Hedge funds, companies, and their lawyers are in discussions about a redrawing of the legal battle lines come October. The first of the month will see the introduction in the UK of a raft of new measures from the Companies Act 2006.
Of particular interest to the growing number of funds aiming to take an activist stance in the UK may be parts 10 and 11 of the Act, those dealing with directors’ duties and derivative claims.
The content of these is not new per se - but it has been recast, and made more visible, in a way that could attract the attention of some funds.
Part 10 of the Act lays down seven general duties of directors - the type of material that previously would have had to be painstakingly assembled through past case law. One section, that dealing with conflicts of interest, is not expected to take effect until 2008. The principles laid out should be familiar - to act in the best interests of the company and its shareholders; the duty of loyalty to the company; and the duty of skill, care and diligence.
But there are new forms of wording. The so-called ‘enlightened shareholder value duty’ replaces the familiar duty to ‘act in the best interests of the company and its shareholders.’
The new ‘enlightened’ version is a requirement to ‘promote the success of the company for the benefit of its members’. That explicitly brings into play the long-term impact of decisions, the impact of operations on the community and the environment, and the effect on a company’s reputation.
A briefing note prepared by Linklaters for its clients jokes (and warning - this is lawyer humour): “While the codification will provide a relatively short statement of the duties of a director, making it easy for directors to learn the duties - or at least to carry the text of them in their pocket - the duties will have to be interpreted in the light of both existing and future case law (which is not easily reducible to pocket size).”
The changes have added bite in combination with the following section dealing with derivative claims. This puts into statutory law the ability of shareholders to take action related to a breach of trust or duty by directors.
“The worry is that the new shareholder derivative action is so clear that people are bound to want to take advantage of it. There’s a huge temptation to use the stick because it’s there and because it’s new,” points out Alan Karter, partner in the London corporate group of Simmons & Simmons.
Unlike in the US, the changes do not provide a right for shareholders to seek damages directly - any payout would go to the company, rather than the shareholders conducting a claim. But it will be easier to bring claims, say Linklaters. Previously it was necessary to show that the company would not act because the alleged wrongdoers were in control. And since claims can be brought in relation to prospective actions or omissions, there is a chance that they may be used to try to prevent boards from taking certain decisions.
But before those with an axe to grind get too excited, there are various safeguards built into the legislation. They must prove they have a prima facie case before a judge.
How the courts will interpret the provisions under which they can dismiss a claim will be crucial in determining the impact of the new laws.
“It remains to be seen whether this combination (of statutory general duties of directors and shareholder derivative action) will be used by those with an activist agenda such as some hedge funds…. Most business people regard litigation as a tool of last resort in the UK. It will be interesting to see if litigation around these issues starts to be used in the UK as a tool more in the American style,” says Karter.
