The Companies Act 2006

The Companies Act 2006 is a piece of primary legislation that, once brought into force, will largely apply to companies directly and govern the duties directors owe to their companies. There are several duties which businesses need to be aware of.

DUTY TO ACT WITHIN THEIR POWERS

This codifies the common law rule that directors should exercise their powers under the terms that were granted for a proper purpose. Directors' powers are normally derived from the companies' constitution, its memorandum and articles of association.

DUTY TO PROMOTE THE SUCCESS OF THE COMPANY

This is a new duty developed from one of the heads of the overriding principles of the fiduciary duties (duty of good faith to act in the company's best interest). The act imposes a duty to act in the way a director considers in good faith would be most likely to promote the success of the company.

Although this duty is still owed to the members as a whole, when exercising this duty, the director is required to consider a list of factors, including the long-term consequence of the decisions as well as the interest of the employees, the relationships with suppliers customers, and the impact of the decision on community and environment.

DUTY TO EXERCISE INDEPENDENT JUDGEMENT

Section 173 of the act imposes a positive duty on a director of a company to exercise independent judgement. There are two elements to this section. The director must exercise judgement and secondly he must exercise the judgement independently.

Prima facie this rule will impinge on so-called sleeping directors who claim no active role in the management and leave decisions to others. This would impact on shadow directors. Arguably if a director is to exercise independent judgement then there will be no scope for shadow directors.

This duty is not infringed upon if a director acts in accordance with an agreement that was duly entered into by the company. It remains to be seen how in practice this rule will impact on a director.

DUTY TO EXERCISE REASONABLE CARE, SKILL AND DILIGENCE

It is the level of care, skill and diligence that would be exercised by a reasonably diligent person with:

• the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company
• the general knowledge, skill and experience that the director has

This is the same test imposed under Section 214 of the Insolvency Act 1986 in the context of a director's wrongful trading. A director who has more experience, knowledge and skill will have a higher threshold in discharging this duty.

DUTY TO AVOID CONFLICT OF INTEREST

The duty applies to a transaction between a director and a third party, such as the exploration of any property information of opportunity, in other words the duty does not extend to a transaction between the director and his own company, in respect of which a different rule applies which requires a director to declare his interest to the other directors. That makes it easier for directors to enter into transactions with third party, when director's interest conflict with company interest.

Previously shareholder approval was required to enable directors to enter into transactions with third parties.

Now such transactions can be authorised by the non-conflicted directors on the board, provided that certain requirements, including who can participate and vote on such authorisation, are complied with.

It is feared this duty may impact on a director who holds multiple directorships, or even discourage a director to hold non-executive directorships.

DUTY TO NOT ACCEPT BENEFITS FROM THIRD PARTY

This reinstates the existing rule known as non-profit – that a director is not permitted to accept a benefit from a third party.

Benefits can be both monetary and non-monetary, including for example non-executive directorship and even corporate entertainment.

However a director will not be in breach of this duty if the exception of such benefit cannot reasonably be regarded as likely to give rise to conflict of interest. Nevertheless, as it is not always clear whether certain benefits will give rise to conflicts of interest, it is thought that directors might be more likely to take advice in this area.

DUTY TO DECLARE INTEREST IN PROPOSED TRANSACTIONAL ARRANGEMENT WITH THE COMPANY

Section 177 of the act requires a director to disclose his interest to the board of the company when a transaction is proposed between a director and his company. However, a director is required to declare the nature and extent of the interest to the other directors. Further disclosure must be made where the director is considered, or ought reasonably to be aware of, a conflicting interest.

Disclosure also extends to a person connected with the director, for example his wife and children. The requirement for disclosure is dispensed in circumstances where the interest cannot reasonably be regarded as likely to give rise to a conflict of interest or if other directors are already aware or ought reasonably to be aware of the director's interest.

The Companies Act 2006 will particularly affect private limited companies. However, companies have time to plan for changes as they are being brought into force over a period of time.

The first changes include statutory rules for electronic communications between companies and shareholders – particularly, the power to use websites and emails to publish notices and other communications. Companies that already communicate electronically should consider reviewing their practices to take advantage of the new rules, and those that don't should consider changing their procedures to allow for electronic communications.

Importantly, business owners should set aside some time to ensure that they are fully up to date with new legislation otherwise they may find themselves facing criminal charges.

If you should find yourself in violation of a law, take immediate steps to rectify the situation. Depending on the severity of the law you may only receive a warning or a small fine. More often that not, you will be given a time frame in which to make the appropriate corrections.