Clause 159

Company Law Reform Bill [Lords] – in a Public Bill Committee at 5:15 pm on 11th July 2006.

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Duty to exercise indpendent judgment

Question proposed, That the clause stand part of the Bill.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice)

We move on after a long interlude on clause 158.

Clause 159 introduces to statute a duty that directors must exercise their powers independently and must not fetter the future exercise of their discretion unless acting in accordance with an agreement made with the company or in a way authorised by its constitution. Although clearly based on the current legal position, the wording has been altered significantly.

The provision was debated in the Lords when Lord Freeman moved a probing amendment to omit subsection (1). He said first that directors might be restricted in relying on fellow directors or external advisers, particularly non-executive directors who as common practice rely on advice, reports and recommendations given by others. He also said that nominee directors appointed by a corporate  shareholder would, for obvious reasons, be unable to exercise independent judgment.

Lord Goldsmith responded that a director can take advice or copy someone else’s judgment, but the judgment that he exercises must be his own. He said that in some circumstances directors might breach their duties if they failed to take appropriate advice, but that slavish reliance would be unacceptable. In relation to nominee directors, case law supports the notion that they are required to exercise their best judgment in the interests of the company.

The Law Society’s parliamentary brief recommends leaving out the clause. It points out that the law in this area is developing and that the clause casts doubt on whether a director can rely on other directors or external advisers. Furthermore, it states that it is unclear what, if anything, the clause adds to the duties in clause 158. The CBI and a briefing note received from City solicitors Norton Rose point out that it is unclear whether the duty in clause 159 precludes a director from delegating functions to committees of a board. However, guidance from the Department of Trade and Industry seems to indicate that that would be permitted if allowed by a company’s constitution. Will the Minister explain how the Government came to that point of view?

Our concern is that a non-independent, non-executive director—for instance, a nominee director of a large shareholder—might fear that under the clause the duty to exercise independent judgment could be used to make their position more difficult. What can the Minister say to put such people’s minds at rest?

Finally, clause 159(2) notes that a director will not be in breach if he acts in a way authorised by his company’s constitution. On that basis, is it not the case that if a company’s articles said that a non-independent nominee director could act in accordance with the instructions of the nominating shareholder, or at least that he could have full regard to such instructions, that would end or reduce the duty set out in the clause, which presumably overrides the existing common law duty?

Photo of Mike O'Brien Mike O'Brien Solicitor General, Law Officers' Department

The duty is about directors having to make their own judgments and not follow blindly the views of another without considering the interests of the company. In other words, the role of a director is to exercise independent judgment for the benefit of the company. That is what we expect directors to do. It is surely right that they should have that obligation, given that it is what they were appointed to do. If the clause were deleted as the amendment proposes, the duty would remain an uncodified equitable principle.

Photo of John Bercow John Bercow Conservative, Buckingham

We are discussing clause 159. I think we are all conscious of that.

Photo of Mike O'Brien Mike O'Brien Solicitor General, Law Officers' Department

I did refer to an amendment, and I have a note here on it, but I accept that the hon. Gentleman did not move one, so let us deal with the stand part debate.

The aim is to codify the law so that it is easily accessible to directors. The duty does not mean that a director cannot take proper advice from a lawyer, an accountant or anyone else he feels it appropriate to take advice from. He can take such advice from others and rely on it if he chooses to do so. Although he is exercising an independent judgment, that does not mean that he must be independent himself. He might have an interest in the matter, and conflicts of interest are dealt with in clauses 161 to 163. It is only the director’s judgment that must be independent, in the sense that it must be his judgment, not that of someone else.

The director may even adopt another’s judgment, provided that he believes that it is in the best interests of the company—in other words, that his judgment is that someone else’s judgment is in the best interests of the company.

Subsection (2)(a) reflects the current law in Cabra Estates plc and Fulham football club. Under subsection (2)(b), companies can authorise the fettering of the discretion through their constitution, if they choose to do so.

The statutory statement does not affect the current law that a delegate may not delegate unless he has been given the power to do so. Provided that a company gives a director a power to delegate, he may choose to exercise that power, but it is for the company itself to give him it. Directors may delegate the performance of their functions and the exercise of their powers if the company has given them the power to delegate. They will know whether they have that power, because it may be conferred expressly on them by the company’s constitution or by shareholders’ resolution, or it may be implied, provided that it is clearly implied.

Article 15 of the draft model articles for companies limited by shares, which were published in the March 2005 White Paper, provides that, with certain exceptions, directors may delegate any of their functions to any person they think fit. The Law Commission’s draft summary of the general duties did not deal with delegation. The company law review included the principle in its draft statement because it wanted to emphasise the fact that directors may not subordinate their judgment to that of another by delegating their functions unless such delegation is authorised by the constitution. We have concluded that the principle does not belong in the statutory statement. How the directors distribute their functions among themselves on a day-to-day basis is part of how they organise their affairs in accordance with the constitution.

The question arises as to how the duty adds to clause 158. It has been said that most of the fiduciary duties can be seen as aspects of one fundamental duty to act in good faith for the benefit of the company. Even if that is so, the conventional approach is further to classify the duties. That helps to show the range of the duties and the various ways in which they apply. The Law Commission and the company law review both considered that the statement of duties should include a separate reference to a requirement on a fiduciary not  to fetter discretion, and we agree with that.

I was asked whether the Bill will change the law on nominee directors. The general duties do not prevent the appointment of nominee directors, who are appointed by a particular party to protect their interests. However, once appointed, the nominee director must be left free to exercise his best judgment in the interests of the company that he serves. The nominee director must ignore the interests and wishes of the person who appointed him, and we rely there on case law, including Scottish Co-operative Wholesale Society Ltd v. Meyer and Kuwait Asia Bank EC v. National Mutual Life Nominees Ltd. The statutory statement does not change that, but subsection (2)(b) will allow the status of the nominee director to be enshrined in the company’s constitution so that the nominee is able to follow the instructions of the person who appointed him without breaching that duty. The extent to which that is possible under the existing law was unclear, but we have now made it clear. However, even when a nominee follows instructions, he must still comply with all his other duties—there may well be other duties—such as a duty to act broadly in the interests of the company. I hope that that deals with the points raised by the hon. Gentleman and I hope that he will be able to support the clause.

Question put and agreed to.

Clause 159 ordered to stand part of the Bill.