The need to succeed
1/2/2008
Directors of struggling businesses may face tough automatic penalties following the implementation of the UK's largest ever single piece of legislation.
The 2006 Companies Act could result in the directors of any company that becomes insolvent being punished for failing to promote ‘success'.
The Act is largely intended to consolidate existing legislation, but there are also significant new provisions, notably the duty of each director to promote the success of the company for the benefit of its shareholders.
To do this, directors must take into account the company's staff, customers and suppliers, as well as the environment and the local community. However, I am particularly concerned about the meaning of ‘success' which is not defined in the Act and can clearly mean different things to different people. How this is to be enforced is not entirely clear.
As an example, a company may face a difficult decision designed to enhance long-term prosperity, but at the cost of short-term profitability, such as a major capital investment, which could result in loss of employment.
Some shareholders will be delighted with the long term view, even if their share price falls in the short term. Other shareholders would want to see short term profits maximised. The employees and possibly unions are very unlikely to be happy if the investment proceeds, but how can the directors satisfy all types of stakeholder?
This is a difficult balance, but one which the directors must strive to achieve. More importantly, they need to demonstrate that they have considered these and many other implications of their decision.
Some well-managed companies may already have procedures in place to ensure that the long and short term perspectives of decisions are considered as well as the possible implications for all stakeholders and the environment.
If these companies fell on hard times, the directors may need to demonstrate that they had considered the effects of their decisions by producing board minutes, feasibility studies or that they have sought external advice. Many SMEs, however, are unlikely to have such rigorous procedures in place.
Entering insolvency is an obvious indication that the company has not succeeded and this presents a raft of potential problems for directors of struggling businesses.
When a company enters some type of insolvency proceedings, could it be inferred that the directors have automatically breached their duty to promote the company's success? This is, perhaps, the greatest uncertainty for directors, and the consequences of this for them could be severe.
An insolvency practitioner (IP) must report to the Department for Business, Enterprise and Regulatory Reform ("BERR" - formerly the DTI)on the conduct of the directors. It could become common practice for IPs to note this breach of duty in their conduct reports, which could result in the director being disqualified from being involved in company management for a number of years.
I would advise company directors to ensure that all key decisions they make are properly documented and to seek professional advice as soon as they become aware that their company is facing financial difficulty. The potential consequences for failing to take this advice at an appropriate time could be about to become more severe.
