A House of Commons Select Committee spells trouble for company directors, and joy for the plaintiffs’ bar

A little while ago, I blogged about the Financial Reporting Council’s (“FRC”) proposal that it be given the power to impose sanctions on all listed company directors who preside over serious accounting irregularities. Now it seems these proposals not only have the backing of the House of Common’s Business, Energy and Industrial Strategy Committee (the “Committee”), but may be expanded further.

The Committee recently published its recommendations on U.K. corporate governance. In its report, the Committee notes that Section 172 of the Companies Act 2006 (the duty to promote the success of the company) has been in force for almost ten years, yet during that time, there have been no reported cases of shareholders bringing claims under that section. The section had been the cause of long-standing debate pre-implementation, as it combined a director’s fiduciary duty to act in good faith in the best interests of the company with the statutory duty to consider a variety of disparate factors listed below:

  • The likely consequences of any decision in the long term
  • The interests of the company’s employees
  • The need to foster the company’s business relationships with suppliers, customers and others
  • The impact of the company’s operations on the community and the environment
  • The desirability of the company maintaining a reputation for high standards of business conduct
  • The need to act fairly as between members of the company

The report acknowledges certain difficulties with the phrasing in section 172, noting “the requirement for directors to “have regard to” other stakeholders and considerations is lacking in clarity and strength and is not realistically enforceable by shareholders…”

The Committee considers a number of alternatives to address these perceived difficulties and shortcomings and, in that context, notes that the FRC were:

 ..seeking wider powers, via changes in legislation, to enable it to investigate and pursue potential breaches of existing duties under section 172 by any directors, not just those who happen to be auditors, accountants or actuaries. To do this properly, it will need new powers to secure information in order to take action directly with the companies….. The prospect of investigation by an expanded FRC in respect of section 172 duties is a much more effective deterrent than the remote prospect of legal action by shareholders. Such an enhanced role will no doubt require extra resources, which the FRC should pay for via a small increase in the levy which funds it.

This is interesting as it’s not so much aimed at cases of potentially serious bad practice, or corruption in which there are already other tools available. Under the Companies Act 1985 for example, the Secretary of State has a range of powers to send inspectors to investigate the affairs of a company in which circumstances suggest grounds for suspicion of fraud, misconduct, conduct unfairly prejudicial to shareholders or failure to supply shareholders with information they may reasonably expect. Instead, the aim is to hold directors more accountable to the stakeholders ( listed above) to which companies were originally intended to have regard in their decision-making processes when Section 172 was first introduced.

The report by the Committee therefore contains the following recommendation:

….that the Government brings forward legislation to give the Financial Reporting Council the additional powers it needs to engage and hold to account company directors in respect of the full range of their duties. Where engagement is unsuccessful, we would support the FRC in reporting publicly to shareholders on any failings of the board collectively or individual members of it. If companies were not to respond satisfactorily to engagement with the FRC, we recommend that the FRC be given authority to initiate legal action for breach of section 172 duties. Given the broader powers we have recommended in this Report, the Government should consider re-establishing, renaming and resourcing appropriately the FRC to better reflect its expanded remit and powers. 

No doubt, the report will not have gone unnoticed by the “Plaintiffs’ Bar” in the U.K. (i.e., the law firms which specialise in bringing class action and other large scale, if occasionally, speculative litigation). They will undoubtedly see this as an encouraging development. If implemented, it will not only put more pressure on potential high-value targets, it will also provide them with ammunition in the form of findings from future FRC reports, which can be used in claims brought either directly or derivatively against company directors.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
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