Companies Act 2006

Author:Mr Paul Salmon
Profession:Salans
 
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In November 2006 a new Companies Act was passed intended to modernise and simplify British Company law. This briefing highlights some of the key changes. Some are in effect but most will be implemented in three tranches in October 2007, April 2008 and October 2008 - giving companies time to prepare.

BACKGROUND

The Government has indicated that key themes underpinning the new Act are:

To enhance shareholder engagement and a long term investment culture.

A "think small first" approach.

To make it easier to set up and run a company.

To provide flexibility for the future.

The Act represents a thorough overhaul of company law and also consolidates existing law, creating a comprehensive code of company law in one place.

DIRECTORS

Duties

For the first time directors' duties are set out in statute. The new statutory duties of directors to their company are intended to reflect (and to replace) the existing position which has developed by case law.

Seven duties are set out as follows:

To act in accordance with the company's constitution and only to exercise his/her powers for the purposes for which they were conferred.

To promote the success of the company for the benefit of its members as a whole, having regard to:

The interests of the company's employees

The need to foster business relationships with the company's suppliers and customers

The impact of the company's operations on the community and the environment

The desirability of the company maintaining a reputation for high standards of business conduct

The need to act fairly as between members of the company

The likely consequences of any decision in the long term

To exercise independent judgement.

To exercise reasonable care, skill and diligence.

To avoid conflicts of interest. This duty applies to the exploitation of any business opportunities. Conflicts can be authorised by directors without an interest in the matter in question, if, in the case of public companies, the company's articles permit or if, in the case of private companies, they do not prohibit it.

Not to accept benefits from third parties.

To declare to the other directors any interest in a proposed transaction or arrangement with the company.

Although intended to reflect the current position there are changes, most notably (a) the requirement for directors to have regard to the factors referred to above in connection with their duty to promote the success of the company - this is the Government's concept of "enlightened shareholder value" - and (b) allowing independent directors to authorise conflicts of interest - currently this can only be done by shareholders.

The duty to promote the success of company having regard to the factors listed is one of the most controversial provisions of the new Act. It reflects the existing duty to act in the best interest of the company, but the wording is different as, of course, are the factors to be taken into account. There is concern over the interpretation of this duty. In particular, the weight to be given to each factor, the extent to which directors will have to take independent advice and what records must be kept. The Government has said that "success" means long term increase in value and that the Act does not require directors to keep additional records, it simply requires them to have due regard to these wider factors, with the weight to be given to any factor a matter for their good faith business judgement.

Although the duties listed replace the equivalent existing duties, it is not an exhaustive list. For example a director is under a duty to consider creditors' interests in times of threatened insolvency. Shareholders can, as at present, ratify most breaches, but a new provision will mean that the vote of any person who is connected with the director in question must be disregarded.

So far as the power for independent directors to approve conflicts of interest is concerned, the government has indicated that transitional provisions will be introduced providing that existing companies will require members' approval to permit this. Most of these provisions are due to come into force in October 2007, but provisions relating to directors' conflicts of interest are only due to come into effect in October 2008.

Liability - Derivative Claims

A new statutory procedure for claims against directors by shareholders on behalf of a company is scheduled to be introduced by the Act in October 2007.

A claim may be brought in the event of negligence, default, breach of duty (including the above mentioned duties) or breach of trust by a director.

This procedure replaces the existing common law right to bring a derivative action but includes some significant differences intended to make the process more modern, flexible and accessible. In particular:

There is no need to prove that a director has benefited personally.

It is not necessary for the shareholders to show that the directors who carried out the wrongdoing control the majority of the company's shares (ie the old requirement that the wrongdoing amounts to a fraud on the minority).

There is concern that the procedure will be used by pressure groups (eg environmental groups) to challenge directors' decisions on the basis that they have not properly taken into account the factors they are required to as part of the new duty to promote the success of the company. In order to alleviate concerns over increased and speculative litigation, provisions are included requiring a claimant to present a good case to the court before the action can be continued, with the court having the ability to make a costs order against an applicant as a deterrent, if appropriate.

Proposed transitional provisions mean that (a) the new procedure will not apply to claims issued before 1 October 2007 where the claimant has applied for permission to continue the claim before that date and (b) if the claim arises from acts or omissions occurring before that date, the new procedure will only apply if the claim would have been allowed to proceed under the old derivative claim procedure.

Business Review

At present all companies (other than those meeting the statutory definition of a small company) must include a business review in their directors' report. The new Act extends the information to be included, especially for companies that are officially listed1 (not AIM) which must include certain forward-looking statements. In particular such quoted companies must, to the extent necessary for an understanding of the development performance or position of the company's business, include:

The main trends and factors likely to affect the future development, performance and position of the company's business.

Information about environmental matters, the company's employees, and social and community issues.

Information about persons with whom the company has contractual or other arrangements which are essential to the business of the company unless such disclosure would, in the directors' opinion, be seriously prejudicial to that person and contrary to the public interest.

The last requirement has raised some controversy, but the Government has stated that they do not envisage companies having to give sensitive lists of customers and suppliers, or producing "miles and miles" of paperwork, but that directors must use their judgement to decide what is relevant in the supply chain for them to report on.

Directors will not have to disclose information about impending developments if in their opinion such disclosure would be seriously prejudicial to the interests of the company.

The Act provides that the overall purpose of the business review is to allow members to assess how the directors have performed their statutory duty to promote the success of the company and accordingly the provisions complement the new statutory duties. It is currently proposed that these provisions will apply in respect of accounting periods beginning on or after 1 October 2007.

Directors' Liability for Statements in Reports

The Act introduced a new liability regime as from 20 January 2007 by which a director will be liable to compensate the company for any loss it suffers as a result of any untrue or misleading statement in, or omission from, the directors' report (including the business review), the remuneration report and information in summary financial statements derived from them.

A director will only be liable if he knew (or was reckless as to whether) the statement was untrue or misleading, or knew the omission to be a dishonest concealment of a material fact.

A director will not be liable to any other person resulting from reliance on these reports.

The Government's stated intention in formulating this regime is to ensure that the right incentives are in place to encourage meaningful, forward-looking information for shareholders, while also ensuring an appropriate but limited right to recover losses.

See below for details of the new liability regime for misleading statements in reports by quoted companies.

Fraud Act 2006

This Act introduces a criminal offence of 'fraud by abuse of position' which can apply to directors who dishonestly abuse their position to obtain a gain or cause a loss to someone, for example by diverting business opportunities from the company to themselves. It came into effect on 15 January 2007.

Loans to Directors

Currently, loans to directors are prohibited, with limited exceptions such as loans of small amounts. The most significant change the new Act introduces is that loans made on or after 1 October 2007 may be made to directors provided they are approved by shareholders.

Payments for Loss of Office

The position remains that shareholders' approval is required for payments to a director as compensation for loss of office but there is some clarification and there are some new provisions which are due to come into force in October 2007. Key points are:

The Act clarifies the fact that these provisions cover payments to directors...

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