New Companies Act 2006 (“Companies Act”) Impacts Upon Directors of UK Companies

December 7, 2006

The new Companies Act 2006 (the “Companies Act“) was published today. The Companies Act contains over 1,200 sections and 15 appendices and has taken 10 years to reach the statute books. It represents the most significant reform of UK company law in more than twenty years and impacts upon both privately owned and publicly owned companies registered in the UK. Only time will tell whether the Companies Act will achieve its stated objective of saving UK companies an estimated £250 million per year through deregulation. This publication will focus on the impact of the Companies Act upon those individuals who hold directorships in UK companies.

Implementation timetable for the Companies Act

The Companies Act is not yet in force and will be implemented in stages between January 2007 and October 2008 (the first provisions to come into force being connected with the European Union takeover transparency directives, e-commerce and shareholders’ information) A full implementation timetable is expected to be published by the Government in February 2007.

Who is a Director?

Before examining the impact of the Companies Act upon directors it is important to note that the term “director” has a broad meaning under English law. A director will include any person, firm, company or other entity who or which: (i) exercises management control over a UK company; or (ii) participates in the management of a UK company in the manner usually expected of a director. The determining factor is not therefore whether a person or entity uses the title “Director”.

The Companies Act continues to recognise the concept of “shadow directors”. A shadow director is defined as a “person in accordance with whose directions or instructions the directors of a company are accustomed to act”. An officer of a parent company (whether based in the UK or overseas) could qualify as a shadow director of a UK subsidiary, in the event that the board of directors of the UK subsidiary is accustomed to acting in accordance with the instructions of that officer.

Impact of the Companies Act upon Directors of UK Companies

Whilst the impact of the Companies Act will be felt by directors in a number of areas, this publication will focus on 6 key areas:

• directors’ duties and liabilities;

• release, indemnification and Directors’ and Officers’ insurance;

• shareholder actions against directors;

• directors’ service contracts;

• severance payments to directors; and

• loans to, and substantial property transactions with, directors.

Directors’ duties and liabilities

The Companies Act codifies for the first time, and at the same time revises, the law on directors’ duties in the UK. The following changes are particularly noteworthy:

• The Companies Act clarifies and expands upon a director’s duty to act in good faith and in the best interests of the company. The duty will be expressed as a duty to act in the way the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole. In fulfilling this duty, a director must have regard (amongst other matters) to:

  • the likely consequence of any decision in the long term;

  • the interest of the company’s employees;

  • the need to foster the company’s business relationships with suppliers, customers and others;

  • the impact of the company’s operations on the community and the environment;

  • the desirability of the company maintaining a reputation of high standards of business conduct; and

  • the need to act fairly as between the members of the company.

• The Companies Act introduces an objective standard of care and skill expected from directors. A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both the general knowledge, skill and experience which: (i) he or she in fact has; and (ii) may be reasonably expected of a person carrying out the functions carried out by that director;

• The Companies Act introduces an express duty not to accept any benefit (including a bribe) from a third party in connection with that directorship.

The increasingly prescriptive approach adopted by the Companies Act when characterising directors’ duties, coupled with the higher standard of skill and care expected of directors could expose directors of UK companies to a greater risk of claims. We will therefore consider below to what extent a UK company can release, indemnify or otherwise protect its directors against liability.

Release, indemnification and Directors’ and Officers’ insurance

In general terms, the Companies Act permits UK companies to agree to indemnify directors against (but not release them from) claims and liabilities arising out of negligence, default, breach of duty or breach of trust together with associated legal costs in relation to claims brought by third parties or unsuccessful claims brought by the company. A director cannot be protected against criminal liabilities and liabilities owed to the company. However, companies remain free to purchase Directors’ and Officers’ liability insurance for the benefit of directors.

Shareholder actions against Directors

With the permission of the court, a shareholder in a UK company may bring a derivative claim on behalf of the company against a director arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust.

The court will refuse permission in circumstances where the conduct of the director in question has been approved by the company or if the court considers that a person acting to promote the success of the company would not seek to pursue the claim.

Otherwise, the court has a discretion as to whether to permit the derivative claim to proceed taking into account factors such as the good faith (or otherwise) of the shareholder concerned.

Directors’ service contracts

The Companies Act extends shareholders’ rights of access to directors’ service contracts. Shareholders of the company will be able to obtain copies of directors’ service contracts (or, alternatively, details of the terms of those contracts) upon payment of a fee. Interestingly, the shareholder of a parent company has no automatic right to access the service agreement of a director of a UK subsidiary.

The Companies Act also introduces tighter controls over the duration of directors’ service contracts. Service contracts which run for a fixed term in excess of two years or which cannot be terminated without compensation by a notice period of two years’ or less, must be approved by shareholders.

Severance payments to Directors

Under the Companies Act, directors’ severance payments will continue to require shareholder approval with very few exceptions. Most notably, shareholder approval will not be required to the extent that a severance payment represents: (i) damages for breach of contract; (ii) pension for past services; or (iii) payment made in accordance with the terms of the director’s service contract.

Furthermore, the Companies Act resolves a longstanding debate about the requirement for shareholder approval for payments to directors which represent compensation for statutory employment law claims, such as claims for unfair dismissal (generally capped at approximately £65,000) and unlawful discrimination (such as age or sexual discrimination and to which no statutory cap applies). The Companies Act confirms that such statutory claims may be compensated without shareholder approval.

Loans to, and substantial property transactions with, Directors

The Companies Act relaxes the rules on making loans to directors, in that UK companies will be permitted to make loans and quasi-loans to directors (or connected persons) of the company or a holding company or to give guarantees to such persons with the consent of shareholders. The Companies Act also slightly increases the financial thresholds for de-minimis loans to and transactions with directors, which do not require shareholder approval.

Conclusion

Persons and entities involved in the management of UK companies should be aware of their duties, obligations and liabilities as directors which in many cases are impacted (in some cases, adversely) by the Companies Act. Care should be taken to ensure that directors are adequately protected against such liabilities by means of appropriate insurance and indemnification.

© 2006 Gibson, Dunn & Crutcher LLP

The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.