The Law of Business and Enterprises

The Law of Business and Enterprises

Introduction

Prior to the enactment of the Companies Act 2006 (“the Act”) in 8 November
2006, common law regulated the directors’ duties in the UK. That means the principle of
stare decisis was central to the formation of rules built up through incremental decision-
making as the source of law. The judiciary had relatively adopted the laws from the
existing on, which established the duties of trustees. As such, in the 19 th century,
directors and trustees were on the same pedestal – the director duties were equated
with those of trustees. However, an examination of the position justifies the need for
reform since there was an apparent contrast or rather conflict in both the duties and the
roles. Sealy observes that the trustees, at equity have a duty and role to preserve and
conserve the assets of the trust while the practical purpose of the directors is to take
risks with the assets of the company in pursuit of profits. 1

For years, common law has apportioned the duties of care and loyalty to the
directors. The duty of care is fiduciary in the sense that it creates a principal-agent
relationship between the directors and the shareholders. Fused into the two duties was
also skill and diligence, which was concerned with the competence of the directors in
the execution of their roles as risk-takers on behalf of the company. As a fiduciary, the
directors were supposed to act in the best interests of the company. 2 Besides, the
directors were required to act for proper purpose without offending the constitutional
balances between them and the shareholders.3 Thus, they should not fetter their
discretion4, or engage in issues, which would lead to conflict of interests. 5 Additionally,
they should not misuse their positions for personal profits 6, or use any corporate
information for their own gain.7

1
Professor Sealy’s criticisms in his seminal article, “The Director as Trustee”
[1967] Cambridge Law Journal 83.
2
Re Smith & Fawcett Ltd. [1942] Ch. 304, 306 per Lord Greene M.R.
3
Hogg v Cramphorn Ltd. [1967] Ch. 254 and Howard Smith Ltd. v Ampol Petroleum
Ltd. [1974] A.C. 821 (Privy Council).
4
Fulham Football Club Ltd. v Cabra Estates plc [1994] 1 BCLC 363.
5
Aberdeen Railway Co. v Blaikie Bros (1854) 1 Macq 461
6
Regal (Hastings) Ltd. v Gulliver [1967] 2 AC 134n; [1942] 1 All ER 378, HL.
7
Cook v Deeks [1916] 1 AC 554

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From the foregoing, it is evident that common law had articulated the duties in an
elaborate and flexible manner. As such, it was possible to adapt the rules to resonate
with the changing economic and commercial conditions, considering that the business
and enterprises environment is ever dynamic. The flexibility of common law allowed the
courts the chance to meet the demanded requirements. This was because of what has
been referred to as the dynamism of common law due to its generality. 8 However, it has
not been all bloom with the common law standing on the roles and duties of directors.
For instance, the generality rather translated to ambiguity. Directors could hardly
understand their duties without seeking expert advice. Pro legal reforms appreciated the
lack of transparency and thus recommended the consolidation of the laws in the form of
a statutory law.9 Consequently, the Company Act 2006 was enacted with the aim
reforming and codifying common law.

Philosophical Underpinning of the Director Duties

The question of on whose interests should corporations be run is endemic and

has been popping up in the corporate law even before the enactment of the Act.
Common law principles were undergirded on the philosophy of shareholder primacy.
When running a company, the shareholders must put the interests of the fluctuating first
as opposed to a single or individual shareholder. 10 This is because the company is an
independent legal entity, which can have different past, present and future
shareholders. Thus, it can be construed to mean that the goal of the director is to
maximize the shareholders return on investment.11 However, the issue of maximization
of shareholders’ wealth appears to be changing with dynamics of the corporate
environment. For instance, corporate social responsibility has since changed the sole
agenda of the directors of making decisions for the benefits of the shareholders only.

Nowadays, the board of directors must consider other stakeholders such as the
larger society and the employees. The theory of rabid wealth accumulation is poised to

8
Item Software (UK) Ltd. v Fassihi [2005] 2 BCLC 91, 103-104 at paras. [41]-[43]. Per LJ Arden in obiter
9
The Law Commission Report (Law Com 261; Scot Law Com 173; Cm4436), “Company Directors;
Regulating Conflicts of Interests and formulating a Statement Duties”
10
Pervical v Wright [1902] 2 Ch. 421.
11
Parke v Daily News Ltd. [1962] Ch. 927.

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be in conflict with the interests of the larger constituency, which are the shareholders.
Thus, the maximization of profits is not an automatic role or duty of the directors; they
decisions can weight and they must be cognizant of the issues, which affect other
stakeholders. This is known as the pluralistic philosophy, which seems to be on the
other extreme end of the shareholder primacy theory. In this case, directors have to
take into consideration how their decisions affect other parties such as creditors,
members of the public, and customers among others. Hence, the new paradigm has to
forge a balance between the two extremes. Balancing the two extremes also serves to
confuse the directors and possibly undermine the legitimacy of the law. Such a setting
ends up increasing the agency costs while diminishing social wealth. 12

As such, critics have argued that the approach is self-defeating. It is impossible

for a director to effectively serve the interests of another constituency apart from the
shareholders. In that regard, Easterbrook and Fischel state that it is impossible to serve
two masters; a servant required to do so, is freed of both and thus becomes answerable
to neither of the two.13 Seeing the lacuna, the UK government resolved to cure it using
the enlightened shareholder value approach, in which good faith becomes the primary
guide of the directors.14 That paves way for the achievement of long term and
sustainable success considering the directors look at the collective good of the
company by addressing all the interests of the shareholders. The approach makes it
possible for the directors to address the welfare of employs and engage in practices,
which promote a sustainable environment. 15 While the Act does not reflect the
shareholder primacy per se, it gives the shareholders priority at the primary level but
also considers other stakeholders at the secondary level.

Do the directors have the final say?

Berle and Means famously observed that the ownership and control in a limited
liability company is separate.16 While the shareholders own the company, the board of

12
F. Easterbrook and D. Fischel, The Economic Structure of Corporate Law (Cambridge, Massachusetts,
Harvard University Press, 1991) 38.
13
Ibid
14
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255.
15
Alistair Darling, Commons Second Reading, 6 June 2006, column 125.
16
Adolf A. Berle and Gardiner Means, The Modern Corporation and Private Property, 1932.

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directors takes charge in controlling the running of the company. 17 As such, the
supervisory role of the shareholders becomes ineffective and directors always have the
final say.18 Berle and Means position have received both appraisals and criticisms. To
the critics, the shareholders yield supervisory powers over the directors. However, the
proponents of the position observe that shareholders are technically only left with the
power of appointing the board of directors. Nonetheless, going by the pronouncement of
both common law and statute, it would be erroneous to argue that the directors yield the
final say. Firstly, by the virtue of the existence of a fiduciary relationship between the
shareholders and directors it goes without saying that the shareholders are the principal
while the directors are the agents. Thus, the directors act under delegated duty, which
behooves them to act in good faith and for proper purpose.

Regardless, in the absence of the both common law and statutory law, it would
be confusing to understand the supervisory roles of the shareholders or the director
duties. It is imperative that the two are intertwined. This is because, when executing
their duties, the directors are simply responding to the supervision of the shareholders.
However, it is imperative to answer the simple yet important question of who owes
duties and to who are, those duties owed. Sections 171 to 174 are very express in
answering the question: the directors owe the company the duty. That the directors owe
the company the duties specified in ss 171 to ss 174, has an implied meaning – the
directors owes the duties to the company as a separate entity from the shareholder.
Thus, when exercising their duties, the focus is on the welfare of the company as a
whole as opposed to an individual shareholder. That is why a closer look at ss 172 (3)
reveals that the director also owe a duty to the creditors. The provision is evidence of
the deviation from the shareholder primacy philosophy; it is a movement towards the
doctrine of the enlightened shareholder value, which places the long-term interests of
the company first.19

Fiduciary and Non-Fiduciary Duties

17
Ibid
18
Ibid
19
Supra nt. 14

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Notably, the Act fails to separate expressly the fiduciary and non-fiduciary duties
the way common law does. Perhaps the framers of the law saw no value in separating
the two since it was a continuation of the then present law. 20 However, it would be a
breeding ground for injustices if the two were not separated. This is because there is
wide berth between the repercussions of a breach of either of the two duties. For
example, the breach of a fiduciary duty would lead for a claim of damages for profits lost
while non-fiduciary duties would not allow that. As such, it is imperative to differentiate
the two as laid down in the Act although it has not separated them expressly. For
instance, section 171 provides that the director must act within the powers granted to
him by the constitution. That not only imposes a fiduciary duty on the directors but also
shows how the Act has enhanced the supervisory powers of the shareholders.

A company’s constitution is a very crucial document. It delegates the powers of

the shareholders to the directors. It is the basis of the fiduciary relationship. It is
evidence of what the principal needs the agent to do. As such, it is a symbol of the
supervisory role of the shareholders over the directors. Thus, the provisions of ss 171 of
the Act enhance the exercise of supervisory powers and control of the shareholders by
invoking that directors must follow the constitution. The logic behind the provision is to
prevent the risks, which may ensue from unwary directors who would fail to follow the
resolutions of the members. That the members are responsible for passing the articles
of association is a clear indicator they wield both supervisory powers and control. For
example, by imposing the duty of for proper purpose, a director cannot usurp his powers
and dilute the shareholding of a shareholder he does not like. That shows that the
assertion by Berle and Means21 is far-fetched: directors do not have the final say over all
the company matters.

Good Faith: Directors’ Say v. Shareholder Control

However, on the issue of good faith, it appears the law has given directors ample
powers. Possibly, the meanings construed under section 172 (1) for instance, supports
the view that director may possibly be having the final say. Similar to the principle in Re

20
Company Law Review Steering Group, “Completing the Structure”. Para 3.12
21
Supra nt. 16

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Smith & Fawcett Ltd.22, the act has retained the concept of good faith at section 172 (1).
Indeed, the principle of good faith grants the directors a lot of power regarding
commercial decisions. Whenever directors make a commercial decision, the court
desists from interfering with such decisions. Courts have held that they can only
interfere if there is sufficient proof that directors acted mala fides.23 As such, suffice it to
say, provided the decision of the management is bona fide arrived at, meaning they
acted in good faith, the courts will not have an avenue to set aside such a judgment.
Thus, the provisions of section 172 (1) reflects the averments of Berle and Means that
“the owners rely on the board of directors to represent their interests.

Nonetheless, it would be superficial to conclude that section 172 (1) expressly or

impliedly issues the directors the final say on company matters. Section 174 provides
an objective window, which allows for the examination of director’s act even though
done in good faith. In addition to the duty of acting in good faith, the Act provides that
the director be supposed to exercise reasonable skill, care, and diligence. Evidently, the
provisions have the potential of conflating with the fiduciary duties. Consequently, they
can yield controversies since it has been the traditional of the court to desist in
interfering with commercial decisions insofar as the board of directors was honest.
However, the position has the potential of subtly shifting the power of control from the
shareholders to directors and thus apportioning them the final say. That would defeat
the very essence structural foundation of a company, which is based on a principal
agent relationship24. To avert such dangers, thus section 174 comes into play since the
shareholders rely on the skills and expertise of the management especially in the
company setting, where directors are sine qua non for effective running of the business.

Conclusion

Ultimately, the director’s duty according to the Act converges on the promotion of
company’s success. However, the Act has not expressly defined what is meant by
success with the confines of company law. Nonetheless, Lord Goldsmith has defined

22
Re Smith & Fawcett Ltd. [1942] Ch. 304
23
Re Tottenham Hotspur plc [1994] BCLC 655. 660.
24
P.L.Davies, Gower’s Principles of Modern Company Law (Sweet & Maxwell, 6th ed, London, 1997) pp
742-745.

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success as what the shareholders collectively want to achieve. 25 Suffice it to say, it is

something defined in the companies constitution, which thus guides the directors in
exercise of their decisions. Thus, to say that the director is expected to promote the
success of the company simply means that the director has to use diligence, exercise
care, and apply his reasonable skills towards the attainment of the goals set out by the
members in the company’s constitution. Thus, the director will be discharging his duties
in accordance with the law if he is using his position and power to promote the
attainment of the objectives of shareholders. Thus, going by the provision of section 174
of the Act, which imposes various duties to the directors, they will have to meet a certain
standard. That means, the provisions of the law in the Act, particularly ss 171 to ss 174
bring about a mixture of both subjectivity and objectivity, which can be used to assess
whether a director exercised his duties. The provisions as read together with the
company’s constitution show that shareholders still yield supervisory powers and control
over the directors.

25
Supra nt. 14

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Bibliography

Statutes

Companies Act 2006

Case Law

Aberdeen Railway Co. v Blaikie Bros (1854) 1 Macq 461

Cook v Deeks [1916] 1 AC 554
Fulham Football Club Ltd. v Cabra Estates plc [1994] 1 BCLC 363.
Hogg v Cramphorn Ltd. [1967] Ch. 254 and Howard Smith Ltd. v Ampol Petroleum Ltd.
[1974] A.C. 821 (Privy Council).
Item Software (UK) Ltd. v Fassihi [2005] 2 BCLC 91
Parke v Daily News Ltd. [1962] Ch. 927.
Pervical v Wright [1902] 2 Ch. 421.
Re Smith & Fawcett Ltd. [1942] Ch. 304
Re Tottenham Hotspur plc [1994] BCLC 655. 660.
Regal (Hastings) Ltd. v Gulliver [1967] 2 AC 134n; [1942] 1 All ER 378, HL.
Publications

Adolf A. Berle and Gardiner Means, The Modern Corporation and Private Property,
1932.
Alistair Darling, Commons Second Reading, 6 June 2006, column 125.
Company Law Review Steering Group, “Completing the Structure”. Para 3.12
F. Easterbrook and D. Fischel, The Economic Structure of Corporate Law (Cambridge,
Massachusetts, Harvard University Press, 1991) 38.
Lord Goldsmith, Lords Grand Committee, 6 February 2006, column 255.
P.L.Davies, Gower’s Principles of Modern Company Law (Sweet & Maxwell, 6th ed,
London, 1997) pp 742-745.
Professor Sealy’s criticisms in his seminal article, “The Director as Trustee” [1967]
Cambridge Law Journal 83.
The Law Commission Report (Law Com 261; Scot Law Com 173; Cm4436), “Company
Directors; Regulating Conflicts of Interests and formulating a Statement Duties”

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