Abstract
The purpose of this paper is to critically appraise and evaluate whether the directors are abusing their powers and privileges based on existing laws. The study will also show whether the key duties imposed on directors by statutes as interpreted by the judiciary are being fulfilled. The article gives a detailed analysis of the duties of directors and determines the instances when they had exceeded the authority granted to them by the company, laws and statutes. Directors exercise potentially a broad range of powers in managing the company business and there are instances when they may be held personally liable for acts that required them to exercise due diligence and care in managing the affairs of the company. Finally, this research aims to appraise and evaluate whether the existing provisions of corporate law are adequate to prevent the directors from abusing their powers, duties and privileges.
Keywords: directors, company, corporation, liability, abuse of power, doctrine of corporate opportunity.
Introduction
The main objective of this article is to provide an overview of the duties and responsibilities of directors of small and medium enterprises (SME’s) under the UK Companies Act 2006. Directors have obligations and duties which they owe to the companies that had given them a broad range of powers (Ashraf 125). The codification of directors’ duties under the UK Companies Act of 2006 has explicitly enumerated the penalties that may be imposed for the abuse of powers that may be committed by directors. Other laws that coincide with the UK Companies Act of 2006 or CA 2006 are the Bribery Act 2010 or BA 2010, and the Corporate Manslaughter and Corporate Homicide Act 2007 or CMCHA of 2007, which are all within the context of the responsibilities and duties of directors (Ashraf 125).
This article is intended to provide sufficient research work for academics, directors, company secretaries and legal practitioners and will carefully examine whether the provisions of the UK Companies Act 2006 have adequately captured the totality of the core fiduciary duty of directors to prevent the potential abuse of powers and conflict of interest by directors (Lowry 2). It is essential for the company owners and directors of limited companies to know and learn about the duties they owe to their employees, the shareholders and the company not only under the CA 2006, but other pertinent laws as well (Ashraf 126).
Since corporate scandals are commonly seen and heard in news programs, this may be the appropriate time to reconsider the laws that will impose penalties on the directors who defraud the company by using the responsible corporate officer (“RCO”) doctrine (Kushner 681). Such doctrine has not yet been used and can be considered as an innovation in the criminal law, which holds the corporate officer to be vicariously liable for the criminal violation of a subordinate. Such officer who was appointed to his position is given the responsibility and authority by the corporation to prevent the violation. His failure to do so due to inaction is tantamount to imposing liability upon the said officer for the illegal acts of other corporate agents, despite proof that the officers directly participated in or authorized the crime (Kushner 681). However, such provision cannot be found in CA 2006 since the intention of the framers of CA 2006 is to codify and enumerate the general duties of directors and to ensure that the code is exhaustive enough to adopt and respond to the changing circumstances and needs of corporate business operations (Lowry 3).
As companies and organizations develop their strategies to manage their internal ethics programs, focus in made on how to intensify the accountability of its directors and officers. In some countries like in the U.S., one of their strategies is the appointment of a corporate ethics officer who will help the companies manage their ethics programs and to provide leadership and oversight (Adobor 57).
Thesis Statement: The present provisions of the UK Companies Act 2006 are inadequate not exhaustive enough to explain the standard of care, skill, diligence and the fiduciary duty expected of directors in order to avoid conflicts of interest and the corporate opportunity doctrine.
The main focus of this research is to explore the core fiduciary duty of loyalty of the directors to avoid conflicts of interest and the corporate opportunity doctrine. The present provisions of CA 2006 do not expound the consequences when the no-conflict duty is breached by a director or in the event that a corporate opportunity has been utilized for the director’s own benefit.
The main concern over the extension of corporate liability is that it will open the floodgates for the prolonged litigation proceedings. While the creditors and shareholders are protected under the Companies Act of 2006 (CA 2006) in UK, there are some nations that are protected by sovereign immunity. This will serve as a protection for the individual defendants who do not have the resources to successfully collect on judgments against corporate entities (Fuks 141).
The CA 2006 provisions on the duties and obligations are vague and should be more specific to impose punishment for the fraudulent acts of directors or to prevent them from committing actions that resulted to conflict of interest. Specifically under Section 172 of the CA 2006, directors have the obligation not only to promote the success of the company, but also to ensure that the success and survival of the company against unnecessary and substantial risks (Paulo 62). Furthermore, the directors are expected to meet challenges especially when it comes to making capital structure and financial leverage decisions keeping with Hamada’s equation. The rationale behind such particular provision of the law is to be able to estimate how the changes in the debt/equity ratio can affect the cost of equity capital of a company (Paulo 62).
Additionally, under Section 417 (2) of the UK Companies Act of 2006, all directors are required to file an annual business review for the purpose of informing the members of the company and all stakeholders. At the same time, such provision will aid in providing an assessment on how the directors have performed their duty under Section 172 of CA 2006, which is the obligation or duty to promote the success of the company (Paulo 61). On the other hand, Section 417, requires that there should be business review and includes the provision, and analysis of financial key performance indicators of the company’s performance (Paulo 61).
UK Companies Act of 2006
The UK Companies Act of 2006 or the CA 2006 is originally intended to regulate the conduct of directors of any given company, regardless of the size, to have access to fundamental wealth creation in a free-market economy. With reference to statute and case law, the provisions of CA 2006 are inadequate to prevent directors from abusing their powers and privileges. The core powers of directors as well as their duties and privileges are expressly enumerated in the Companies Act 2006, and interpreted further by pertinent case laws.
For the first time, the UK Companies Act of 2006 has incorporated in Section 172(1), the corporate objective as part of the duty of the directors to promote the success of the company for the benefit of its all its members (Paulo 262). Thus, the directors have the statutory duty to promote the success of the company by fulfilling their duty to ensure that the assets of the company are properly invested and not dissipated by avoiding conflict of interest. The brief review of the function and impact the firm’s capital should be properly assessed based on financial valuations on the investment, financing, and dividend decisions to avoid losses for the company and all the stakeholders (Paulo 262).
A basic principle that was reflected in the reforms that was incorporated in the Company Act 2006 was the “think small first” principle (Tomasic 45). The intention of the framers is to equalize the obligations imposed by the company law which can affect a vast number of small to medium-sized corporations. The enactment of the Companies Act 2006 in UK is one of the major developments that occurred in the history of the country since the said Act received Royal Assent. The Act consists of 1300 sections and has been considered as the biggest piece of legislation that took effect in United Kingdom. The CA 2006 included new principles for the purpose of reducing the burden of regulation imposed by the company law that may discourage smaller companies which are obligated to comply with corporate governance (Tomasic 45). Some of these small to medium companies practice and implement their own private codes of conduct, while some of them demonstrated resistance to regulation involving corporate governance in the United Kingdom (Tomasic 45).
While there may be a number of reforms that were introduced by the Companies Act 2006, the main highlight of these reforms included the promotion of shareholder’s value in the decision-making of directors (Tomasic 45). Additionally, under Section 417 (2) of CA 2006, all directors are required to file an annual business review for the purpose of informing the members of the company and help them assess the performance of the directors’ duties as stated under Section 172. Section 172 specifically provides that all directors have the obligation to promote the success of the company (Paulo 61). On the other hand, Section 417 requires that aside from the business review, there should be a provision that analyses the financial key performance indicators of the company (Paulo 61).
In fact, Section 232 of the Act on directors’ liabilities is a provision that prevents the directors to protect them from any liability that may be imposed in case there are acts that fall under the definition of negligence, breach of duty, violation or breach of trust or default in relation to the company shall be considered as void (Paulo 61). Thus, such provision is the only provision which gives protection to the company from the negligence or any wrongdoing of the director, whether it was done directly or indirectly. However, such provision is vague and does not provides a definite punishment for a director of the company for any liability that will be attached for acts that shall be considered as negligence, default, breach of duty or breach of trust in the performance of the duties of the directors (Paulo 61). The provision of Companies Act 2006 failed to impose precise and definite terms that provide for punishment in the event that the directors abuse their powers, duties and privileges.
Given the enshrining directors’ duties provided under CA 2006 shows that the intention of the law is to bring the application of the law to the business activities of the directors based on the duties they are supposed to fulfil, but does not explain how the courts should apply the law. (Ashraf 127). Thus, Section 170(4) only mentions the general duties of the directors that are based on common law rules and principles, and may only be interpreted and applied in the same manners as the common law rules apply (Ashraf 127). In effect, CA 2006 does not codify the penalties and punishment imposed upon the directors in the event that they will not be able to perform their duties or committed acts that will cause negligence or breach of trust to the corporation. Therefore, the key duties imposed on directors under CA 2006 or in any other statute, do not prevent them from abusing their power and privileges that have been granted to them under the law.
Ethical Directors
It is expected that every director should make ethical decisions in behalf of corporations. In fact, in some countries like the U.S., they deemed it fit for every company to elect its designated ethics officers. These ethics officers are vulnerable to various types of conflicts such as the experience person-role conflict (Adobor 61). Such conflict arises when the personal values of an ethics officer become inconsistent with his or her defined role. The conflict between the personal values of the ethics officer and their role expectation may result to some officers who violate their own personal values. Some directors may behave in manners that may be inconsistent with their role expectations. Thus, there are instances when these directors make decisions which are not aligned with their own values (Adobor 61).
Liability of Directors
Under UK law, the directors are not required to undergo and file for formal insolvency proceedings in the event that the company becomes insolvent. There are only two rules which impose liability on the directors who permit the company to trade and operate its business, even when there is no reasonable prospect for the company in order to avoid insolvent liquidation, or being carried on to defraud creditors that may result to fraudulent trading (Hajjiri 192).
Under Section 214 of the Insolvency Act 1986, it imposes civil liability for directors for the losses incurred by the creditors if such directors knew or ought to have concluded that there was no reasonable prospect of the company to avoid insolvent liquidation. These are the directors who had knowledge that the company will file for insolvent liquidation and that its assets are insufficient to fully pay all its debts to the creditors. The directors are liable for civil liability if the company files a formal liquidation proceeding because only a liquidator is authorized under the statute to sue on the ground of wrongful trading (Hajjiri 192).
On the other hand, the directors may be absolved of liability against a wrongful trading suit if such directors will be able to prove that they took every step to minimize the potential loss to the creditors of the company (Hajjiri 194). The law requires that the director must be able to clearly demonstrate before the court by presenting evidence that shows that he or she took steps to keep the company operating. The director has the obligation to take reasonable efforts to minimize the loss of its creditors (Hajjiri 194).
However, a director who is proven to have violated Section 214 of the Insolvency Act of 1986 will incur financial liability as a way to compensate the creditors for their incremental losses from continued trading, after the time when insolvent liquidation appears to be inequitable (Hajjiri 194). This shows that such occurrence or event has reasonably informed the director that such is the case. The determination of liability on the part of the erring director shall be proven by facts and evidence. Due to the breadth of the statute and the potential significant liability on the part of the director, wrongful trading is likely the most difficult issue to be faced by directors in view of the insolvency of the corporation (Hajjiri 194).
Thus, the burden of proof rests on the director to demonstrate that at the time when the corporation chose to continue with the trading despite the fact of knowledge that the company is already in the zone of insolvency, the continued operations proved to be beneficial to the company (Hajjiri 194). Such fact may be proven by the acts of the director showing that they made decisions to return the company to its state of profitability, by setting the stage for restructuring or to allow a more advantageous sale process (Hajjiri 194).
It is also important for every corporation to establish essential interrelationships between corporate governance and business ethics (Llopis, Gonzalez & Gasco 97). It is essential to determine the characteristics and specific roles of directors and officers of the board by taking into account that there are corporate governance and ethical guidelines to be followed. It is important for every corporation to establish the patterns for the creation of an ethical culture through the symbolic leadership of the board’s strict implementation of corporate governance and creation of formal corporate ethics programmes (Llopis et al. 97).
The establishment of ethical culture must be expressly stated by laws in order to require corporations to create ethics programs that should incorporate certain elements to ensure that the directors’ actions are in accordance with laws. Some of the guidelines include the formal drawing up of a code of ethics that must articulate the ethical expectations among directors, officers and the board (Llopis et al. 100). At present, there are no laws that are existing that mandates the creation of ethical committees, that are mainly tasked to develop ethical policies, provide an assessment of the employees’ actions, and to investigate ethical violations (Llopis et al. 100). Aside from this, the maintenance of ethics communications systems should be established in order to allow the employees to report the abuse of power on the part of the directors, and receive penalties and punishment for failure to follow the proper behaviour guidelines.
The appointment of an ethics officer should also be mandatory in order to appoint a person in charge of coordinating ethics-related policies (Llopis et al. 100). Additionally, it is important to develop ethical training within the firm to help the employees to recognise and respond to ethical issues. It is also mandatory on the part of the firms to ensure the regulation of a disciplinary process to correct unethical behaviours committed by directors or officers. The decision to modify or improve ethical values should be made at the corporate governance level and the directors are expected to be the ones on top of the organisation to assume ethical roles (Llopis et al. 100). The directors are also expected to make critical decisions for the firm, and their ethical behaviour will be reflected in those decisions. The existence of a corporate governance ethical culture is expected among directors and officers of the firm and such expectation should be expressly mandated by corporate law and statutes.
However, despite the fact that majority of directors’ duties cases were decided before the CA 2006 came into force, they still retain relevance and application. However, the new law (CA 2006) does not explicitly provide that directors may incur personal liability, both civil and criminal, for their acts or omissions in managing the affairs of the company, unlike under Insolvency Act 1986 and the Company Directors’ Disqualification Act 1986 (Kushner 681).
The provisions of CA 2006, particularly Section 1157 does not expressly determine the liability of the directors which will depend on the participation of the director who is at fault. Thus, the director is not automatically held liable provided that there is proof that he was honest and careful in his or her dealings. However, one particular case against directors is the declaration of dividends. Hence, when a director declares a substantial amount of dividends, it will not automatically result to a breach of duty, but the court will exercise its prerogative with regard to the technical issues of the case (Ferran 321).
In the case of Dovey v Cory, it was clearly stated by the House of Lords that a director of a company who assents to the payment of dividends, and was later on found to be unlawful because of a previously undetected fraud, shall not liable for breach of duty to the company. However, it must be proven that such director relied on the judgment, information, and advice of other people who have the integrity, skill, and competence on such matter before he can be absolved from liability (Ferran 322). In the case of Dovey v. Cory, it can be concluded that it was decided based on a fault-based view, which has become the trend in the modern authorities for strict liability. Such approach has been considered as the most reasonable approach for the possibility of relief, and regarded as the “better” view. Such decision follows a stricter approach and is in keeping Section 32 of the Companies Act 1907 (Ferran 322).
While in the case of In re Brazilian Rubber Plantations and Estates, Ltd., the High Court held that it is not conclusive that a man is guilty of negligence, gross or otherwise, unless the extent of the duty for which he is alleged to have neglected has been determined.
Similarly, in the case of Overend & Gurney Co. v. Gibb, the High Court held that the test on whether or not the directors exceeded the powers entrusted to them, simply means that if indeed they exceeded their powers, it should be cognizant based on the circumstances of such character. Thus, the abuse of power must be clearly manifested. Furthermore, such director would not have entered into such transaction based on the degree of knowledge that even a man of ordinary degree of prudence would have.
The power for the court to grant relief from liability of a director is based on evidence that such director acted with honesty and reasonable fairness. Hence, he can be absolved from liability. Such decision on the director’s right to claim relief is now reflected under Section 1157 of the Companies Act 2006 (Ferran 332). The court is given the power to mitigate the potentially harsh effect of being held strictly liable, provided that the director acted with honesty and fairness in the declaration of dividends, after he relied on the judgment, information, and advice of other people who have the integrity, skill, and competence on such matter (Ferran 322).
It would have been a different scenario where in a finance director who “cooks the books” committed grave abuse of discretion since it will be tantamount to fraud when he used a scheme in order to avoid detection by the other directors that the declaration of dividends is unlawful (Ferran 332). Hence, it is apparent that such act was done to defraud the company, which will make the director liable for his wrong judgment.
Recommendations
It is recommended that the responsible officer doctrine (RCO) should be incorporated in the future pieces of legislation of corporate law in UK, since it presents an opportunity to modernize the criminal law due to the difficulty of proving that a senior officer authorized a criminal act of a subordinate (Kushhner 681). Such recommendation is in keeping with the classical criminal law that seeks to prove that an officer who directed or authorized a criminal act should be punished. It clings to an archaic common law emphasis on overt criminal acts on the part of erring directors, who had the intention to defraud the corporation (Kushner 681). At the same time, it deters abuse of power on the part of the director for the transactions among routine corporate events by acting in a negative manner. Hence, the RCO doctrine will work as an advantage despite the fact that it imputes, in limited situations, the acts of the directors and officers of a corporation to abuse the powers and privileges granted by the corporation (Kushner 681).
This can be illustrated when some juries are permitted to infer knowing authorization from circumstantial evidence involving criminal acts that had been committed by directors or officers of the corporation, in order to defraud the corporation (Kushner 681). However, these cases typically involve small, closely-held corporations where the inference which may involve the conspiracy of officers and officers, who had been tasked to closely supervises the operations of the company. At the same time, since they have intimate knowledge of all business operations, such criminal acts may be performed under that officer's direction or with his express or implied consent (Kushner 681).
Conclusion
The directors’ duties are not explained in detail by new provisions of the law to adequately since the existing provisions of CA 2006 failed to provide measures to prevent the directors from abusing the powers and privileges granted to them by the companies they represent. The main highlight of the UK corporate law shows that the companies are managed for the benefit of shareholders (Paulo 61). At present, the ultimate objective of companies is to generate maximum wealth for shareholders based on the recommendation made by the Company Law Review Steering Group (CLRSG) (Paulo 61). Such conclusion has been reflected in the statement concerning the corporate objective that has been incorporated in the new legislation known as the “enlightened shareholder value’ principle” which has been accepted by the UK Government (Paulo 61). Such principle was included in the 2005 Company Law Reform Bill, and later become known as the UK Companies Act of 2006.
The CA 2006 provisions on the duties and obligations are vague and should be more specific to impose punishment for the fraudulent acts of directors or to prevent them from committing actions that will result to conflict of interest. Under Section 172 of the UK Companies Act of 2006, directors have the obligation not only to promote the success of the company, but also to ensure that the success and survival of the company against unnecessary and substantial risks (Paulo 62). Furthermore, the directors are expected to meet challenges especially when it comes to making capital structure and financial leverage decisions in keeping with Hamada’s equation. The rationale behind this is for the purpose of estimating how changes in the debt/equity ratio can affect the company’s cost of equity capital (Paulo 62).
Additionally, under Section 417 (2) of the UK Companies Act of 2006, all directors are required to file an annual business review for the purpose of informing the members of the company and help them assess how the directors have performed their duty under Section 172, which is the obligation or duty to promote the success of the company (Paulo 61). On the other hand, Section 417, requires that there should be business review and includes the provision, and analysis of financial key performance indicators of the company’s present standing (Paulo 61).
Furthermore, Section 232 of CA 2006 on directors’ liabilities is a provision that prevents the directors to protect them from any liability that will be attach in case there are acts that shall constitute acts of breach of duty, breach or violation of trust, negligence, or default, that are connected to the management of the company shall be considered as void. Thus, such provision is the only provision which seem to shield the company from the negligence or any wrongdoing of the director whether it was done in a direct or indirect manner. Such provision is vague and does not provide a definite punishment for a director of the company for any liability that will be attached for acts that shall be considered as negligence, default, breach of duty or breach of trust in the performance of the duties of the directors. The provisions of the law do not provide precise and concrete terms that impose punishment in the event that the directors has abused their powers, duties and privileges. Therefore, the key duties imposed on directors under CA 2006 or in any other statute, do not prevent them from abusing their power and privileges that had been granted to them under the law.
Given the enshrining directors’ duties provided under CA 2006 shows that the intention of the law is to bring the application of the law to the business activities of the directors based on the duties they are supposed to fulfil, but does not provide how the courts should apply the law. (Ashraf 127). Thus, Section 170(4) only mentions the general duties of the directors that are based on common law rules and principles, and may only be interpreted and applied in the same manners as the common law rules apply (Ashraf 127). In effect, CA 2006 does not codify the penalties and punishment imposed upon the directors in the event that they will not be able to perform their duties or committed acts that may result to negligence or breach of trust to the corporation.
This simply means that the application of the new law does not provide for any new judicial discretion or indeed direction, but merely required the application of the old common law rules to the new legislation. While it may be true that CA 2006 offers a more positive approach that provides for the nature and scope of general duties of the directors, the law should have followed the punishment and consequences approach as shown in the Directors Disqualification Act 1986 (DDA 1986) and Insolvency Act 1986 (IA 1986) (Ashraf 127).
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