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Companies (Audit, Investigations and Community Enterprise) Act 2004

The nature of directors’ potential liabilities

100.Directors’ general duties are owed to the company rather than to individual shareholders.  It therefore falls to the company to take action for breach of duty (including the duty of care, skill and diligence): in practice this usually means the board of directors (in some cases a new board of directors) or the administrator or liquidator.

101.Directors may also have liabilities to third parties e.g. in respect of a class action by a group of shareholders in the US, or criminal or regulatory penalties.

102.The prohibition on companies exempting their officers from, or indemnifying them against, liability in respect of any negligence, default, breach of duty or breach of trust in relation to the company dates back to the 1920s.  It arose because individual company articles were beginning to relieve directors from the consequences of breach of their duties. This meant the shareholders were unable to obtain redress, especially as the courts then took a very relaxed approach to the directors’ duty of care. Parliament therefore changed the law in 1928 so that these exemption clauses ceased to have any effect.  The Companies Act 1989 relaxed the prohibition by providing that companies could purchase liability insurance for directors and pay their legal costs if they were successful in defence of legal proceedings.

The Department’s consultation on directors’ liability

103.The Department of Trade and Industry published a consultative document in December 2003 in response to business concerns that suitably qualified individuals may be deterred from accepting positions as company directors.  The consultation exercise built on the work of the independent Company Law Review and of the subsequent review of the role and effectiveness of non-executive directors undertaken by Sir Derek Higgs.

104.The consultation identified two particular concerns:

  • exposure to liabilities arising from legal action against directors by third parties. The sharp rise in the number of class actions by groups of shareholders in the US has made this a particular concern for directors of British companies with a US listing;

  • the cost of lengthy Court proceedings. Companies are currently permitted to indemnify a director against the cost of defending legal proceedings, but only when judgment has been given in the director’s favour or he has been acquitted.

105.The consultation provided strong evidence that these issues are affecting the recruitment and behaviour of directors.   Sections 1 9 and 20 have therefore been included in the Act to address these concerns.

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