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You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Discussion Papers) >> Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties [1998] SLC 105(13) (DP) (August 1998) URL: http://www.bailii.org/scot/other/SLC/DP/1998/105(13).html Cite as: [1998] SLC 105(13) (DP) |
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Part 13 Previous Proposals for a Statutory Statement of Directors Duties13.1 Over the last 100 years or so, there have been many views expressed on the case for a statutory statement of the duties of directors and attempts to introduce the same. In this Part we set out some of those views and the arguments that were advanced. We do this under the following heads:
- The Davey Committee
- The Greene Committee
- The Jenkins Committee
- Attempts to introduce statutory statements of the duties of directors
The Davey committee
13.2 This Committee, chaired by Lord Davey, was set up by the Board of Trade to enquire what amendments were necessary in the Acts relating to joint stock companies formed with limited liability under the Companies Acts 1862-1890. The Davey Committee recommended that the Companies Act should provide that the director owed a duty to his company to exercise reasonable care and skill. It proposed the following clause for this purpose:
10(2) Every director shall be under an obligation to the company to use reasonable care and prudence in the exercise of his powers, and shall be liable to compensate the company for any damage incurred by reason of neglect to use such care and prudence.
The Davey Committee said in their report:
13.3 No action was taken on the Davey Committee's recommendation.It may also be thought that the clause which imposes on every director an obligation to use reasonable care and prudence in the exercise of his powers, and gives the company a right of action for neglect to do so, goes beyond any actual decision of the courts. But your Committee think it is right in principle.[1]
13.4 The Davey Committee also recommended that the fiduciary duties of promoters of companies and the duties of directors with prospectuses should be set out in the Companies Acts. The recommendation of the Davey Committee with respect to the fiduciary duties of promoters was not implemented but it is interesting to read the terms of their recommendation as it echoes many of the concerns that are echoed about a statutory statement of directors' duties:
13.5 It is useful to note that the Davey Committee recommended a statutory statement because they felt that the duties of promoters were not well understood. In other words they thought that the purpose of the statement would be to inform and educate rather than to change the law. Moreover the Davey Committee contemplated, as appears from the draft bill annexed to their report, a statutory statement which would not limit or diminish any liability which a person might incur under the general law. In other words the statutory statement would be in addition to the general law.30. Before making their recommendation as to the contents of the prospectus your Committee resolved that it was expedient that clauses should be inserted declaring general law with regard to the duties and liabilities of promoters and directors in respect to the promotion of companies and the issue of prospectuses. They have done so because their experience leads them to believe that the principles of law and commercial morality long since adopted and acted on by courts of law and equity are not generally recognised, or, if known, are frequently overlooked and disregarded. They also think that those principles of law, if thoroughly grasped, leave little to be desired so far as concerns the general principles which should regulate the dealings of men of business in this matter. The incorporation of those principles in an Act of Parliament is more likely to bring home to promoters and directors the obligations they undertake, and to shareholders and others the standard of commercial morality which they have a right to expect in those whom they are invited to trust. Your Committee have framed these clauses with great care, and so far as they purport to express the existing law they believe that they are accurate, but they dare not expect their clauses on so delicate a subject to be free from criticism. Your Committee are fully sensible of the danger incident to partial consolidation of the law, and of the possible loss of elasticity and adaptability involved in any attempt to express principles of law in formal clauses of an Act of Parliament. But they believe that the advantages in this case will outweigh the inconvenience. They have endeavoured to provide, as far as possible, against any danger of limiting the ordinary jurisdiction of the courts by recommending that nothing contained in the clauses shall limit or diminish any liability under the general law except as expressly provided. In this respect they have followed the precedent of the Partnership Act (section 46).
The Greene committee
13.6 The Company Law Amendment Committee (the Greene Committee) considered the question of codifying directors' duties in 1926 and concluded succinctly:
To attempt by statute to define the duties of directors would be a hopeless task.[2]
The Jenkins committee
13.7 The question of codifying directors' duties was further considered by the Jenkins Committee in 1962. The Report of the Jenkins Committee[3] dealt with the point as follows. It recorded that the Committee had received arguments for and against codification. It stated that the arguments in favour of codification were twofold. First, the duties of directors were contained in complex case law. The second reason given by the Jenkins Committee was that evidence had been given to that Committee that the law on directors' duties was inaccessible to company directors. It then cited some arguments that it had received against codification. First, it was impossible to define directors' duties exhaustively. Secondly, it was said in evidence to the Committee that there was a danger that there would be lacunae or gaps where it would be more difficult to say what the law was if there was a statutory statement of directors' duties.13.8 The Jenkins Committee came down between the two views and recommended a non-exhaustive statement of the basic principles underlying the fiduciary duties which a director owed to his company. The statement set out a duty to act in good faith and a duty not to make improper use of money or other property of the company or information obtained while acting as a director. The statement also set out the consequence of a breach of one of these duties. These provisions were replicated with immaterial changes in clause 52 of the Companies Bill 1973, which we set out below. The final provision set out in the Jenkins statement of duties was in these terms:
13.9 It is not clear from this concluding provision, read in the context of the report, what status the Jenkins Committee intended the statement of duties to have. The report expresses the view that "a general statement of the basic principles underlying the relationship between directors and their companies - nowhere explicitly stated in the Act - might be useful to directors and others concerned with company management and we recommend such a provision in paragraph 99(a) below." This passage suggests that the statement was simply to replicate without replacing the core provisions of the general law. The provisions are not however a full or complete statement of the equitable rules: for instance the duty not to use company assets under the general law[5] applies even if the use is not at the expense of the company and the company itself could have made no profit.(iv) these provisions should be in addition to and not in derogation of any other enactment or rule of law relating to the duties or liabilities of directors of a company.[4]
13.10 Likewise the statement of the consequences of a breach of duty takes no account of the factors that may result in a reduction of the amount for which a director is liable, such as an order that he is indemnified for the expenses that he incurred in making a profit from the use of company assets. Again, the statement makes no reference to ratification of a breach of duty, though this may be implied, since the use of company assets is not a breach of duty unless "improper advantage" is taken of them; nor does it deal with the possible release of such a claim by the company. If the limitations that apply to the equitable rules under the general law apply to the duties as set out in the Jenkins statement then the effect of the Jenkins statement is merely to create mirror images of the equitable duties. This would probably lead to confusion, because there are further equitable rules not replicated in the statutory statement of which someone who only read the statutory statment would be unaware. It is possible that the Jenkins Committee did not intend to recommend the imposition of new statutory duties co-terminous with the relative equitable duties. It may be that all they were seeking to do was to set out in the statute a statement of directors' duties which would act as a signpost to directors and other users of company law that such duties existed but that they were governed by the general law. As we shall see when steps were taken in 1973 to implement the Jenkins Committee recommendation a different formula was used in place of paragraph (iv) set out above.
Attempts to introduce statutory statements of the duties of directors
Companies Bill 1973
13.11 Clause 52 of the Companies Bill was introduced to give effect to the recommendation of the Jenkins Committee. It provided:
52. ((1) A director of a company shall observe the utmost good faith towards the company in any transaction with it or on its behalf and shall act honestly in the exercise of the powers and the discharge of the duties of his office.
(2) A director of a company shall not make use of any money or other property of the company, or of any information acquired by him by virtue of his position as a director or other officer of the company, to gain directly or indirectly an improper advantage for himself at the expense of the company.
(3) A director of a company who, by any breach of subsection (1) or (2) above, makes a profit or inflicts any damage on the company shall be liable to account to the company for the profit or to compensate it for the damage.
13.12 The proposal in 1973 was thus to have a statutory statement of directors' duties which would not be a comprehensive statement. It would merely set out the principal duties. In the event the Companies Bill 1973 was lost due to the first general election of 1974. It may be inferred from the terms of the Bill that it was appreciated that there was an ambiguity in paragraph (iv) of the Jenkins Committeestatement. Clause 52 substitutes a new provision for that paragraph. It is doubtful, however, whether clause 52(4) was any more satisfactory. There are two possible views of the meaning of clause 52(4). One view might be that it made the statutory rules a second set of rules which existed alongside the duties arising in general law. This would mean that directors would be at risk of being held liable under either set of rules. It has been noted above[6] that the Jenkins Committee statement appeared to go further than the general law. On this basis the unsatisfactory result of clause 52, if it had become law, would have been to impose new duties on directors which would appear to be wider than the general law. Another view of clause 52(4) might be that it was intended to displace rules of law in so far as they corresponded to the matters dealt with in clause 52(1)-(3). On this view, the reference to other provisions of the Companies Acts and rules of law would be taken to be a reference to the provisions and rules which do not deal with the matters dealt with in clause 52(1)-(3). In other words, clause 52(4) is intended to confirm that no other duties etc are affected by clause 52(1)-(3).(4) This section is without prejudice to any other provision of the Companies Acts and to any rule of law with respect to the duties or liabilities of directors.
Companies Bill 1978 clauses 44 and 45
13.13 The Companies Bill 1978 was the next attempt to codify directors' duties. It contained two clauses which aimed to codify directors' fiduciary duties and their duties of skill and care. The Bill was a major departure from the previous proposals because it was intended that the statutory statement of fiduciary duties should replace rather than be in addition to the general law.13.14 Clause 44 provided:
44.((1) A director of a company shall observe the utmost good faith towards the company in any transaction with it or on its behalf and owes a duty to the company to act honestly in the exercise of the powers and the discharge of the duties of his office.
(2) A director of a company shall not do anything or omit to do anything if the doing of that thing or the omission to do it, as the case may be, gives rise to a conflict, or might reasonably be expected to give rise to a conflict, between his private interests and the duties of his office.
(3) Without prejudice to subsection (1) and (2) above, a director of a company or a person who has been a director of a company shall not, for the purpose of gaining, whether directly or indirectly, an advantage for himself:
(a) make use of any money or other property of the company; or
(b) make use of any relevant information or of a relevant opportunity—
(i) if he does so while a director of the company in circumstances which give rise or might reasonably be expected to give rise to such a conflict; or
(ii) if while a director of the company he had that use incontemplation in circumstances which gave rise or might reasonably have been expected to give rise to such a conflict.
(4) In this section—
'relevant information', in relation to a director of a company, means any information which he obtained while a director or other officer of the company and which it was reasonable to expect him to disclose to the company or not to disclose to persons unconnected with the company;
'relevant opportunity', in relation to a director of a company, means an opportunity which he had while a director or other officer of the company and which he had—
(a) by virtue of his position as a director or other officer of the company; or
(b) in circumstances in which it was reasonable to expect him to disclose the fact that he had that opportunity to the company.
(5) If any person contravenes any of the foregoing provisions of this section he shall be liable to account to the company for any gain which he has made directly or indirectly from the contravention or, as the case may be, shall be liable to compensate the company for any loss or damage suffered directly or indirectly by the company in consequence of the contravention.
(6) A person shall not be liable under the foregoing provision of this section for any act or omission which is duly authorised or ratified.
(7) This section has effect instead of any rule of law stating the fiduciary duties of directors of companies, but is without prejudice—
(a) to any remedies which may be available apart from this section for a breach of any such duty; and
(b) to any other provision of the Companies Acts imposing duties or liabilities on such directors or defining their duties or liabilities;
13.15 Like clause 52 of the 1973 Bill, clause 44 uses the concept of "utmost good faith", which is not a concept used in this area of law and could if enacted have given rise to doubt and dispute. Clause 44(2) contained no exception for the situation where the interest was a minor kind or consisted of a duty to a third party rather than the private interests of the director. Clause 44(3) and (4) are complex and seem to have been tailored to meet the situation that had arisen in Industrial Development Consultants Ltd v Cooley.[7]and compliance with any requirement of those Acts shall not of itself be taken as relieving a director of a company of any liability imposed by this section.
13.16 Clause 44(6) dealt with authority and ratification. However, there are many problems which it does not address. In particular, it does not lay down which organ of the company could authorise or ratify, and in what manner and in what circumstances. It was therefore not clear for example whether an act done in bad faith could be ratified or whether ratification was ineffective if it rendered the company insolvent.
13.17 Clause 44(7) was a major departure from the clause that the Jenkins Committee had recommended. The effect of that provision is that the statement of the fiduciary duties of directors would have become a comprehensive statutory code. The clause met a barrage of criticism and did not become law.[8]
13.18 Clause 45 provided as follows:
45. ((1) In the exercise of the powers and the discharge of the duties of his office in circumstances of any description, a director of a company owes a duty to the company to exercise such care and diligence as could reasonably be expected of a reasonably prudent person in circumstances of that description and to exercise such skill as may reasonably be expected of a person of his knowledge and experience.
(2) Subsection (1) above shall have effect instead of the rules of law stating the duties of care and diligence and of skill owed by a director of a company to the company.13.19 Clause 45 thus drew a distinction between care and diligence, and skill.[9] In the former case the standard of care was purely objective whereas in the case of skill it was sufficient if the director showed the skill reasonably to be expected of a person with his particular attributes. This approach has been overtaken by section 214 of the Insolvency Act 1986 (first enacted in the Insolvency Act 1985) which applies an objective test to skill. This development demonstrates the possible dangers in statutory codification of a duty: it is crystallised and cannot be developed by the courts in accordance with changing social and economic conditions. The movement in the case law setting out the standard of care to be shown by a director - from a subjective test[10] to a dual subjective/objective test[11] - in line with the increasing professionalism of business in the course of the twentieth century - is a remarkable example of the modernisation of the law by the judges, facilitated of course by the changes in insolvency legislation made by Parliament.
13.20 In the event, however, the Companies Bill 1978 was lost when a general election was called in 1979.
Note 1 C 7779, para 32. [Back] Note 2 Report of the Company Law Amendment Committee (1925-26) (Cmd 2657), para 46, p 20. The Chairman of this committee was Sir Wilfred Greene KC, who later became Master of the Rolls and a Lord of Appeal in Ordinary. [Back] Note 3 Report of the Company Law Committee (1962) Cmnd 1749, paras 86, 87 and 99(a). [Back] Note 4 This is similar to s 317(9) (see para 4.73 above) and s 232(11) of the Australian Corporations Law (Appendix H). [Back] Note 5 See eg Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n. [Back] Note 7 [1972] 1 WLR 443, more fully reported at [1972] 2 All E R 162. [Back] Note 8 See Philip L R Mitchell, Directors Duties and Insider Dealing (1982) p 37. [Back] Note 9 See para 12.11 above, and paras 15.23-15.24 below. [Back] Note 10 See Re Brazilian Rubber Plantations and Estates Co Ltd [1911] 1 Ch 425. [Back]
