Company Directors: Who Cares About Skill and Care?
| Date | 01 March 1992 |
| Author | Vanessa Finch |
| Published date | 01 March 1992 |
| DOI | http://doi.org/10.1111/j.1468-2230.1992.tb01871.x |
Company Directors:
Who
Cares About
Skill
and Care?
Vanessa
Finch
*
The common law operates
to
give directors a remarkable freedom to run companies
incompetently. Provided that their behaviour falls short of the grossest negligence
they are unlikely to be held to account.’ As a result, directors’ duties of skill and
care have long been low on their list of concerns. In recent years, however,
expectations
of
more rigorous duties have grown, fed
inter
alia
by indications of
a new statutory interest in responsible management and by developments at
EC
level,
in North America and in the Commonwealth.2
A
dominant view on how to develop such duties has nevertheless yet
to
emerge.
Debate has focused on the standard of care to be imposed but little attention has
been paid to the question of who is
to
make the duties effective and how. Such
a focus, moreover, has failed to relate common law duties to alternative methods
of controlling directorial competence. The debate needs to be broadened, for there
is little point in formulating appropriate standards of care if those standards cannot
or
will not be brought to bear on directors
or,
indeed,
if
other methods of controlling
competence are likely to be more effective.
To
this end, this article assesses the strengths and limitations of potential enforcers
of
duties of skill and care; considers a number
of
suggestions for upgrading such
duties; tests these suggestions with reference to enforceability; and sees duties of
skill and care in the context of other ways to control competence. It also assesses
the implications of companies’ newly acquired ability to insure their directors against
liability for breaches of their duties.
For
the purposes of this discussion,
it
is important
to
keep separate two questions:
What are the strengths and limitations of different potential enforcers? Who, as a
matter of policy, should be given which powers and roles in enforcement? The first
question is the concern
of
Part
1
of the article and the second is dealt with in Part
2.
1
Who
Cares?
Effective application of standards of directorial behaviour requires that participants
in
the enforcement process possess a number of properties.’ The first is an ability
*Lecturer in Law, London School
of
Economics and Political Science.
I
would like to thank Elizabeth Durant, Caroline Bradley, Judith Freedman and Robert Baldwin for their
help in connection with this article.
I
See judicial dicta in
Overend and Gurney
Co
v
Gibb
(1
872)
LR
5
HL
480.
at
487;
Re
Brazilian Rubber
Plantations and Estates Lrd
(
191
I]
1
Ch D
425,
at
436;
Lagunas
Nitrate Co
v
Lagunas
Syndicate
(18991 2
Ch
392,
at
435.
2
See eg Company Directors Disqualification Act
1986,
s
6
(hereafter CDDA
1986);
Insolvency Act
1986,
ss
214
and
216
(hereafter IA
1986).
DTI Consultative Document,
Amended Proposal fora
Fifrh
Directive
on
the
Harmonisation
of
Company
Law
in
the
European Community,
January
1990;
Interim
Report of Select Committee on Company Law (Ontario)
1967;
Report of the [Cooney] Committee
on the Social and Fiduciary Duties and Obligations
of
Company Directors (Canberra,
1989);
Company
Law
Reform and
Restatement
-
Report (No
9)
of
the New Zealand Law Commission (Wellington,
1989).
3
See Sabatier and Mazmanian, ‘The Conditions of Effective Implementation: A Guide
to
Accomplishing
Policy Objectives’
(1979)
Policy Analysis
48
I
;
Van Meter and Van Horn, ‘The Policy Implementation
Process:
A
Conceptual Framework,’
Administration and Society
(February
1975) 445;
Institute
of
Chartered Accountants (ICA)
et
a/,
‘Report of the Study Group on the Changing Role of the Non-
Executive Director’
(1991:
ICA) para
4.14
(commitment; communication skills; independence of mind;
experience; objectivity and probity).
The
Modern
Laul
Revieuv
55:2
March
1992 0026-7961
179
7he
Modern
Law
Review
[Vol.
55
to acquire and use relevant information. Enforcement of a standard demands not
only information concerning the standard but also factual knowledge concerning
its breach. Second, expertise is called for. An understanding of the activity being
controlled
is
necessary
in
order to appreciate the nature of any failing or to devise
a response to
it.
Commitment is the third property
-
the willingness to act in a determined fashion.
Personal commitment is one aspect, another the commitment of any groups or
institutions involved or affected. Finally, an ability to deliver is necessary. Sanctions,
threats or inducements may be required and the ability to apply such measures will
depend on factors such as the availability of resources, organisational skills or the
ability to overcome procedural obstacles.
Shareholders as Enforcers
Shareholders may acquire a certain amount of information on a company’s operation.
The disclosure philosophy fundamental to company law assures this
in
recognition
of both their monitoring role
vis-u-vis
directors’ performance and the requirements
of an effective capital market.4 Thus, copies of the company’s annual accounts,
the auditors’ report on these accounts and the directors’ report must be laid before
the general meeting of the company’s shareholders and must have been sent to every
shareholder at least
2
1
days before that meeting. Shareholders of listed companies
can alternatively receive summary financial statements and are also entitled to half-
yearly reports on their company’s activities and its profits and losses. Finally, all
shareholders of limited companies can inspect the company’s account documents
at the Company Regi~try.~
Shareholders may also gain information through annual general meetings and
notices to those meetings or from additional company meetings (EGMs) convened
either by the directors or by shareholders holding at least
10
percent of the voting
paid up capitaL6 Circulars may be supplied by directors and should’ provide share-
holders
with
sufficient information to understand board policy (albeit from a board
perspective). Views opposing those of the directors’ may be issued by shareholders
in
a statement under section 376(1)(b) CA
1985.*
Additionally, shareholders may
secure information from the Secretary of State. Thus,
if
an investigation into the
company’s affairs has been undertaken and a report submitted to the minister, then
any shareholder may request a copy of that rep01-t.~
4 See
Loss,
‘Disclosure as Preventative Enforcement’ in Hopt and Teubner (eds),
Corporate Governance
and
Directors’ Liubiliry
(Walter de Gruyter, 1985) at pp 327-35;
Sealy,
Compuny
Law
and
Commercial
Realiry
(Sweet and Maxwell, 1984) Ch 2; Ferrara, ‘Disclosure of Management Integrity and Competency
-
Sliding Down the “Slippery Slope”
of
Materiality’ in Gower,
Loss
and Sommer Jr (eds),
New
Trends in
Company
Law
Disclosure
(New York: Law and Business, 1980); Meier-Schatz, ‘Objectives
of
Financial Disclosure Regulation’ (1986)
8
Journal
of
Comparative Business
and
Capital Marker
Law
2 19; Brudney, ‘The Independent Director
-
Heavenly City or Potemkin Village?’ (1982) 95
Haw
L
Rev
597, at 636; Fama, ‘Efficient Capital Markets: A Review
of
Theory and Empirical Work’ (1970)
25
Journal
of
Finance
383.
5
Though the information filed may be in abbreviated form for ‘smalllmedium sized’ companies
-
Companies Act 1985 (CA 1985),
s
246(1) and Sched
8,
substituted by CA 1989,
s
13(1)
and (2) and
Sched 6; Financial Services Act 1986,
ss
7(1),
l5(
I), 22,23(1), 24.25 and
3l(
1);
CA 1985,
s
246(3)
and (4).
6 CA 1985,
s
368(1)(2); see also CA 1985,
s
142 re public companies.
7
Peel
v
London
and
N.
W.
Railway
Co
[
19071
I
Ch
5
per Vaughan Williams
W.
See also
Admissions
8
CA 1985,
s
376(2)
-
must
be
supported by
5
percent
of
total voting rights or not less than
100
members
9 CA 1985,
s
437(3)(a)(b): but
on
non-publication of reports see
s
432(2A) inserted by CA 1989,
s
57.
of
Securities to Listing
(SE)
s
5,
Ch 2, paras 31, 32 and 33 regarding listed companies.
with shares paid up to at least flOO per member; limited to 1,OOO words.
180
March
19921
Company Directors:
Who
Cares about
Skill
and Care?
Do these seemingly impressive sources of information provide an effective basis
for scrutinising directorial performance? Effective monitoring demands that such
information
be
accessible, intelligible, up-todate and relevant. While all shareholders
may have access to the information included in the company records, the
10
percent
and
5
percent of total voting rights required for calling EGMs and circulating
members’ statements may provide substantial obstacles to the dissemination of, and
access to, shareholder information.
As
for intelligibility, the company accounting records may be comprehensible
to large scale institutional shareholdersI0 and to the very sophisticated individual
shareholder who may be able to judge whether a company’s affairs are being
competently managed. For ‘ordinary’ shareholders, however,
it
is doubtful whether
the annual reports are anything more than glossy corporate brochures. Even the
more financially aware shareholder cannot
be
taken to
be
able to use the stock market,
financial analysts and the financial press to ‘access’ the information contained
in
the accounts and reports. These sources will only serve to provide comparative
information even when the company happens to receive press attention and the
shareholder may be little able to evaluate the accuracy of these assessments.”
The timeliness and quality of information is, of course, crucial to its effective
use. It is not, however, uncommon for annual returns to be a year out of date and
commentators have noted the staleness of much that is obtainable from the Company
Registry.IZ Concern about the frequency, clarity and reliability of corporate
reporting was indeed a major factor behind the establishment of the Cadbury
Committee on Financial Aspects of Corporate Governance
in
May 1991.13
Is
such information
in
the shareholders’ hands likely to be relevant to the exercise
of skill and care? Information yielded by the methods discussed above is likely to
present a board view. It is likely also to address the broad issue of the company’s
position which may be necessary but hardly sufficient for judging the specific
performance of any director(s). Improvements in shareholder information can, as
we see below, be suggested but, as the
US
Securities and Exchange Commission
has pointed out,l4
it
should not be assumed that statutory rules can be wholly
effective
in
allowing shareholders to assess the context
within
which directors’
competence falls to be judged.
Formal sources of information thus offer limited prospects of assistance to share-
holders. Does the answer lie
in
informal sources? For small investors this seems
10
On the incidence of institutional shareholding
in
the
UK,
see
The
Srock Exchange Fact Book, cited
by Oakley and Harris,
The
City
of
Capital(l983) pp 106-107. (Combined holdings of institutional
investors made up 54.1 percent of market value of UK listed equities
in
1981.) See also Davies.
‘Institutional Investors: A
UK
View.’ unpublished paper given at workshop on Corporate Control
and Accountability, Warwick University, July 1991 (1985: 58.9 percent of
UK
listed equities; 1990:
‘over two-thirds’).
I I
See Axworthy. ‘Corporate Directors
-
Who Needs Them?’ (1988) 51 MLR 273, at p 286. But cf
O’Keefe and Soloman, ‘Do Managers Believe
in
the Efficient Markets Hypothesis?’ (1984/8S)
15
Accounting and Business Research 67.
12 Trebilcock, ‘The Liability of Company Directors
for
Negligence’ (1969) 32 MLR 477. 514; Mackenzie,
‘A
Company Director’s Obligations
of
Care and Skill’
[
19821 JBL 460, 475-76; Sealy, supra
n
4.
Although the time lag may be great, 81.6 percent of companies werejled up to date regarding annual
returns and accounts
-
Companies
House
Annual Report
1990-1991.
But cf DTI Annual Report,
‘Companies
in
1990-91’ (October
1991).
Also note the new civil late filing penalty regarding accounts
under CA 1989,
s
242A (not yet
in
force).
13 SeeFinancialTimes,
31
May 1991.p 7. SeeReaCoNo
00789(1989)5BCC793-directorsfailing
to file accounts not per
se
unfairly prejudicial management.
14 Franchard Corp, 42 SEC 163 (1964) at p 178
-
disclosure rules allowing directors’ diligence to
be judged
in
the context
of
the whole business operation could ‘result
in
self-serving generalities of
little value or grave uncertainties’ for enforcers and directors.
181
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