The Continuing Value of Relief for Directors' Breach of Duty

AuthorJohn Lowry,Rod Edmunds
Publication Date01 Mar 2003
DOIhttp://doi.org/10.1111/1468-2230.6602002
The Continuing Value of Relief for
Directors’ Breach of Duty
Rod Edmunds and John Lowry
n
The nature and scope of relief for directors in breach of their duties did not figure
prominently in the Steering Group’s fundamental review of company law. Little is
proposed beyond removing one of the two pre-conditions for relief laid down in
section 727 of the Companies Act 1985; the requirement of reasonableness. This
article seeks to subject the relieving discretion to a more radical re-appraisal.
Drawing upon the views expressed by its architects together with the current
judicial approach adopted towards the provision, it is argued that its underlying
rationale would be better met if the test for relief was based solely upon the court’s
determination of fairness. It will be demonstrated that such a model would better
serve to bolster the fundamental tenets of transparency, simplicity and
accessibility that underpin the approach of the Government’s White Paper
towards company law reform while also reinforcing the continuing value of relief.
Introduction
An errant director may seek total or partial relief from liability under section 727
of the Companies Act 1985 provided the breach of duty is honest and reasonable
and the court decides that it ought fairly to be excused.
1
Throughout its century
long existence,
2
this judicial relieving provision has failed to excite a great deal of
academic discussion or comment.
3
Nor, unsurprisingly, did it figure prominently
n
University of Sussex and the Centre for Commercial Law Studies, Queen Mary, University of
London, respectively. The origin of this article is a lecture delivered at the Institute of Advanced
Legal Studies in June 2002. In addition to thanking the participants, the authors wish to record
their gratitude to Vanessa Finch and James Penner, both of the LSE, Philip Rawlings, University
of Warwick, and to the anonymous referees for their helpful comments on an earlier draft.
1 Section 727(1) provides: ‘If in any proceedings for negligence, default, breach of duty or breach
of trust against an officer of a company or a person employed by a company as auditor (whether
he is or is not an officer of the company) it appears to the court hearing the case that that officer
or person is or may be liable in respect of the negligence, default, breach of duty or breach of
trust, but that he has acted honestly and reasonably, and that having regard to all the
circumstances of the case (including those connected with his appointment) he ought fairly to be
excused for the negligence, default, breach of duty or breach of trust, that court may relieve him,
either wholly or partly, from his liability on such terms as it thinks fit.’
2 See the Companies Act 1907, s 32, which was substantially reproduced in the Companies
(Consolidation) Act 1908, s 279 which extended the availability of relief to any ‘person occupying
the position of director’. The original provision in the 1907 Act, which was based upon the
Judicial Trustees Act 1896, s 3 (now Trustee Act 1925, s 61), granted the court discretion to
relieve a director from liability in negligence. Further subsequent modifications include extending
its reach to cover (i) ‘default, breach of duty, or breach of trust’ (Companies Act 1929, s 372);
and (ii) ‘an officer of the company or a person employed by the company as an auditor’
(Companies Act 1948, s 448). For comparable provisions in other jurisdictions see: Corporations
Law, s 1318 (Australia); Companies Act 1955, s 468 (New Zealand).
3 It does not feature prominently in major textbooks such as P. Davies, Gower’s Principles of
Modern Company Law (London: Sweet & Maxwell, 6
th
ed, 1997) 652; J.H. Farrar and B.M.
Hannigan, Farrar’s Company Law (London: Butterworths, 4
th
ed, 1998) 427–428; and J. Birds,
A.J. Boyle, E. Ferran and C. Villers, Boyle & Birds’ Company Law (Bristol: Jordans, 4
th
ed, 2000)
545. The provision fares better in practioner works such as Gore-Browne on Companies (Bristol
Jordans Loose-leaf, 44
th
ed) at 27.21.5; British Company Law & Practice (Bicester, Oxon: CCH
Editions Loose-leaf) 32–950; and Corporate Law Service (London: Butterworths Loose-leaf)
rThe Modern Law Review Limited 2003 (MLR 66:2, March). Published by Blackwell Publishing Ltd.,
9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA. 195
in the DTI’s Company Law Steering Group’s deliberations that culminated in
sweeping modernisation proposals for company law reform.
4
In its Final Report,
section 727 is approached rather obliquely, almost as a footnote to the
recommendations concerning minor changes to the permissibility of exclusionary
provisions allowed for by section 310 of the Companies Act 1985. Undoubtedly,
this may serve to underscore the existence of important inter-connections between
court-determined relief from liability and other mechanisms such as a statutory
provision governing indemnity, or exoneration provisions (whether contained in a
contract between the company and the director or in the company’s articles of
association).
5
The way in which the matter is dealt with is also explicable by
reference to the nature of the provision. As a legal backstop it is more of a
peripheral company law concern than the facilitative or regulatory rules that
occupy the Steering Group’s attention. Somewhat less helpfully, approaching
relief indirectly through section 310 tends to obscure precisely what is intended by
way of reforming section 727 itself. This caveat aside, it is possible to discern three
substantive proposals to change its ambit. The first will re-define who is entitled to
be considered for relief by restricting it to directors. This will remove other
company officers and auditors from the purview of section 727.
6
Our discussion of
the current regime is itself confined to the availability of relief to directors. The
Steering Group’s second substantive reform addresses the type of breach for
which relief may be granted. The aim here is to strip out the detailed statutory
language indicating the range of breaches to which relief currently applies and to
confine it to those duties laid out in the new statutory statement of directors’
duties.
7
If their third change is implemented, one of the two existing pre-
conditions to the availability of statutory relief, that of reasonableness, will be
removed.
8
While the first two changes will narrow its sphere of application, the
third is seen as having a potential for making the relieving provision more readily
available.
Whatever the value of the minor adjustments to the language of the section, the
Steering Group’s review is less than explicit in defining the place court-determined
relief does and should fulfil within modern company law. It settles upon the
conclusion that section 727 is something of a benign mystery, ‘little used and still,
27.216–27.235. It has been afforded greater attention by M.R. Pasban, C. Campbell and J. Birds,
‘Section 727 and the Business Judgment Rule: A Comparative Analysis of Company Directors’
Duties and Liabilities in England and United States Law’ (1997) 6 Journal of Transnational Law
and Policy 201.
4Modern Company Law For A Competitive Economy: Final Report, DTI/Pub 5552/5k/7/01/NP.
URN01/942 and 943, 2001 (hereafter Final Report). This mammoth enterprise culminated in a
two volume White Paper Modernising Company Law (Cm 5553-I) (hereafter White Paper I) and
Modernising Company Law- Draft Clauses (Cm 5553-II) (hereafter White Paper II) published on
16 July 2002. Although s 727 is referred to in passing in earlier Law Commissions’ Reports (see,
Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Law
Com No 261, Scot Law Com No 173, 1999 paras 11.40–11.45; and Fiduciary Duties and
Regulatory Rules Law Com No 236, 1995 para 15.13.), its review was left to the Steering Group.
For a commentary on the Steering Group’s proposals, see Rt Hon Lady Justice Arden, DBE,
‘Reforming the Companies Acts-The Way Ahead’ [2002] JBL 579.
5 See R. Cranston, ‘Limiting directors’ liability: ratification, exemption and indemnification’ [1992]
JBL 197. See further, Gore-Browne on Companies, n 3 above, para 27.21.
6 The current provision also applies to liquidators: Re Home Treat [1991] BCC 165.
7 See Final Report, n 4 above, para 6.3 read with para 6.4. For a statement of the proposed
statutory duties, see White Paper II, n 4 above, Schedule 2.
8 See n 91 below.
The Modern Law Review [Vol. 66
196 rThe Modern Law Review Limited 2003

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