Corporate Law

Water pollution, sewage discharges, billions of litres flowing out of cracked or broken water pipes, risks to security or continuity of supply to consumers, as well as arrangements relating to bonuses for water company executives, all seem to be in the headlines on a regular basis.

I have been thinking about this question: “Could the directors of water companies be in breach of their directors’ duties?”

This piece looks at just one part of that question: their duties under section 172 of the Companies Act 2006. Ofwat and Environment Agency enforcement issues are separate topics, and for another day.

The Complexity of Directors’ Duties

Any piece about directors’ duties seems to lead me into a rabbit warren of complexity – this one, sadly, is no exception.

If anyone reading would like to simplify it, go ahead. The worrying practical point is that these seemingly simple, but in reality complex, rules apply to all directors. Not just those of large companies who will have advisors to guide them.

Onwards… to whom does the section 172 duty apply?

It puts a duty on each director, personally; not on “the board” as a single body. There’s no legal entity called “the board” that can be found in breach.

When people say, “the board has breached its duties,” what they probably mean, from a legal point of view, is that one or more individual directors has done so.

Boards act and decide together in practice, but the legal duty – and any personal liability – is with each director, judged on what they individually knew and did.

I’ve noted before that whether a director is an executive or non-executive, their liabilities and statutory duties are the same. A court would therefore examine an individual director’s conduct, knowledge, belief and contribution to any decision, even though a director may be responsible for participating in or approving a collective board decision.

What Does Section 172 Require?

Section 172 of the Companies Act 2006 requires each director to act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.

In doing so, they must have regard, amongst other matters, to:

• the likely long-term consequences of decisions;
• the interests of employees;
• the company’s relationships with suppliers and customers;
• the impact of its operations on the community and the environment;
• the company’s reputation; and
• the need to act fairly between members.

Unsurprisingly, a considerable body of case law and general guidance has developed around section 172.

This is a good example of how words and the interpretation of legislation can become incredibly complicated when they are applied to real-life facts. I’ve also written before about the difficulties most directors would have, quite reasonably, in trying to interpret the section.

What Does This Mean for Water Companies?

Using a water company as an example, directors’ considerations might include environmental damage, regulatory fines, customer trust, borrowing costs and infrastructure risk.

But section 172 does not require the board to guarantee good environmental outcomes, or necessarily to put environmental considerations ahead of the interests of the company and its members.

Rather, those matters should form part of the overall considerations which the directors must take into account when deciding what is most likely to promote the success of the company.

You might assume that some or all of these matters are serious enough to amount to a breach of section 172, but not necessarily; not without more.

Good Faith and Commercial Judgment

A breach of section 172 can be difficult to establish because the court will generally respect a director’s genuine assessment of what would best promote the company’s success.

It will not simply substitute its own view of what would have been the better commercial decision, and a decision that subsequently turns out badly is not, merely for that reason, a breach.

But genuine belief is not a complete answer. The director must also have acted in good faith, and cannot rely on an honest belief to justify conduct that was deceptive, disloyal or otherwise inconsistent with the director’s duty to the company.

Imagine a director of any company, particularly an SME, having to work through these concepts.

Section 174 – Another Rabbit Hole

There is also section 174 to be considered. This one is different because it imposes a care, skill and diligence standard with an objective element, assessed in light of the knowledge, skill and experience reasonably expected of a person performing the relevant functions and the director’s own knowledge, skill and experience.

This is another “rabbit hole” which we will also leave for another day.

But you can see the complexities of interpretation, as I have mentioned.

When Does the Risk Become More Than Hypothetical?

A breach becomes something more than merely hypothetical where the evidence shows directors:

• knowingly allowed pollution or regulatory breaches to continue;
• ignored foreseeable long-term risks – environmental, financial or reputational;
• approved bonuses without honestly and properly considering performance;
• didn’t obtain or consider the relevant information;
• put short-term payouts ahead of the company’s financial stability; or
• gave a misleading account of how they weighed up their section 172 duties.

So: poor results, a regulatory fine, or a bonus payment don’t by themselves prove a breach, not if the directors can show they genuinely looked at the risks and made an honest, good-faith decision.

What About Executive Bonuses?

A bonus award to a director could still amount to a breach, particularly if it was approved without proper information or consideration, or if it rewarded conduct or results materially inconsistent with the company’s long-term interests, regulatory obligations or reputation.

The question is whether the decision was made in good faith, on an adequately informed basis, and with proper regard to the company’s interests and the relevant circumstances.

Why the Paper Trail Matters

A proper paper trail is crucial.

Minutes and supporting papers do not make a decision lawful, but they can show what the directors knew, what risks they considered, what information they relied on, and why they reached their conclusion.

Conversely, an inadequate record may make it much harder to demonstrate that the relevant matters were genuinely considered.

It’s something I have written about (as have many others) numerous times – because it is an important/key point.

A Legal Breach Does Not Always Mean a Practical Remedy

Finally, even where a legal or regulatory rule may have been broken, that does not necessarily mean that a private claimant has a practical route to challenge it, or that an enforcement body will choose to act.

The availability of a remedy, the identity of the person entitled to bring proceedings, limitation periods, enforcement priorities and evidential difficulties all matter.

So do the costs of litigation and the time involved.

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