Clause 160

Company Law Reform Bill [Lords] – in a Public Bill Committee at 5:30 pm on 11th July 2006.

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Duty to exercise reasonable care, skill and diligence

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

I beg to move amendment No. 272, in clause 160, page 70, line 34, leave out subsection (2).

The clause is a new provision and codifies the duty to exercise reasonable care, skill and diligence, which is to be judged by both a subjective and an objective standard. Lord Freeman moved a probing amendment in the other place to leave out subsection (2) so as to remove the objective/subjective test introduced by section 214 of the Insolvency Act 1986 as it adds a level of severity. The extent of a director’s duties, failings and liabilities should be determined on the particular facts of a case. This also raises the issue of the standard on which a director who is also a professional should be judged. Lord Goldsmith responded that subsection (2) is essential to establish what the standard of care owed by director to a company is. He said that the wording of subsection (2) is clear and that the duty of care will take into account the general knowledge, skills and experience of that director. He also said, in response to a Law Society query, that if a director is a professional but is not employed by the company in his professional capacity, he would not be expected to bring his professional expertise to the directorship. Will the Solicitor-General provide the grounds on which the Attorney-General made that statement?

The City firm, Linklaters, pointed out in a report that the provision follows recent case law, which has adopted the twofold duty that I discussed. However, adopting such a test, which was originally introduced in an insolvency context, may cause concern if applied in all situations and for all types of company. Directors of smaller companies, particularly those established for non-commercial purposes, would find that standard particularly onerous. Furthermore, non-executive directors are to be judged by the same standard as executive directors. Norton Rose’s report pointed out that non-executive directors will often have more experience than their executive counterparts. Does the Solicitor-General consider that the impact of the clause could be to put directors off serving as directors?

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

Those who take it on themselves to act on behalf of or to advise others may have a duty to exercise care and skill in doing so. The clause is concerned with the application of that duty to company directors. The duty of care that a director owes to his company is an important area of law and has evolved significantly over the past 20 years. Historically, there was a very low standard of care and a director was not required to exhibit in the performance of his duties a greater degree of skill than might reasonably be expected from a person of his knowledge and experience. That was in re City Equitable Fire Insurance Company.

Some 19th century cases remain well known, in part because their outcome now strikes us as out of step with modern expectations. For example, in 1892 the court held that the Marquis of Bute, who was appointed a bank president at the age of six months and attended only one meeting of the board in 39 years, had not breached his duty of care. That was in re Cardiff Savings Bank. Standards have changed and the law has developed significantly. The Law Commission considered that we should ensure that our current standard is the right one and that that should be set out in statute. The company law review agreed, as do we.

The duty requires a director to exercise reasonable care, skill and diligence. Subsection (2) explains what that means. It

“means the care, skill and diligence that would be exercised by a reasonably diligent person.”

The duty is based on

“the general knowledge, skill and experience that may reasonably be expected of a person carrying out the” same functions as the director in that particular company, and the actual

“general knowledge, skill and experience that the director has.”

The former is the minimum standard required by the duty on all directors. If the particular director possesses greater general knowledge, skill or experience than that which may reasonably be expected of a director carrying out the same functions as him in that company, he will have to meet a higher standard of care, skill and diligence appropriate to his general knowledge, skill and experience.

That deals with executive or non-executive directors who might have different levels of knowledge and skill, where they are expected to exercise that. If the director  happens to possess less knowledge, skill and experience than that which would be reasonably expected of a director carrying out the same functions as him in that company, he would nevertheless be required to meet the minimum standard set by the objective test in subsection (2)(a), which was referred to also in the case of re DKG Contractors Ltd.

The standard of care takes account of the differences between the responsibilities of directors of different types and in different situations—for example, the chairman, chief executive, finance director, chairman of the audit committee or an independent non-executive director. The objective element of the test looks at the general knowledge, skill and experience that may be reasonably expected of a person carrying out the same functions as the director in that company, enabling the court to take account of all such differences.

In a sense, I have dealt already with non-executive directors. The duty takes into account an individual’s general knowledge, skill and experience that they are expected to deploy. However, the duty does not require the director to use all his skills. For example, a lawyer on the board of a company is not expected to second guess the lawyers advising the company, but to use his general knowledge, skill and ability to look at things. It might be that, as a result of those skills, he will have some questions about a decision with a legal impact and for which legal advice has been obtained. However, he is not expected to go off and spend a week researching the subject that a barrister has been employed to research in order to see if he agrees with it. That is not the required level of diligence. So it is about  exercising reasonable care, skill and diligence. The non-executive director will use some of his experience and skill in his involvement, but he is not expected to have all the knowledge about the internal workings of the business that, say, an executive director is, and so the law will take account of people’s different perspectives.

The clause provides sufficient guidance to directors so that they can exercise their roles with a degree of certainty about what is required of them. I hope therefore that the hon. Gentleman will feel able to support our position.

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

The Solicitor-General explained the test in section 214 of the Insolvency Act 1986 very well, and I appreciate that we have moved on from the Marquis of Bute case. However, I am still not quite sure why we have to go to the level of toughness in section 214.

Tom Mackay, chair of the legal committee of the Quoted Companies Alliance, said that that duty

“could have dire consequences in that directors, especially those of FTSE 100 companies, would be reluctant to become a director of a smaller company. Liabilities will arise as they will be measured by a higher standard of care, skill and diligence”.

Clearly, a number of people are concerned about that, and we will have another look at the clause over the recess, but for the moment, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 160 ordered to stand part of the Bill.

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