Companies Act gives UK Shareholders New Rights

On October 1, 2007, provisions of the United Kingdom’s Companies Act 2006 (“the Act”), the largest piece of legislation ever to have passed through Parliament, went into effect. The legislation expanded the obligations of the board and expanded the instances when shareholders could bring derivative suits against the board.  The Act can be found here.  It illustrates that while the US debates whether to restrict litigation, the trend is often the reverse overseas. 

Sections 171 to 177 of the Act codify several directorial duties including: (1) the duty to act within powers; (2) the duty to promote the success of the company; (3) the duty to exercise independent judgment; (4) the duty to exercise reasonable care, skill and diligence; (5) the duty to avoid conflicts of interest; (6) the duty not to accept benefits from third parties; and (7) the duty to declare interest in proposed transaction(s) or arrangement(s). While duties 1 through 4 came into effect on October 1, 2007, provisions 5 through 7 will not take effect until October 1, 2008

Section 172, which identifies a duty to promote the success of the company, has received particular attention from commentators. See article here.  The duty essentially replaces more traditional language that required directors to act in the best interests of shareholders.  The term "success," however, remains undefined in the law. The explanatory notes to the Act notes can be found here.

A significant reform concerns derivative suits.  Section 260 allows a derivative action against a director for acts or omissions amounting to negligence, default, breach of duty, and breach of trust. Section 260 vastly expands the circumstances under which a shareholder can initiate a derivative suit against directors. A director, for example, no longer needs to have benefited from the negligent behavior.  However, the Act provides courts with substantial discretion and control over procedural aspects of derivative claims, including those expounded in Section 261.

Because the range of circumstances for initiating a derivative suit are expanded, Section 261 includes a two stage procedure to control derivate suits beyond the initial filing. During the first stage, the shareholder is required to make a prima facie case to the court for permission to continue the derivative claim. The determination of the court is based solely on the evidence submitted by the shareholder. The court must dismiss the shareholder claim if the act or omission was authorized or ratified by the company, a person acting in accordance with the duty to promote the success of the company would not continue the claim, where the cause of action has not yet occurred or has been authorized by the company, or the cause of action arises from an act or omission that has already occurred. If the shareholder cannot make a prima facie case, the court is required to dismiss the claim. If the shareholder survives the first stage, the court will move on to the second stage, which occurs before the substantive action begins, and may require the company to produce evidence in response to the claim.

With codification of various directorial duties through the Act UK corporate law in this area is more transparent and conforms to modern business practice. However, confusion is likely to result when existing common law interpreting and applying director duties is applied to duties codified through the Act. Until the courts begin to hear derivative cases addressing the duties in the Act, it is difficult to predict with certainty how the courts will interpret and apply the statutory duties.

The primary materials for this legislation may be found on the DU Corporate Governance website.