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The Company Law Reform Bill

DNH Stallard Solicitors

Sweeping changes are about to be made to Company Law which will simplify it and make it easier to understand. This is legislation which will affect all companies.

On 1 November 2005, the Company Law Reform Bill (“CLRB”) was finally introduced some seven years after the Government first initiated a review of Company Law.

The CLRB is a significant piece of legislation (it is apparently one of the longest statutes ever to go before Parliament) and it will repeal large portions of the Companies Act 1985. It is anticipated that the CLRB will come into force as the Company Law Reform Act in April 2007 (although following a recent reading in the Lords, it might just be called The Companies Act 2007).

There are three key areas to note from a dispute resolution point of view:

(1) Directors’ duties

For the first time, the duties owed by directors to their companies will be written down. Currently the duties are set out in individual Court decisions and this has led to uncertainty and complexity.

The new duties are owed to the company and only the company, therefore, can act to enforce them (save in certain circumstances when shareholders may be able to bring actions – see (2) below). In particular, directors must now promote the success of the company for the benefit of its members as a whole having regard to six factors which must be specifically considered. The factors include: the likely consequences of any decision in the long term; the interests of the company’s employees; and the need to act fairly between members of the company.

The key question, and only time will reveal the answer, is what liability could attach to directors for failing to consider the six factors. The DTI guidance suggests that directors must do all they reasonably can to take these factors into account. The advice we would have to give, therefore, is the more significant a decision the more important it will be to document it, in minutes or otherwise, to show that the various factors have been considered by the directors and to document how, if at all, a decision will impact on the company. If there is evidence to show that the factors have been properly considered then it would seem likely that the duty has been discharged.

Key Point: To discharge the duties, all important decisions should be documented carefully in minutes to show that the factors set out in the statute have been considered by the directors.

(2) Shareholder claims

The ability of shareholders to take action on behalf of a company against directors will be extended and, in the Government’s own words, the law will become “clearer and more accessible”.

Currently, the opportunities that exist for a shareholder to sue directors in the name of the company are quite limited. The main cause of action at present is where the wrongdoers in control of the company have abused their power in some way. This is known as a “fraud on the minority”. Such a claim is typically brought under section 459 of the Companies Act 1985 but involves lengthy Court proceedings and potentially substantial costs being incurred. Such a claim is brought by a member on his own behalf and so any remedy is for the benefit of the individual shareholder.

Under the new law, shareholders will be able to bring actions against a director if he is in breach of his duties or if he has been negligent. These are much wider circumstances than those in which a shareholder can currently bring a claim. A shareholder may be able to sue others where, for example, a person has received money transferred by a director in breach of trust.

These “derivative actions”, so called as they are brought by shareholders on behalf of and for the benefit of the company due to a wrong sustained by the company, require the shareholder to obtain permission of the Court to continue with the claim once it has been issued. In deciding whether to give permission the Court must look at factors such as whether the shareholder is acting in good faith; the importance of the claim to the company; whether the conduct would be likely to be ratified by the company; and indeed the merits generally. If the Court decides that the claim has no merit then it will dismiss the claim.

A Court must dismiss a claim if a person seeking to promote the success of a company would not continue with the claim or if the conduct complained of has been ratified by the company or its shareholders.

It is difficult to know whether the new regime will lead to more claims than at present. Aggrieved shareholders now have more scope in which to complain but as damages recovered will go to the company, rather than the shareholders, even the more litigious shareholders might be discouraged. It also remains to be seen how widely the Court will use its discretion to intervene. Will the Courts see a breach of health and safety obligations as a breach of duty, for example? In any event, companies should make sure that any insurance policies include defending derivative claims.

Key point: Check that your insurance covers the possibility of derivative claims.

(3) Auditor’s liability

When a company fails, those who have suffered losses look around to see who they can pursue for compensation. It is usually the auditors who have the biggest pockets.

There will now be a limit on auditor’s liability to stop the situation where an auditor may have to pay out compensation even where other parties might be as least or more to blame for any loss.

Subject to annual shareholder approval, all companies will be allowed to limit the liability of their auditors to an amount considered by a Court to be “fair and reasonable”.

As agreeing to liability will reduce the risk the auditor is exposed to, it is perhaps conceivable that directors will be able to negotiate and seek a reduction in audit fees or other concessions in the terms of the audit contract.

Key point: In light of the limit on liability, see what deal can be struck with your auditors over fees.

For more information please contact Joe Copping in our Dispute Resolution team.

dmhstallard.com/disputeresolution