The Companies Act and Directors
What expectations are set out in law in respect of directors? The legal provisions are found in sections 170–177 of the Companies Act 2006.
Section 172 is intended to clarify the wider expectations and responsibilities relating to a director, who must act in ‘good faith’, and in acting for the benefit of the company’s members (shareholders) as a whole, must take into account several other factors, including the long-term consequences of decisions, a company’s various stakeholders (employees, customers, suppliers), sustainability, fairness and the ‘desirability of the company maintaining a reputation for high standards of business conduct’ (s 172(1)(e)). The Oxford Business Law Blog discusses the reasonableness of decision-making by directors in company law:
Under s 172 of the Companies Act 2006 (‘the Act’), courts will not interfere with the board’s decision concerning an alleged breach of the duty to promote the success of the company unless it is one that no reasonable director could have made, which is known as the Wednesbury standard. Section 172 has been interpreted to mean that courts are to abstain from reviewing on objective grounds whether the board’s decision was actually in the best interest of the company; it is for the directors, in their subjective view, to decide. Courts will only intervene if the decision is one that no reasonable director could have considered to be in the company’s best interest. In short, the standard of conduct required of directors under s 172 is subjective, and the standard of review adopted by courts is rationality or plausibility.[1]
The Wednesbury standard referred to derives from Associated Picture Houses Ltd v Wednesbury Corporation (1948): a decision is unreasonable or irrational only if it is so unreasonable that no reasonable person acting reasonably could have made it. In essence it puts in place a reasonableness test in the discharge of directors’ duties under Section 172.
Courts have generally been reluctant to find directors in breach of their Section 172 duties if they have acted reasonably. One recent example is in Re Marylebone Warwick Balfour Management Limited (2022), where the court found that the directors had discharged their duties under Section 172 by taking and relying on professional advice in respect of a tax avoidance scheme.[2] A further example is Atkinson & Mummery v Kingsley and Smith (2020), where a director was found not to be in breach of their Section 172 duty in failing to prevent access to the company bank account for one of the directors with whom relationships had deteriorated and who made a transfer from that account. While the facts are specific to the case, the point under Section 172 is that the initial test is subjective: based on the information available, did the director honestly believe they were acting in the best interests of the company and its shareholders? The court then applied an objective test: would an honest and intelligent person have taken the same actions to comply with their duties? This ensures that directors cannot simply ignore things and absolve themselves of responsibility, but there is also a reasonableness test in place. The recent case of ClientEarth v Shell Plc (2023) reinforced these points. It is for the directors themselves, acting in good faith, to determine how to act in the best interests of the company under Section 172. A breach requires proof of conduct other than in good faith. Indeed, under the general duty of reasonable skill, care and diligence imposed under Section 174 (discussed below), the law does not ‘superimpose on that duty more specific obligations as to what is and is not reasonable in every circumstance’.[3]
Section 172 is not without its controversies and detractors, and forms part of the wider debate around company purpose. Some criticism focuses on the expectation that the directors must act for the success of the company rather than any stated wider purpose.
A further important provision is Section 174 of the Companies Act 2006. This sets out that a director must exercise reasonable skill, care and diligence – a legal provision that applies to all directors, not just NEDs, in accordance with the principle that all directors have the same duty of care and diligence. This duty, however, is also qualified by both an objective reasonableness test and a subjective contextual test, set out in Section 174 (2) as follows:
2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with –
a. 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, and
b. the general knowledge, skill and experience that the director has.[4]
In respect of proceedings under the Company Directors Disqualification Act 1986, the test under its section 6 (1) (b) is that of unfitness. The courts have found that this test is also one that must be measured by context, by the actual responsibilities undertaken by the director. In Re Keeping Kids Company (2021), Falk J, at paragraph 144, cited Jonathan Parker J, in his judgment in Re Barings plc (No. 5) (1999), summarising the principles to be used in respect of disqualification and making clear that conduct must be evaluated in context, by reference (paragraph 144 (h)) to the actual role and responsibilities.
We might summarise the legal position around directors’ duties as a standard duty of care but tested by reasonableness and context. Thus, Gower’s Principles of Modern Company Law (11th edition) states:
What does this all mean for directors? First, although directors, executive and non-executive, are subject to a uniform and objective duty of care, what the discharge of that duty requires in particular cases will not be uniform. As the statutory formulation itself recognises, what is required of the director will depend on the functions carried out by the director, so that there will be variations, not only between executive and non-executive directors but also between different types of executive director (and equally of non-executives) and between different types and sizes of company.[5]
Notes to Chapter 3
[1] Ernest Lim, ‘Judicial Intervention in Directors’ Decision-Making Process: Section 172 of the Companies Act 2006′, Oxford Business Law Blog, 22 February 2018, https://blogs.law.ox.ac.uk/business-law-blog/blog/2018/02/judicial-intervention-directors-decision-making-process-section-172.
[2] This case is under appeal.
[3] ClientEarth v Shell plc, [2023] EWHC 1897 (Ch), paragraph 31.
[4] Companies Act 2006, Part 10, Chapter 2, ‘General duties of directors’, Section 174, https://www.legislation.gov.uk/ukpga/2006/46/section/174.
[5] Gower: Principles of Modern Company Law, 11th edn, ed. Paul Davies, Sarah Worthington and Chris Hare, London: Sweet & Maxwell, 2021.