Companies Act 2006 – COMMENTARY ON INDIVIDUAL DUTIES

Section 171: Duty to act within powers

323. 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.

324. 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 section 257. 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 are to be treated by
virtue of any enactment or rule of law as decisions of the company, for example a
decision taken by informal unanimous consent of all the members.

Section 172: Duty to promote the success of the company

325. This duty codifies the current law and enshrines in statute what is commonly referred
to as the principle of “enlightened shareholder value”. The duty requires a director to 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 and, in doing so, have regard to the factors
listed.

326. This list is not exhaustive, but highlights areas of particular importance which reflect
wider expectations of responsible business behaviour, such as the interests of the company’s
employees and the impact of the company’s operations on the community and the
environment.

327. The decision as to what will promote the success of the company, and what
constitutes such success, is one for the director’s 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.

328. In having regard to the factors listed, the duty to exercise reasonable care, skill and
diligence (section 174) will apply. It will not be sufficient to pay lip service to the factors,
and, in many cases the directors will need to take action to comply with this aspect of the
duty. At the same time, the duty does not require a director to do more than good faith and
the duty to exercise reasonable care, skill and diligence would require, nor would it be
possible for a director acting in good faith to be held liable for a process failure which would
not have affected his decision as to which course of action would best promote the success of
the company.

329. In requiring directors to have regard to the interests of employees, this provision
replaces section 309(1) of the 1985 Act.

330. 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.

331. Subsection (3) 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.

332. 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 (3) will leave the law to develop in this area.

Section 173: Duty to exercise independent judgment

333. 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).

334. The section 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.

335. The duty does not confer a power on the directors to delegate, nor does it prevent a
director from exercising a power to delegate conferred by the company’s constitution
provided that its exercise is 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.

Section 174: Duty to exercise reasonable care, skill and diligence

336. 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 section is modelled on that section.

337. The section 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).

Section 175: Duty to avoid conflicts of interest

338. This duty replaces the no-conflict rule applying to directors. Under the current noconflict
rule, certain consequences flow if directors place themselves in a position where their
personal interests or duties to other persons are liable to conflict with their duties to the
company, unless the company gives its consent. A conflict of interest may, in particular, arise
when a director makes personal use of information, property or opportunities belonging to the
company or when a director enters into a contract with his company. Conflicts of interest may
also arise whenever a director makes a profit in the course of being a director, in the matter of
his directorship, without the knowledge and consent of his company.

339. This duty covers all conflicts, actual and potential, between the interests of the
director and the interests of the company. This includes conflicts relating to the exploitation
of the company’s property, information or opportunity for personal purposes. The only
conflicts not covered by this duty, are those relating to transactions or arrangements with the
company (interests in transactions or arrangements with the company must be declared under
section 177 in the case of proposed transactions or under section 182 in the case of existing
transactions unless an exception applies under those sections).

340. Section 180(4) preserves any current ability of the members of a company to
authorise conflicts that would otherwise be a breach of this duty.

341. Under subsections (4) to (6) the duty is also not infringed if:

• the situation cannot reasonably be regarded as likely to give rise to a conflict of
interest;

• in the case of a private company, unless its constitution prevents this, authorisation has
been given by directors who are genuinely independent (in the sense that they have no
direct or indirect interest in the transaction);

• similarly, in the case of a public company, but only if its constitution expressly
permits this, authorisation has been given by the independent directors.

342. The present law is that in all cases, conflicts of interest must be authorised by the
members of the company, unless some alternative procedure is properly provided. The CLR
were concerned that this strict requirement might stifle entrepreneurial activity; and therefore
recommended that, in the case of a private company, it should be possible for conflicts to be
authorised by independent directors unless the company’s constitution prevents this.

343. Under subsection (6), board 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: the votes of the conflicted directors
in favour of the decision are ignored and the conflicted directors are not counted in the
quorum.

Section 176: Duty not to accept benefits from third parties

344. This section codifies the rule prohibiting the exploitation of the position of director
for personal benefit. This duty prohibits the acceptance of benefits (including bribes). The
acceptance of a benefit giving rise to an actual or potential conflict of interest will fall within
the duty to avoid conflicts of interest (section 175) as well as this duty. This specific duty
dealing with benefits from third parties is not subject to any provision for board authorisation.

345. Any current ability of the members of a company to authorise the acceptance of
benefits which would otherwise be a breach of this duty is preserved by section 180(4).

346. 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. Benefits conferred by the company
(and its holding company or subsidiaries) do not fall within this duty.

Section 177: Duty to declare interest in proposed transaction or arrangement

347. The equitable rule that directors may not have interests in transactions with the
company unless the interest has been authorised by the members is replaced by this duty.
This section requires a director to disclose any interest, direct or indirect, that he has in
relation to a proposed transaction or arrangement with the company. The director does not
need to be a party to the transaction for the duty to apply. An interest of another person in a
contract with the company may require the director to make a disclosure under this duty, if
that other person’s interest amounts to a direct or indirect interest on the part of the director.

348. Under the current equitable rule, shareholder approval is required for transactions
between a company and a director. Company articles often modify the equitable rule,
requiring disclosure of the conflict instead. As proposed by the CLR, shareholder approval
for the transaction is not a requirement of the statutory duty. The members of the company may however still impose requirements for shareholder approval in the articles.

349. The duty requires directors to disclose their interest in any transaction before the
company enters into the transaction (subsection (4)). The duty does not impose any rules on
how the disclosure of interest must be made, but subsection (2) allows the disclosure to be
made by written notice, general notice or disclosure at a meeting of the directors.

350. Disclosure to the members is not sufficient. The director must declare the nature and
extent of his interest to the other directors. It is not enough for the director to merely state that
he has an interest.

351. If after he has disclosed his interest, he becomes aware that the facts have changed, or
for some other reason the earlier disclosure is no longer accurate or complete, the director
must make a further declaration, correcting the earlier one (subsection (3)). However, this is
only necessary if the company has not yet entered into the transaction or arrangement at the
time the director becomes aware of the inaccuracy or incompleteness of the earlier
declaration (or ought reasonably to have become so aware).

352. As the duty requires disclosure to be made to the other directors, no disclosure is
required where the company has only one director. There is no need to disclose anything the
other directors already know about or ought reasonably to have known (subsection (6)(b)). A
director will breach the duty if he fails to declare something he ought reasonably to have
known, but the duty does not otherwise require a director to declare anything he does not
know. Subsection (6)(c) makes special provision for service contracts that are considered by a
meeting of the directors or a committee appointed for the purpose (such as a remuneration
committee).

353. No declaration of interest is required if the director’s interest in the transaction cannot
reasonably be regarded as likely to give rise to a conflict of interest (subsection (6)(a)).
Currently regulation 85 of Table A imposes a materiality test.

354. Conflicted directors may, subject to the company’s articles of association, participate
in decision-taking relating to such transactions with the company.

Section 181: Modification of provisions in relation to charitable companies

355. This section reverses certain relaxations made to the no-conflict rule as it applies to
the directors of charitable companies in England and Wales and Northern Ireland.

356. Subsection (2)(a) replaces section 175(3) which excludes conflicts of interest arising
out of transactions or arrangements with the company. The replacement excludes such
conflicts of interest from the duty only if or to the extent that the charitable company’s
articles so allow. The articles must describe the transactions or arrangements which are to be
so excluded from the duty.

357. Subsection (2)(b) replaces section 175(5) which allows authorisation for conflicts of
interest to be given by the directors. The replacement only allows authorisation to be given by
the directors where the charitable company’s constitution expressly allows them to do so.

358. Subsection (3) restricts the application of section 180(2)(b) which disapplies sections
175 and 176 in relation to those matters excepted from the requirements for member approval
under Chapter 4. Section 180(2)(b) is restricted so that it only applies if or to the extent that
the charitable company’s articles allow the duties in sections 175 and 176 to be disapplied.
The articles must describe the transactions or arrangements which are to be so excluded from
those duties.

359. Subsection (4) amends the Charities Act 1993 to give the Charity Commission the
power to authorise acts that would otherwise be in breach of the general duties. This is
necessary to preserve the current power of the Charity Commissioners to do so, in the light of
the statutory statement of the general duties.