Corporate Law Update

In this week’s update: the Chartered Governance Institute publishes updated guidance on directors’ duties and the LSE allows AIM companies to adopt IFRS 16 early.

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ICSA publishes updated guidance on directors’ duties

The Chartered Governance Institute (a branch of ICSA) has published updated guidance on directors’ general duties under the Companies Act 2006. The guidance is available only to subscribers to ICSA’s website, although subscription is free for this particular guidance.

The updated guidance replaces the previous guidance published by ICSA in 2015. It is primarily aimed at public quoted companies, but it can also be applied to private companies.

What are a director’s duties?

As a reminder, directors of a UK company are subject to seven statutory duties, which they owe to the company. The duties are set out in sections 171 to 177 (inclusive) of the Companies Act 2006 and are as follows.

  • To act within their powers (i.e. to act in accordance with the company’s constitution and to exercise powers only for the purposes for which they are conferred) (section 171).
  • To promote the success of the company for the benefit of its members (usually, shareholders) as a whole (section 172).
  • To exercise independent judgment (section 173).
  • To exercise reasonable care, skill and diligence (section 174).
  • To avoid a conflict of interest (section 175).
  • Not to accept benefits from third parties (section 176).
  • To declare any interest in a proposed transaction or arrangement (section 177).

In particular, when discharging their duty under section 172, directors must “have regard” to six statutory considerations, namely:

  • the likely consequences of any decision in the long term;
  • the interests 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 maintaining a reputation for high standards of business conduct; and
  • the need to act fairly as between members of the company.

These seven duties are also supplemented by certain non-statutory duties, including a duty to keep company information confidential and not to exploit it, and a variety of other obligations under statute. These include a duty (under section 182) to declare an interest in an existing transaction or arrangement (unless the director has already declared the interest under section 177).

Where a director breaches any of their duties, the company itself can bring civil action to recover any loss it has suffered or unlawful profit the director has made. In addition, in certain circumstances, a member (i.e. shareholder) of the company may be able to bring an action in the company’s name under a so-called “derivative action”.

There is no criminal sanction for breach of the statutory duties, although a breach of certain related obligations (including section 182) is a criminal offence.

The statutory duties above are imposed not only on official (or “de jure”) directors of the company, but also on so-called “de facto” directors (i.e. persons who have not been officially appointed as directors but who act as directors) and, to some extent, to shadow directors (i.e. persons in accordance with whose wishes the board acts). In some circumstances, the duties continue to apply even after a person has ceased to be a director.

The guidance sets out practical guidance for directors to comply with each of their statutory duties. It also now includes guidance on the requirement for large companies to include in their strategic report a section 172(1) statement setting out how the directors have complied with their duty to promote the company’s success for the benefit of its members.

The key points from the updated guidance note are set out below.

  • To comply with section 171, directors should always comply with the company’s constitution. For example, they should always follow formal procedures and distinguish between meetings of the full board and meetings of committees of the board. If in doubt, directors should seek the advice of the company secretary.
  • When considering the interests of employees, directors might reflect on fair remuneration practices (including the ratio of employee to executive pay) and how they will manage any deficit in any defined benefit pension plan.
  • When considering the community and environment, directors should first identify the community or communities of which the company is a part, then proceed to analyse the impact on those communities of any specific action (e.g. the closure of branches in those areas).
  • When acting fairly between members, directors should ensure equality of access to information and consider disseminating information via the company’s website. Directors who represent particular shareholders must bear in mind that they must exercise their duties for the benefit of all members of the company and not merely those they represent.
  • Directors should not balance the interests of the company with the interests of stakeholders. Whilst directors of commercial companies must “have regard” to the six factors in section 172 (see “What are a director’s duties?” above), their duty to the company is paramount. That said, the six factors should be “embedded within the culture and policies” of the organisation and taken into account at all decision-making levels.
  • Directors should not allow personal interests to affect their judgment. Ideally, they should excuse themselves from any decisions that relate to their own property or interests. Directors should not promote a collective line without due consideration; they should instead bring to the board the benefit of their own independent judgment.
  • Before accepting board positions at other companies, directors should consider whether multiple directorships are likely to give rise to a conflict of interest or might materially affect the time they can devote to the company. More generally, companies might consider maintaining a register of director’s conflicts of interest, which should be reviewed before authorising a conflict.
  • When analysing benefits from third parties, directors should remember that benefits can take non-monetary forms, such as corporate hospitality. Directors should exercise particular care where they are involved in negotiating a new contract with a person who offers corporate hospitality.
  • Directors should remember that they may have an indirect interest in a transaction or arrangement through (for example) a spouse. Any interest must be declared before the company enters into the transaction or arrangement.

In relation to the duty to publish a section 172(1) statement, the key points from the updated guidance are set out below.

  • Although the section 172(1) statement will need to be set out in the company’s strategic report, the company will need either to report separately on how it has engaged with employees and had regard to its relationships with customers and suppliers in its directors’ report or to include in its directors’ report an appropriate cross-reference to its strategic report.
  • The guidance note endorses the separate guidance on section 172(1) statements published by the Financial Reporting Council as part of its Guidance on the Strategic Report.
  • When reporting on employees, companies should consider including a description of the workforce (including demographic and diversity), how the company engages with the workforce, how the workforce contributes to the success of the company’s business strategy and creates value, and how the company invests in its workforce.
  • When reporting on relationships with other stakeholders (such as suppliers and customers), companies might set out how they engage with stakeholders and include information on prompt payment practices, supply chain sustainability and resilience and responsible sourcing.
  • When reporting on the impact on the community and the environment, disclosures might cover how the directors monitor and mitigate the environmental impact of the company's operations, how the company contributes to environmental concerns relating to its operations, and how it engages with the local community.

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