in the best interests of IHL because it was calculated to ensure the group's survival, including that of Extrasure itself? - If the directors gave no independent consideration to the question, would a reasonable director in their position have reached that conclusion? - The court held S + B in a breach of duty. Neither director had an opinion on whether the transfer was of the best interest of either company and therefore no consideration or thought was given to the best interests of the company - A rare example of case success in a breach of DD s.172 'to promote success'.

What is stated in s.172(3)? -

- It states that 'the duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company'.

What are other factors that directors should have 'regards to' to be compliant with s172? Which factor should take primacy and why? -

- Middle ground of stakeholder theory A-F s172 CA 2006. Down side of this: lack of authority and enforcement is still present. Only a company can sue itself, the court cannot be involved in company matters otherwise. This does not give stakeholders anything in particular to hold accountable for. However, a regulatory framework in which companies can operate on a massive scope.

What occurred in Extrasure Travel Insurances Ltd v Scattergood 2003 (prior to intro of statute CA 2006) in regards to directors duties to act bona fide for the benefit of the company? -

- Mr Scattergood owned 51% shares in Inbro Holdings Ltd. It was a group company with 2 wholly owned subsidiaries. The subsidiaries were Extrasure - an insurance intermediary (not regulated) and Citygate - an insurance broker (regulated). - At the relevant time, S was the director of Extrasure, de facto director of IHL and attended the board meetings of Citygate. - B was a director of IHL, E and C - all 3 companies.

In which case were the discretionary powers of the director assessed to be in the interests of the company? -

- Mutual Life Insurance Co v ROL - By articles of allotment of shares under the control of the directors ('discriminated' against shareholders as reason for breach) - P argued the breadth of the director's discretion was controlled by a requirement to afford all members (of a particular class) equal treatment - Question: did the directors exercise their discretionary powers in good faith, in the interests of the company? - As for fairness between different shareholders, equality.. does not always require an identity of treatment - Court did not agree that all shareholders needed to be treat equally, as long as the choices benefit the company as a whole, shareholders did not need to be treat similarly, all the time.

Which case involved a 'membership contract'? -

- Mutual Life Insurance Co v ROL (1985) - Public offers of shares by company ROL, half of which offered on a preferential basis to existing shareholders, except those resident in US or Canada - Certain shareholders were sued on the basis of a breach of 'membership contract' NOTE: the duty is owed to the company (not the shareholders)

What was the result of Charterbridge? -

- Obiter (as not necessary for this decision) "In the absence of actual separate consideration, whether an intelligent and honest man in the position of a director... could, in the whole of existing circumstances, have reasonably believed that the transactions were for the benefit of the company" - On these facts, the directors could have so believed

What was the authority for directors' duties prior to the introduction of the CA 2006? -

- Previously there was no law of directors duties and it was not codified in legislation. It was judge made law. The law recognised clear duties of directors but no legislative reference was made until the intro of CA 2006 in which the Parl. interpreted the common law and attempted to make statute in line with the existing common law i.e. 'for the benefit of a company as a whole', success and the promotion of it. In 2006, the Parl changed the nature of some of the duties.

What is a more recent case to consider prior to CA 2006? -

- Regentcrest plc v Cohen 2001. In this case, the company through subsidiaries carried out property development. The properties were used as the loan to the banks. In property development, there is dealing in properties with capital growth for profits/cash flow and properties used as security for bank borrowings. - In 1985, DR and RR acquired 29.9% interest through a holding company and became directors of R. - April 1987, R merged with another company, DR/RR interest was reduced to 13%. - In July 1988, R acquired shares in Greenground which owned development land. The vendors were MC, Scott and Farley. The agreement to buy land contained a clawback provision. This is a clause which entitles the purchasers to claw back money of £1.5 million of the purchase price from the vendors. This is normal in commercial situations.

What occurred in Charterbridge Corp? -

- Renegotiations with the bank led to a "chain of guarantees" by Mr P and various companies - This included a guarantee and a charge given by C Ltd for debts and liabilities of P Ltd (which included cross guarantees) - Mr P was looking to interests of group as a whole, not C Ltd separately from the group

What is considered as the governance framework? -

- Role of company/insolvency law - Other areas which are legally regulated e.g. employment, environment, consumer - Regulation for listed companies * Corp governance codes (Cadbury, Greenbury, Hampel, Higgs, Walker) * Seeking shareholder engagement, system of non-executive directors and independent committees for audit, remuneration * Comply or explain

What is 'stakeholder theory' and what are the company stakeholders? -

- Stakeholders are any person that has a stake, an interest in the company. From directors, to workers, to the community, to shareholders etc. - A company is a set of contracts between different people, only difference of stakeholders is that shareholders have capital. There is an importance of being an integrated company as more than just the shareholders, stakeholders are important in operating a business even the community and the environment. The government are a potential stakeholder through tax, similarly as the tax payer. - Company is not just a machine to maximise profit, there are other interest groups with legitimacy to consider. Part of corp gov to promote good business practice, considering ethics and morals.

Where is the subjective basis of s172 confirmed? -

- The basis of the statutory duty is confirmed by the wording of s172(1) - However, the more objectively unreasonable the transactions involve, the more difficult the director will find it to convince the court that he could have honestly believed he was acting in the company's interest

Who enforces the duty? -

- The company The company as a proper claimant (directors) as in Extrasure v Scattergood - The insolvent company The liquidator/administrator as in Regentcrest - Ratification The members may decide to ratify a director's breach of duty - Relief by the court Under CA 2006, s1157, the court has power to grant relief to a director in breach of duty, subject to strict conditions

Why is the test beneficial as a subjective one? -

- The court should not affect business decisions. Judges do not want to intervene with company decisions therefore a subjective test must be used. - Consider retrospective bias, by the court looks at the decisions, they know what happened at the end, not during i.e. Richardson brothers in Regentcrest, decision would be tainted by hindsight.

What is 'shareholder primacy'? -

- The directors are instead required to act in the interests of the shareholders as it is their property. Investments and therefore control for the results, therefore to consider shareholders. - Do other stakeholders have legal protection? i.e. customers have consumer protection, employees have employment law. Certain statutory rights that are independent of the company.

What is important in regards to s.172(1)? -

- The element of subjectivity. The duty is subjective. The directors must act in the 'best interests' of the company, in a way most likely to promote success of the company. There is no objectivity of this test. - As this duty is subjective, it is difficult to find people that breach this duty in particular as the courts do not want to second guess company initiative. - As long as there is honest belief, the duty is fulfilled. - As long as it was in the best interests of the company to 'promote success' then the director is not liable.

On what basis was the fiduciary duty judged? -

- The fiduciary duty was judged on a subjective basis - i.e. the court asked whether the director in good faith (honestly) believed that he was acting in the company's interests - not whether the court might (objectively) consider that his actions were detrimental to the company - see strong statements to this effect in cases like Re Smith and Fawcett 1942, Regentcrest plc v Cohen 2001, Extrasure Travel Insurances Ltd v Scattergood 2003.

What is enlightened shareholder value ESV? -

- The idea that corporations should pursue shareholder wealth with a long-run orientation that seeks sustainable growth and profits based on responsible attention to the full range of relevant stakeholder interests - Should shareholder values be guarded as they are the main guardian of the company?

What is the meaning of company/What does a company consist of? -

- The legal separate entity, shareholders, stakeholders.

What is the meaning of company to consider? -

- The meaning of company As a legal entity itself, shareholders, stakeholders, various interest groups to consider (though there is not an equal impact of the decisions of the factors). s172 highlights a) - f) statutory factors to consider in regards to the meaning of a company. Gives some guidance of corporate governance decisions to make informed choices i.e. the likely consequence of decisions in the long term, interests of company employees

What is the fiduciary duty under s.172? -

- The s.172 duty is based on the equitable duty of a director to act bona fide in the [best?] interest of the company

How will the court establish whether a directors' act promotes the success of the company? -

- There are 2 things to consider when 'promoting success' (a shift from 'benefit the company as a whole') from considerations of subjectivity and the meaning of company. It is a subjective duty and the director(s)must act in a way most likely to promote the success of a company. There is no objectivity to the test. As long as there is honest belief that the director acted in a way to best promote the success of the company, the duty is fulfilled. The court do not want to second guess company initiatives, it doesn't matter if the court does not agree.

Where is the duty owed to creditors based in statute? -

- There is a clear 'duty to creditors' under s172(3) CA 2006 "the duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company". - Was a principle in common law before intro of ss3 - This is linked to the concept of the nature of the company. - Duty owed to creditors was given statutory significance as creditors are listed as a member whose interests should be considered at the beginning along with customers etc. - Interests in insolvency regarding creditors (firstly and most importantly): In certain circumstances, interests of creditors become more important than others, e.g. in insolvency, this duty outweighs all others as directors must preserve money owed to creditors so something can be removed by the creditors.

What were the reasons for the court to believe that the directors made their choices in the best interests and to promote success in Regentcrest plc v Cohen? (2001) -

- There was good commercial reasons why. It seems an irrational decision of the face, but it isn't as straightforward - 2 separate legal actions wanted by the liquidator 1) against all 3 vendors of the original property for specific performance of the original agreement. This collapsed because Cohen possibly didn't have the assets to provide money It could only be invoked in 2 years procedurally as the liquidator ran out of time limitations to properly serve the other two, so Cohen was served. Cohen case was closed because there was no assets to compensate, there is no point suing someone if they don't have the money 2) Liquidator suing the Richardson brothers for waiving the clawback agreement. It was only pursued against one of the brothers due to the procedural difficulty again of the limitation period - The court held no breach of duty as there was honest belief. Needed a united board of directors that held in the best interests, presented a uniformed front for the company, services for free and couldn't sue own directors at the time of unity. It was not worth £1.5million when decision was made, was worth £50,000. Only parting with that amount of money. - Subjectivity to promote success?

What was found in Re Smith and Fawcett 1942 in regards to subjectivity prior to the introduction of the CA 2006? -

- There were two shareholders which held 4001 in shares each, NS and JF. They were the only directors. JF died and upon his death, left 2000 shares to his daughter and 2001 to his son and appointed his son and widow as his executors. Executors applied to NS to be registered as members and for the son to be appointed as a director. NS refused but offered to register the 2001 and purchase the 2000. A year later, the son applied again and the director again refused. The son applied for rectification of the register. NS would be the majority shareholder in purchasing the 2000 shares from JF's daughter. The son goes to court and the transfer of shares was allowed in accordance with the will of the deceased shareholder. NS as a director was not doing anything wrong, but did he act in the best interest of the company as a director? - Court agreed with NS and he did not have to register the shares as a director.

Why is the case of Re Smith & Fawcett 1942 noteworthy? -

- This case places an emphasis on the construction of articles. There is discussion of circumstances relevant to construction - freely transferable v control in a private company. In this case, the article was drafted widely and the court would not limit it other than by its fiduciary nature. - No evidence for improper purpose

What factors should be considered in regards to s.172(1) 'amongst other matters'? -

- This highlights statutory factors to consider when considering the meaning of a company. There are various interest groups to consider, maybe not equally. They could incur an impact from the decisions on the factors to consider: 'a) likely consequences of any decision in the long term b) the interests of company's employees c) the need to foster the company's business relationships 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 as between members of the company' These are factors for directors to consider in regards to corporate governance decisions, must make an informed choice.

What were the facts of West Mercia Safetywear v Dodd (1988)? -

- WM wholly owned subsidiary AJ Dodd Ltd - Dodd was a director of both companies - Dodd has personally guaranteed AJD's overdraft - May 1984: VM owed AJD £30,000, Dodd transferred £4,000 from WM to AJD - June 1984 WM and AJD went into insolvent liquidation

How has corporate governance evolved? -

- s.172 & corporate governance - Formal considerations: Company Law Review, March '98, purpose: up to date, competitive and designed for 21st century - Relationship between company law and corporate governance identified as a major issue and the main debate as it was in need of good aspects of corporate governance - This CLR led to CA 2006. - Initial consultation by CLRSG: The strategic framework Considered the scope of company law and consulted on the approach to company with mainly ESV and pluralist approach Consider: corporate and social responsibility i.e. wider responsibilities including environment, tax etc e.g. Amazon, starbucks paying corporation tax.

Consider elements and nature of duty in s172, in particular the evolution of the duty to promote success of the company prior to after intro of CA 2006 -

- s172 biggest change is reference to 'company as a whole' as written now Stakeholders are important, a list of factors for the directors to take into account in regards to stakeholders. - Intro of CA attempting to make CL into statute. First solid statute on directors' duties. Statute could have changed the nature of some of the duties. It depends on the measure of success/benefit but these hold similar definitions therefore there may not be a massive difference between the two. There is a specific reference to reputation, good commercial practice. STAKEHOLDERS UNDER S172 c) suppliers, customers d) community and environment b) employees - Further definition of stakeholders "company as a whole". Directors are mentioned in s172 but not only them as demonstrated by A-F factors of s172 CA. - s172 CA creates more complexity, tries to articulate the importance of stakeholders and is much more explicit and clear

Note the importance of:

Enlightened Shareholder Value, the corporate purpose and corporate governance