Critically examine the seven general duties of the directors under Company Act 2006

Abstract:

The purpose of this paper is to critically examine the duties that directors owe to their companies in the light

of the Companies Act 2006. The CA 2006 has introduced many reforms and consolidated of much of the

existing legislation affecting companies, through simplifying the provisions of the director’s duties. The

codification of director’s duties was one of the most controversial aspects of the reform programme

culminating the CA 2006. Some argues that codification would reduce the flexibilities of the common law.

However, it is true that 2006 Act has certainly made the duties more accessible. The increased awareness of

the statutory duties would lead to increased direct enforcement of director’s duties. It has been pondered

whether the statutory clarification of directors duties might herald an increase in derivative actions against

directors in based on claim in relation to s172. At the same time it is also true that an increased transparency

may also lead to increased compliance and consequently to less litigation.

This research is entitled “critically examine the seven general duties of directors under CA 2006. A critical

analysis will be carried from the selected literatures which focus on the extensive analysis of director’s duties

under section 171-177 of the CA 2006. This research will argue that in codifying director’s duties the

Company’s Act 20006 creates a legal presumption that directors owe their duties to shareholders and other

parties interested in takeover activities for which the company is involved. In the conclusion it is suggested

that in the study of directors duties an integrated approach, which looks at the accountability spectrum as

well as the substantive content of the duties, facilitates a realistic appraisal of the impact of directors duties in

U.K. This paper will provide some useful source of impartial information for academics, lawyer’s directors

and those advising directors to gain an understanding of director’s duties under English law.

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Introduction:

Directors are the key organ of the company and the duties of directors are a central part of the company law.

The directors exercise control and management over the company. Director’s duties in England have

traditionally been provided under common law. Before Companies Act 2006 the duties of directors of a

company had governed by the equitable principle of the fiduciary duty and the common law of negligence.

However now they are codified under part 10 of the Company’s Act 2006. The codified duties are based on

certain common law rules and equitable principles as they apply in relation to directors and have effect in

place of those rules and principles as regard the duties owed to a company by a director.1 Basically, the

existence of these duties reflects the tension between the accepted need for directors to be given freedom to

innovate and take risks in order to further company goals and the competing need for controls to guard

against this freedom being abused.

As the whole act now in enforce therefore it is important to discuss each of the duties in turn. Part-1 of this

research will introduce the basic duties of the directors, and Part-2 will critically evaluate the duties of the

directors under CA 2006 and in finally part -3 there will be some suggestions and conclusion.

1 Company Act 2006 Section 170 (3)

Bill Perry, Lynne Gregory, ‘The European Panorama: directors economic and social
responsibilities’ (2004)19 (10), J.I.B.R.R. 402-403.

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Seven general duties under the Companies Act 2006:

The CA 2006 codified the common law duties of directors, forming seven general duties. Basically it is

argued that the aim of codifying these duties is to clarifying and simplifying director’s duties.2 However the

consequences of breach of seven general duties are the same as would apply if the corresponding common

law rule or equitable principle applied and all the seven duties are enforceable in the same way as any other

fiduciary duty owed to a company by its directors.

First codified duty: Duty to act within powers: CA2006: Sec171:

The duty to act within powers requires a director to act in accordance with the company’s constitution and to

exercise powers only for the purposes for which they are conferred.3 Basically this codifies the fiduciary

duties including a duty to act for a proper purpose. In that regard Hoffmann L.J. stated that a director “must

exercise the power solely for the purpose for which it was conferred”.4

However to use powers for the purpose for which they are conferred also means to use the powers for a

proper purpose, for example, if the constitution of the company provides a power to allot shares, that power

has to be used for a proper purpose. It will not be proper purpose if used to defeat a takeover bid.5 Moreover

in Howard Smith Ltd it was held that the court may set aside any action for being an exercise of director’s

powers for an improper purpose it was regarded as an unconstitutional for directors.6 Basically acting

bonafidely in the interest of the company is not an excuse for acting fro an improper purpose in cases where

the directors act for their interest. However the director must use his power to achieve the objects of the

companies not his own objects.7 However the director must use his power to achieve the objects of the

companies not his own objects. It is true that most of the objects clauses are drawn within a company’s

constitution to entitle a company to carry out any type of business, therefore in reality it is arguable that

insofar as this aspect is concerned, there is no real impact on what a director can and cannot do for the

business.8

2 Jonathan Mukwiri, ‘Directors duties in takeover bids and English Company Law’ (2008)19 (9) I.C.C.L.R
281-289.
3 Company’s Act 2006, Section 171
4 Bishopgate Investment Management ltd v Maxwell ( No 2 ) [1994] 1all 261.
5 Piercy v Mills & Co Ltd [1920] 1Ch.77.
6 Howard Smith Ltd v Ampol Petroleum [1974] A.C.821.
7 Ibid (n4)
8 Tahir Ashraf, ‘Directors duties with a particular focus on the Company’s Act 2006’ (2012), 54 (2) Int.J.L.M,
125-140.

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Second codified duty: to promote the success of the company: CA 2006 S172:

This duty obliges a director to act in the way that he considers in good faith and would be most likely to

promote the success of the company for the benefit of its members as a whole.9 This fiduciary duty includes

a duty to act bonafidely in the interests of the company. However, section 172 has becomes the most

controversial and challenging duty that has been introduced in the Act and the one that has given lawyers,

companies and their directors most concern. This is the provision which has led to more debate in the UK

Parliament than any other provision contained in the whole Act. It has imposed a duty on directors to require

them to be more inclusive in their decision-making namely taking into account the relationship which the

company has with stakeholders in seeking to benefit the me Basically unlike the other general duties which

were drafted in such a way as clearly to encapsulate common law rules and equitable principles Section 172

did not do so. There are so many uncertainly continue to surround under this section since its enactment and

coming into operation.10 There is a question whether subjective or objective test is to apply as to whether

directors have promoted the success of the company.11

Under common law duty to act on good faith means the directors is required to act with honesty otherwise it

will be breach.12 Basically in the CA 2006 may seem to be one of the best endeavors for the director to act in

the way he considers best. However a closer look would reveal that, this is a subjective test of honesty, and

which has always been the standard at common law.13

9 Company’s Act 2006, Section 172.

10 Ibid (n4)
11 Bryan Clark, ‘UK company law reform and directors exploitation of “corporate opportunities”’ (2006) 17(8)
I.C.C.L.R 231-241.
12 Extrasure Travel Insurances Ltd v Scattergood [2003] 1B.C.L.C.598.
13 In Regentcrest Ltd v Cohen [2001] 2 B.C.L.C. 80 at 105, Jonathan parker J stated that “the duty imposed
on directors to act bona fide in the interests of the company is a subjective one…the question is whether the
director honestly believed that his act or omission was in the interests of the company …the issue is to the
director’s state of mind.”

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However, the wording may seem to give too much discretion to directors. There are no definite standards

against which the actions of directors can be assessed. Directors can merely say that they acted in good

faith and their position then becomes virtually unassailable. This is unlikely to cause problems as courts have

always take into account what the director, not the court considers to be for the benefit of the company.14

Under section 172 of the CA 2006 provides a list of factors to be taken into account by directors at the time

of taking any decision. However, the list may be a source of litigation by shareholders alleging that the list is

not followed. At the same time it is true that if the director has acted bonafidely in the interest of the company,

it is unlikely that the court will find a breach of Sec.172, unless the action is construed as not taken bona fide

in the interest of the company.15 It is for the directors to decide how best to promote the success of the

company.

In fact, Keay has pointed out that, the Act does not seem to provide any framework to ensure that directors

are held accountable for their decision-making process. This is especially with the daily affairs of the

company, as shareholders will not know what the directors have done, or it will be too late when they do.

Directors will always argue that they did have regard to all of the matters mentioned in the Act, and simply

believed that what they did was to promote the success of the company and for the benefit of the members.

Therefore, it is not difficult for the directors to avoid the consideration of any of the factors on the ground of

their subjective opinion that there was no need to pause and consider these interests.16

Third Codified duty; Independent Judgment: CA 2006 Sec 173:

Directors must exercise independent judgment even which may not necessarily be in accordance with the

wishes of the members. However, it is also true that the duty to exercise independent judgment is not

infringed by a director who is acting in accordance with an agreement entered into by the company which

restrict his discretion further this also includes if the directors act in a way which is authorised by the

company’s constitution.

Moreover as section 173 (2) provides a director not to be concerned with the exercise of his own judgment

so long as the members approve of the actions, however it may be seen in conflict with the duty to consider

the interests of the employees.17

They are in breach of duty if they simply follow another’s instructions without considering and deciding

whether what is imposed is in the interests of the company. Lord,Lowry stated that “in the performance of

14 Smith& Fawcett, RE [1940] Ch.304.

15 Ibid (n4)
16 Key, Section 172 (2) of the Companies Act 2006, (2007), 28 Comp. Law. 106
17 Ibid (n8)

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their duties as directors…they were bound to ignore the interests and wishes of their employer, the bank.

They could not plead any instruction from the bank as an excuse for the breach of their duties.”18

Basically, directors are now expected to have regard among other matters to the likely consequences of any

decision in the long term. However, some also argues that it has the effect of potentially granting even less

protection to stakeholders than before, and the requirement to consider under section 173 will make very

little deference to how directors make decisions.19

However the provision of independent judgment has the potential of diminishing the collective responsibility

of the board of directors. On the other hand this duty also has the potential of increasing the severity of

liability for directors on decisions found not in the best interest of the company.20

Fourth codified duty: to exercise reasonable care and skill: CA 2006:Sec174:

This duty is to exercise reasonable care, skill and diligence this means that directors should have the

attributes of a reasonably diligent person, considering the knowledge, skill and experience that may

reasonably be expected of a person carrying out the same function. In Norman Hoffman J stated that

directors must take any steps or reach to conclusions that reasonably expected from a person having the

general knowledge, skill and experiences carrying out the same quality as are carried out by the director in

relation to the company. 21

In the case of Re City Equitable Fire Insurance Co Ltd, it was held that “a director need not exhibit in the

performance of his duties a greater degree of skill than may reasonably be expected from a person of his

knowledge and experience”.22

Fifth codified duty: to avoid conflict of interest: CA 2006 Section: 175:

A director has a duty to avoid conflicts that is related with his own interests with the interests of the company

and must not enter into any arrangement whereby his personal interest conflict with those of his company.23

Under this obligation directors are prohibited to enter into a position where his interests are related with the

company’s interests, it has restricted directors within a specific boundary. 24

18 Ibid.
19 Demetra Arsalidou, ‘Shareholder Primacy in Cl.173 of the Company Law Bill 2006’ (2007) Comp.Law, 28
(3), 67-69.
20 Ibid (n4).
21 Norman v Theodore Goddard [1991] BCLC 1028.
22 [1925] 1 Ch 407.
23 Aberden Railway Co v Blaikie brothers, [1925] 1 Ch 407.
24 Mayson, French & Ryan, Company Law, (Oxford University Press, 2007-2008) 471.

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 Basically this duty applies in relation to the exploitation of any property, information or opportunity; it is

immaterial whether the company could take advantage of the property, information or opportunity.25

However, It is the rule of equity that any person in a fiduciary position is not allowed to put himself in a

position where his interest and duty conflicts.

This duty also includes an exception that is the situation cannot reasonably be regarded as likely to give rise

to a conflict of interest if the matter has been authorised by the directors. Basically, this exception strikes a

balance between the rigid rule and the business development interest. 26

In avoiding conflict of interest directors often need to take positive actions. The directors who are found to

have transacted with shareholders in a fiduciary capacity are obliged to make full disclosure of materials

facts relating to the transaction. Basically this development has rendered the touchstone of liability when

directors are interested in proposed company transactions. 27

Sixth codified duty: not to accept benefits from third Parties: CA 2006 Sec: 176:

A director of a company must not accept a benefit from a third party conferred on him because of his being a

director of the company, where it was considered that his interest contradicting against the interest of the

company. Basically, this codifies the no profit rules which prohibit the exploitation of the position of the

director for personal benefit. 28 In the case of Attorney – General for Hong Kong, it was held that fiduciaries

are not allowed to bribes or secret commissions. A director must account to his company for any personal

profits or commissions through using company’s property.29

This duty of the directors derives from the common law concepts. However the duty is not infringed if the

acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.

25 In Industrial Developments Ltd v Cooley [1972] 1W.L.R. 434, --- a retired director was found to have
improperly taken advantage of an employment offer that came to his notice in his capacity as a company
director, and it was immaterial that the company could not have taken advantage.
26 Ibid (n2)
27Lusina Ho, Pey- Woan Lee, ‘A directors duty to confess: a matter of good faith?’ (2007), 66 (2) C.L.J ,
348-364
28Andrew Hicks& S.H.Goo, Cases and Materials on Company Law,( Sixth Edition,Oxford University Press,
2008) 410
29 [1994] 1AC 324 (PC)

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Seven Codified duty: to declare any interest in transaction: CA 2006: Sec: 177:

A director must disclose any personal interest that he might have obtained from any transaction with the

company. He must disclose his interest by way of declaration to the directors of the company either at a

meeting of directors or by way of notice. Failing to make such disclosure is a criminal offence under section

183 of the Act. However as an exception a director need not declare an interest if it cannot reasonably be

regarded as likely to give rise to a conflict of interest or to the extent that the other directors are already

aware of it. In that circumstances the other directors are treated as aware of anything which they ought

reasonably to be aware. However the disclosure can be implied from the circumstances suggesting that the

other directors are aware.30 However, section 180 CA 2006 also provides that the directors duty to disclose

an interest in proposed transaction and arrangement cannot be set aside by any common law or equitable

interest requiring the members consent.

30 Ibid (n2)

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Critically analysis the duties of the directors:

In general directors owe their duties to the company. A duty can be owed to other interested parties, such as

shareholders, employees and investors if a special factual relationship can be established in a particular

case. Basically the CA 2006, in codifying director’s duties creates a legal presumption that directors owe

their duties to shareholders and other parties interested in takeover activities for which the company is

involved.

It is true that the codification of director’s duties has included the statutory requirement for directors to

promote the success of a company.31 Therefore, now a director must have regard to the interests of the

company’s employees as a consideration in making business decision. However this could have impact that,

as a result of these statutory duties the mind of many directors would be focused on his perceived primary

duty to continue to trade out of difficulty thereby promoting the success of the company and not necessarily

considering the interests of the company’s employees or the company’s creditors.32

As the Act intended to bring the directors duties into business activities therefore, it is also essential that

there need to be an understanding that how the court and lawyers are to apply them and advise clients. As

section 170 (4) provides that the general duties under sec 171- 177 are based on common law principles

and shall be interpreted and applied in the same way as common law rules. Therefore, this raises the

question of whether director’s duties truly warranted being codified.33

However a statement of director’s duties would provide clarity for directors and members in relation to the

legal expectations of directors. The Attorney General noted that “the main purpose in codifying the general

duties of directors is to make what is expected of directors clearer and to make the law more accessible to

them and to others”.34

Basically, when considering the limits of an accessibility agenda, cognizance must also be taken of the fact

that the general nature of the duties means that, for the most part, direct statutory guidance is not provided

on how to act in a specific situation. This reflects the fact that the relevant principles are drawn in broad

terms so as to be capable of application to a broad range of circumstances. As stated in the Explanatory

Notes: The general duties from a code of conduct, which sets out how directors are expected to behave; it

does not tell them in terms what to do.”35

31 Company’s Act 2006, Section 172

32 Ibid ( n8).
33 Ibid (n8).
34 Lord Goldsmith, Lords Grand Committee, February 6, Col.254.
35 Companies Act 2006, Explanatory Notes, at Para. 298.

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In fact, the equitable and common law duties of the directors such as duty to exercise due care, skill and

diligence in the performance of their duties, to act bonafidely in the best interests of the company as a whole

and duty to act proper purposes and the duty to avoid conflicts of interest and secret profits. These duties are

designed to rein in directors and act as counter – balance to the liberty they are given to engage in risk-

taking with a view to generating corporate wealth.36

Although there are lots of judicial and scholarly ink has been expended on the content of these duties and

emphasis on the importance of roles that directors play in business life. However it is also important to raise

question relating to the likelihood of directors accountability for breach of their duties. Basically the

effectiveness of director’s duties cannot be judged in isolation from wider enforcement realities.37 Still there

are some difficulties relating to the enforcement of directors duties.

However, although there are some speculations tend to suggest that the impracticality of the Acts

mechanisms relating to directors duties may affect decision-making in companies, nevertheless, the Act

provides certain stages and filtering process for the courts refine any misuse or abuse of the action.

However, there are some apparent criticisms about the duties of the directors for example in case of

section172; there is a argument about whether subjective test or objective test would be followed in

determining whether directors acted for the success of the company. Basically it is argued that this Act has

imposed a low standards duty upon the directors. That means a director would not be in breach as long as

he shows that he considered his action in good faith. It would also allow the directors the discretion to

consider any interest above that of shareholders whenever there view of what is needed to promote the

company’s success.38

However under Section 172 directors must act in the way that he considers would be most likely to promote

the success of the company for the benefit of its member as a whole. Before the common law duty directors

were obliged to act bonafidely in what they consider not the what the court may consider. The focus is that

much what the directors themselves consider. Margaret Hodge MP when she said in relation to sec172 is

that: “we believe it is essential for the weight given to any factor to be a matter for the director’s good faith

judgment. Importantly, the decision is not subject to the reasonableness test.”39

36 Ibid (n2)
37 Ibid (n2)
38 John Lowey, ‘The duty of loyalty of company directors: bridging the accountability gap though efficient
disclosure’ (2009) 68 (3) C.L.J, 607-622.
39 http://www.bis.gov.uk/files/file40139.pd

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As it is true that they must act in good faith but there are no any definite standards against which the actions

of the director can be assessed, here the director just merely say that they acted in good faith, but in

situation it would be difficult to prove whether they acted in good faith or not. 40

In addition although the Act provided a legislative mandate that for whose interest the director are bound to

act in case of performing their function but there does not seems to be any framework in order to ensure that

director are held accountable for their decision making process. 41

Moreover, Lowry also argues that directors may not appreciate what their duties were under the law and

similarly that such obligations may be misunderstood by shareholders, in whose interest the directors should

be acting.42 Therefore, it can be said that the government designed general duties is in order to run the

company by directors to consider the long term consequences rather than short term profit. However,

directors also need to take into account a much wider range of interests with the hope that there would be

more responsible in business profit maximization.

However, although there are some speculations tend to suggest that the impracticality of the Acts

mechanisms relating to directors duties may affect decision-making in companies, nevertheless the Act

provides certain stages and filtering process for the courts refine any misuse or abuse of the action.43

Basically by referring general duties of the directors the Act gives clear mandate to the directors to promote

the success of the company.

However, it is true that CA 2006 has not added any new provisions rather it has codified the existing laws. In

the case of Eastford 44 Lord Hodge’s opinion was concerned with s171 of the 2006 Act which provides that a

director must act in accordance with the company’s constitution. In that regard in seeking to interpret whether

an unauthorised act could be ratified, he said that “one must look at the purpose of the statutory statement

which is revealed in 2006 Act. 45 Finally he concluded that there was nothing to suggest that parliament had

40 Andrew Keay, ‘Legislative Comment Section 172(1) of the Company Act 2006, an interpretation and
assessment’ (2007) 28 (4) Comp.L, 106-110.
41 Ibid .
42 Ibid.
43 Mahmoud Almadani , ‘Derivative actions : does the Companies Act 2006 offer a new forward? ‘ (2009) 30
(5) Comp.Law, 131-140.
44 Eastford v Gillespie [2009] CSOH 119
45 Eastford v Gillespie [2009] csoh 119 AT [9]

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intended to alter the pre-existing rules of the law and the courts are entitled to have regard to the pre-

existing case laws. The similar things happened in case of the section 174(duty of care, skill and diligence)

and in case of conflict of interest under S.175, The courts have expressly recognised these codified existing

laws.46

Therefore, it is clear that it is not possible to deny the relevance of pre-existing case law but it would be

preferable if the courts first looked at the natural meaning of the provision and then use case law to help to

understand the application of the provision in practice where necessary. Therefore there remains a distinct

role for judges in shedding light on the intricacies of the statutory duties when the opportunities arise. It can

be expected that the courts will continue to follow sound instincts by sensibly locating the application of duty

within the broader factual surroundings to take account of the type of company, its organisational structures

and the nature of the role undertaken by the director47.

46 Foster Bryant surveying Ltd v Bryant [2007] EWCA, Civ 200.

47 Deirdre Ahern,’ directors duties, dry ink and the accessibility agenda’ (2012) 128 (Jan) L.Q.R. 114-139.

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Conclusion:

However, the concern also rose about the necessity to have regard to all the factors by directors under

director’s duties in every decision. It is thought that this will amount to considerable risk on director’s

decision- making and make matters more bureaucratic and centralised.

It is true the central premise underlying the shift to a statutory statement of the core duties of directors within

the architecture of the companies Act 2006 was a desire to capture the essence of relevant principles in the

hope that it would lend transparency which would facilitate greater understanding among directors as to their

legal duties. Directors now know what their general duties are and where to go to find their duties.

Furthermore, directors may be now more aware that they are subject to legal duties. However in order to

clarify there is need to give more judicial consideration on the directors duties.48

Finally, it is true that powers held by directors are clearly subject to many forms of control. All of these forms

of control have to strike a balance between competing objectives; at the same time they also must be

48 Ibid.

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carefully not to abolish the discretion inherent in the power.49 However still it is too early to pass judgment on

the effect of the organic development of the general duties of directors. To some extent it is fair to conclude

that behind a façade of accessibility lies much complexity.

49 R.C. Nolan, Controlling fiduciary power, (2009) 68(2), C.L.J 293-323.

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