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Scottish Law Commission (Discussion Papers)

You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Discussion Papers) >> Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties [1998] SLC 105(3) (DP) (August 1998)
URL: http://www.bailii.org/scot/other/SLC/DP/1998/105(3).html
Cite as: [1998] SLC 105(3) (DP)

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Part 3 Economic Considerations

Introduction

The purpose of this part is to undertake an economic analysis of the present law contained in Part X of the Companies Act 1985, and to consider economic implications of possible changes to the law resulting from the review of Part X and from the introduction of a statutory statement of directors' duties.

3.2

The discussion is arranged as follows. We firstly consider the contribution which an economic analysis can make to the understanding of legal rules and of their reform (paragraphs 3.3-3.9). This is followed by a very brief overview of the economic approach to company law (paragraphs 3.10-3.18) and by a more extensive economic analysis of the fiduciary principle as it applies to company directors (paragraphs 3.19-3.50). We then look at a number of specific areas of law from an economic viewpoint, namely the detailed requirements of Part X of the Companies Act 1985 (paragraphs 3.51-3.72); the civil sanctions (paragraphs 3.73-3.78) and criminal sanctions (paragraphs 3.79-3.84) which are attached to Part X and to related aspects of directors' liability; and directors' duties of skill and care (paragraphs 3.85-3.91).The main conclusions are summarised at the end of this part (paragraph 3.92).

The contribution of economic analysis

3.3

The economic analysis of law can fulfil two purposes. Firstly, it can be used to evaluate particular legal provisions in terms of how far they enhance efficiency, or, in other words, how far they contribute to the wealth or well being of society as a whole. Secondly, it can be employed to predict the effects of changes in the law.

^[1]

The first type of analysis generally assesses legal rules according to how far they promote allocative efficiency, or the allocation of scarce resources in a way which maximises their value to society. It is also concerned with technical efficiency, or the minimisation of costs which are involved in the use of resources.

3.5

Also relevant here is the concept of dynamic efficiency, which is widely used in the economic analysis of industrial organisation. This idea refers to the capacity of a given system or organisation to innovate and survive in a changing and uncertain environment. The emphasis here is on how far legal rules, and other mechanisms, can contribute to the efficient production of information and the management of risk and uncertainty.

3.6

The second type of economic analysis is concerned with predicting the impact of legal rules on commercial or social practices. The effects of a given legal provision may well be marginal when set against wider economic forces.

^[2]

Equally, economic analysis may help to predict when wider social and economic forces may render a rule ineffective. For example, the intended aim of a rule may be offset by 'second-order effects' as the parties adapt to a new legal environment.

^[3]

The type of analysis used in this part is important, then, for achieving a better understanding of the consequences of legal rules. It is not being suggested that economic analysis is always capable of making clear-cut predictions of the economic and social effects of legal change. While it may not provide a conclusive answer in most cases, it can, nevertheless, inform policy makers of some of the possibly unintended consequences of changes to the law.

3.9

It is also important to be aware of the limitations of a purely conceptual analysis. In the present context of the discussion of reforms to Part X of the Companies Act 1985 and the effects of introducing a statement of directors' duties, the range of factors affecting corporate decision-making is sufficiently wide that a change in the framework of legal rules could, in principle, have one of many different possible effects, the likelihood of which can only be more clearly established through empirical research. As a result, the contribution of economic analysis in this part is three-fold: to identify economic rationales for the existing body of law; to identify possible outcomes of legal reform; and to indicate the main areas in which further, empirical research would be desirable.

^[4]

Company law and economic efficiency

Company law and agency costs

One of the functions which economic analysis attributes to company law is the reduction of agency costs. Agency costs have been described as 'the costs associated with having your property managed by someone else'.

^[5]

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The economic benefits of specialisation make it desirable for the responsibility for management to be vested in the board of directors, which in turn delegates to the senior officers and employees of the company. In economic terms, the problem with such agency relationships is that the 'principal' cannot costlessly observe or monitor the performance of the 'agent'.

^[7]

In particular, efficiency will be increased if an incentive structure can be put in place which will align the interests of the parties as far as possible. This set of incentives may be thought of, in a loose sense, as a contract or governance structure which is the result, in part, of bargaining between the parties, even though not all aspects of the arrangement would be regarded as contractual in the juridical sense of constituting a legally binding agreement.

3.13

Some aspects of the relationship between shareholders and senior managers, for example, may be expressly spelled out. The shareholders can seek to minimise the risks to them of managerial self-dealing and under-performance through the inclusion of express terms in directors' service contracts, ranging from the linking of executive remuneration to performance indicators, to provisions explicitly governing conflicts of interest. Certain provisions of the articles of association, which may deal with the powers and remuneration of directors, can similarly be understood as forming part of the loose or extended incentive 'contract' between shareholders and managers. Shareholders' agreements and resolutions of the company in general meeting may also perform a contractual effect in the loose sense of a consensual arrangement.

3.14

In economic theory, a perfectly efficient or optimal incentive contract is one which would completely specify the mutual rights and obligations of the parties in the event of all relevant contingencies. In long-term relationships based on complex, repeated exchange, such as the shareholder-manager relationship, there will come a point when the costs of anticipating and dealing with future contingencies outweigh the benefits of explicit contracting. Hence, any express agreement is bound to be incomplete to some degree, and to that extent less than 'perfectly' efficient. Here, company law performs an important role in supplying a set of background rules which fulfil a number of functions, including filling in the gaps in express contractual arrangements and facilitating bargaining between the parties.

^[8]

A typology of rules within company law

Default rules may be defined as optional terms and conditions which apply in the absence of specific agreement on a certain point. They specify the parties' rights and obligations in situations which are not covered by an express agreement. At the same time, they can be customised or modified by the parties if they see it as in their interest do so. Such rules therefore allow for flexibility in adapting to particular circumstances.

3.16

Mandatory rules which limit or restrict the scope for bargaining may, for that reason alone, have adverse economic effects; they may lock the parties into an inefficient allocation of resources, or unnecessarily raise the costs of avoiding the rule by requiring the parties to go to certain lengths to contract around it. Alternatively, where bargaining is likely to be extremely costly or where there is an imbalance of power or information between the parties, a mandatory rule may be justified. Thus shareholders are protected, in some instances, by mandatory rules.

^[9]

externalities

unbargained-for effects upon third parties

^[10]

In practice, the distinction between default rules and mandatory rules may not be clear cut. Certain rules of company law can be avoided but only at a cost in terms of time and resources. The circumstances under which a rule or liability may be avoided are complex; they may include requirements of prior or subsequent disclosure of information, prior permission, ratification after the event, and/or release from liability. Rules of this kind are referred in the economic literature as penalty default rules. Their economic importance lies in their use to provide incentives for the sharing of information (see below). Their economic purpose is related to the need to overcome obstacles to cooperation, and hence to the promotion of dynamic efficiency as defined in paragraph 3.5 above.

3.18

To sum up our discussion so far, company law can be seen as having a number of economic purposes, in particular: (1) promoting efficient bargaining between corporate actors; (2) protecting the interests of third parties such as creditors; and (3) providing incentives for cooperation, thereby promoting competitiveness.

The fiduciary relationship

3.19

Before we examine the statutory rules relating to self-dealing and other conflicts of duty and interest in Part X of the Companies Act 1985, we must first consider the economic aspects of the general law relating to the fiduciary obligations of company directors. The central question to be addressed is whether an economic rationale can be found for the application to directors of the fiduciary principle. The fiduciary principle does not, at first sight, conform to the type of efficient default rules which economic theory would predict for this situation. This is because fiduciary duties of loyalty are imposed upon directors by law and cannot easily be excluded by agreement.

^[11]

Notwithstanding the points made in the preceding paragraph, it has been argued by some law and economics scholars that the fiduciary principle is efficient, since 'the duty of loyalty must be understood as the law's attempt to create an incentive structure in which the fiduciary's self-interest directs her to act in the best interest of the beneficiary'.

^[12]

A second factor is the high cost of monitoring the fiduciary's performance; this is said to justify certain deterrent or 'prophylactic' features of the law relating to the duty of loyalty. The rule that a fiduciary must not place him or herself in a position where their duty to the company conflicts with their own interests, or with their duty to another, is one of these. Some commentators see this rule as, in effect, inferring a breach of the duty of loyalty from the appearance of disloyalty or wrong-doing.

^[13]

^[14]

Shareholders are, arguably, particularly vulnerable to the risks of disloyalty by the fiduciaries upon whom they depend.

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Firstly

Secondly, concerted shareholder pressure on management will be costly to achieve because of 'free rider' effects, in companies where shareholdings are widely dispersed. In companies with concentrated shareholdings (such as small family businesses and also companies which have undergone a management buy-out), problems of monitoring may be reduced, but not entirely eliminated. However, there is some evidence to suggest that shareholder activism has increased in both Britain and the United States since the early 1990s.

^[16]

Against these considerations, the application to directors of the fiduciary duty of loyalty also entails potential costs for shareholders and potential efficiency losses. Firstly, there are, without doubt, some instances in which the open-ended fiduciary principle, if unqualified in any way, would deter the exploitation of corporate opportunities by directors and senior managers in such a way as to harm shareholder wealth.

3.25

For example, a manager who was presented with the possibility of exploiting a business opportunity might choose to forego the chance to do so, rather than seek to negotiate an arrangement with the company which would be mutually advantageous, if he or she could not be confident of that arrangement being respected by the courts. Similarly, companies may avoid transactions which would otherwise be beneficial to them, because of the risk of placing a director in a situation of self-dealing, or of a conflict of duty and interest. At the very least, then, clear rules allowing for an exemption from liability in the case of disclosure of information and approval and ratification of directors' conduct are needed by way of qualification to the basic principle.

^[17]

Secondly, the imposition of a too-strict duty of loyalty may give rise to undesirable 'second-order effects'. In the context of directors' duties, these might include premature resignations from office by directors, or a reluctance of potential directors to serve.

^[18]

Thirdly, it is argued that shareholders are already adequately protected against the risk of disloyalty (as certain other de facto beneficiaries of the performance of fiduciary duties are not) by market forces: 'the high powered incentives provided by markets protect [shareholders], making the use of a governance structure - the open-ended fiduciary duty adjudicated by a court - unnecessary'.

^[19]

^[20]

A more fully-informed picture of the potential costs and benefits of the fiduciary principle is only obtainable through empirical research. Nevertheless, it can be seen from the short review undertaken here that economic arguments for imposing the fiduciary principle upon directors are not all one way. It is likely, then, that in some situations, the parties to corporate transactions will seek to adapt or contract around the basic rule. Alternatively, where it cannot be avoided, we would expect to find compensating 'side payments' to managers, the costs of which would have to be met, at least in part, by the shareholders. The expense of contracting around the rule would, in this situation, give rise to unnecessary or 'deadweight' bargaining costs.

3.29

There is a case in principle, then, for constituting the duty of loyalty as a default rule which applies only if it is not varied, modified or customised through a consensual arrangement of some kind. This analysis is compatible with the general thrust of UK company law relating to the fiduciary duties of company directors, although not necessarily with all of its detailed provisions. Although the fiduciary duty of loyalty does not originate in contract and there is a formal statutory bar on agreements which seek to derogate from it in advance,

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not

^[23]

The analysis given above would be compatible with the view that the underlying principle of legal regulation in this area should be the achievement of procedural fairness in the regulation of self-dealing and other conflicts of duty and interest. In other words, the law should be concerned to ensure that there are adequate procedures for dealing with self-dealing and conflicts of interest, for example through disclosure of information and ratification. This would be preferable to a complete prohibition for the reasons just given.

3.31

It also follows that any restatement of the fiduciary duties of directors should make some reference to the role of disclosure, approval, release and ratification in enabling liability for breach of fiduciary duty to be avoided in appropriate circumstances. The rules on disclosure and ratification also need to be clearly stated. Otherwise, any such statement of duties could be perceived as placing excessive emphasis on the deterrent elements of fiduciary obligation, and an insufficient stress on the circumstances under which the obligation may be qualified in the interests of both the company (understood here as the general body of shareholders) and the director or manager concerned.

Efficient default rules: Some general considerations

3.32

A number of different types of default rules, with different effects in each case, may be identified.

^[24]

straightforward default rules

penalty default rules

strong default rules

A straightforward default rule is akin to a standard form contract which applies in the absence of contrary agreement. Its purpose is two-fold: to save the parties the time and trouble of negotiating over all points of detail, and to allow them to customise or vary particular terms as they see fit. The model set of articles of association contained in Table A is the classic example, in this context, of a set of straightforward default rules.

^[25]

By contrast, a penalty default rule sets out to induce the parties to cooperate by sharing risk and information, by providing one or both of them with an incentive to alter or shift a rule which would otherwise impose an unwelcome liability. Hence, 'efficiency-minded lawmakers should sometimes choose penalty defaults that induce knowledgeable parties to reveal information by contracting around the default penalty'.

^[26]

Many of the rules under Part X can be characterised as penalty default rules in the sense just identified. For example, under section 317, a director may incur criminal liability if he or she has an interest in a contract entered into by the company, unless he or she makes disclosure of that interest to the board. The purpose of the 'penalty' here is not necessarily to bar self-dealing, but rather to encourage the disclosure of information by the more knowledgeable party. The rule therefore has an economically beneficial 'information-inducing' or 'cooperation inducing' effect.

3.36

In the case of a strong default rule, by contrast, the court or legislator sets a high procedural barrier to contracting out. Strong default rules are therefore close to being immutable or mandatory rules. They may be based on the assumption that certain transactions are potentially highly disadvantageous to one party, and should therefore require a high degree of formality to be surmounted in order to be legally effective. Another purpose of a strong default may be to avoid a negative externality, or unbargained for cost, arising from the contract. Strong default rules nevertheless allow for the possibility of contracting-out by parties who perceive the high costs of doing so to be outweighed by significant benefits to them. The form of the rule then allows their interests to override the negative effect which their contract or arrangement may impose on the third party, on the grounds that, in this case, the aggregate wealth or well being of society would be enhanced.

^[27]

Under Part X, sections 320-322, governing substantial property transactions between directors and their companies, are an example of a strong default rule. There is a risk of depletion of the company's assets which may detrimentally affect both shareholders and creditors. Such transactions are accordingly voidable at the instance of the company, unless one of a number of conditions apply, one of which is that the transaction was affirmed within a reasonable period of time by a general meeting of the shareholders (section 322(2)(c)). Requiring a vote in general meeting amounts to imposing a costly and inconvenient precondition of the validity of the transaction. Shareholders are thereby given a high degree of protection against this type of transaction. Creditors, on the other hand, may potentially be exposed to risk if shareholders vote to approve transactions of this kind, since they may lead to a depletion of corporate assets. In that regard, sections 320-322 may be contrasted with the absolute prohibition on a director receiving a loan from the company (section 330); this can be seen as a mandatory rule which operates principally for the protection of third parties, that is, creditors, although the rule can also be seen as protecting the interests of shareholders too (see below, Part 6).

3.38

Policy makers have a choice, then, in where to set the initial standard for a default rule and in how far to impose procedural costs or obstacles when enabling the parties to contract around the rule. This requires an assessment to be made of the costs and benefits for particular parties of contracting around, and not contracting around, particular default rules. Some parties will consider it worth their while to contract around, or to modify, a default rule. Where this occurs, a wide variation of practices will result. This resulting situation is known as a separating equilibrium. By contrast, in a pooling equilibrium, the costs of contracting out or around a rule are so considerable that they deter a large number of contracting parties from customising the default rule to their particular circumstances, when they might otherwise have done so.

3.39

The point can be illustrated by reference to the rules concerning the length of directors' service contracts in section 319 of the Act. A term which has the effect that a director must be employed by the company for a period of more than five years, where the contract cannot be terminated by notice or can be so terminated only in specified circumstances, is only valid if given the prior approval of the shareholders in general meeting. A leading authority on company law has suggested that prior to the recommendations of the Cadbury and Greenbury Reports which recommended a shorter period still for service contracts, this provision of the Act had 'largely eradicated long-term service agreements not determinable by the company until the directors reach retirement age', at least in the case of public companies. However, the Act did not outlaw the use of 'five year roller' contracts which can have the effect of guaranteeing that notice of at least five years is nearly always required if the company wishes to terminate the contract.

^[28]

It can be seen from this analysis that the setting of a default rule has effects on both distribution and economic efficiency. Where there are high costs to recontracting or contracting around a rule, or where there are externalities, the allocation of liabilities under a default rule will tend to lock the parties in. Thus it will affect the private wealth of the parties concerned. The choice of rule will also have efficiency effects: these depend upon the incentives for information-sharing and for contractual cooperation which these rules create.

The fiduciary principle should in general operate as a penalty default rule

3.41

We may now place the analysis of default rules in the context of directors' fiduciary duties. As we saw, the arguments for applying the strict and open-ended duty of loyalty to senior managers are finely balanced. It is possible to show that shareholders, as a group, are in need of the deterrent protection which the open-ended rule provides, but that some flexibility in the application of the rule is also needed. The uneven or asymmetric division of information between investors and managers means there is a case for constituting the fiduciary principle in the form of a penalty default rule which places the onus of avoiding liability on the fiduciary.

3.42

This is broadly the effect of the current equitable rule, which enables a director or other senior manager to avoid an otherwise onerous liability through prior disclosure of their interest to the board or, in some circumstances, the shareholders, or through subsequent approval, release or ratification by the shareholders. These rules have an 'information-inducing' effect which, according to the arguments presented above, could be compatible with contractual efficiency under certain conditions.

3.43

However, the advantages of this information-inducing effect would be offset if the rule created a significant disincentive on fiduciaries to seek out the information which the rule required them to disclose in order to avoid liability. Shareholders and managers alike would be worse off if fiduciaries were deterred from investing time and effort in seeking out valuable business opportunities in the first place. This issue could be clarified by empirical research.

3.44

It is also possible that executive directors and other managers would receive implicit compensation in the terms of their service contracts for the limits imposed by the law on their right to exploit corporate opportunities for private gain. The shareholders, in other words, would implicitly be paying more for the right to hold managers to account.

^[29]

However, even if this were so, the resulting combination of incentives arguably leaves shareholders better off than they would be with a rule which allowed managers full discretion to exploit opportunities as they saw fit and so obviated the need for a compensating side-payment in the service contract. This is because the combination of the fiduciary rule and the provisions of the service contract provide for a superior flow of information between the parties than the alternative. Again, this is a possible area for empirical research.

3.46

Non-executive directors, whose role is principally that of monitors rather than managers, are unlikely to come across valuable business information as a result of the investment of their own personal time and effort; a default rule penalising them for self-dealing would not, therefore, result in a diminution in the acquisition of valuable information.

How onerous should the disclosure and/or ratification requirements be?

3.47

If the aim of policy were to induce directors to release information to other corporate actors concerning their exploitation of business opportunities or the possibility of self-dealing, the threshold for disclosure should be set at a reasonably low level - in other words, it should be reasonably straightforward to comply with the disclosure requirements as it is, for example, in respect of the requirement to make disclosure to the board under section 317. Otherwise, both sides might find themselves locked into an inefficient allocation: directors would not disclose information where the private costs of doing so outweighed the gains to them. Shareholders would be less well informed, and the opportunity would be unexploited.

3.48

Consider the situation in which a manager approaches the board with a proposal to be allowed to set up a separate company to exploit an opportunity which he or she has developed.

^[30]

On the other hand, a strong default rule may be thought necessary to protect investors against unilateral behaviour by managers if the prospects of bargaining over corporate opportunities are, in practice, remote. In this context, it is often suggested that the form of articles of association and the terms of directors' service contracts are frequently determined by board members themselves, with limited scope for direct negotiation with investors.

^[31]

The question of whether to set high procedural requirements under Part X depends crucially, then, on the nature of bargaining or negotiation between the different corporate actors. In principle, different patterns of relationships could be found according to whether a company is a public company with a stock exchange listing, at one extreme, or a small private company or 'quasi partnership' at the other. The role of non-executives as monitors acting on the shareholders' behalf also needs to be taken into account. These aspects of the shareholder-director relationship are matters which could be clarified further by empirical research. A central aim of empirical research should therefore be to clarify the precise nature of the relationship between shareholders, non-executive directors and senior management in companies of different types and sizes, and in particular to ascertain the extent to which bargaining over the exploitation of corporate opportunities is a realistic possibility.

Analysis of the disclosure and ratification requirements under Part X of the Companies Act

3.51

It follows from our earlier analysis that while it is important for the law to allow for the principle of disclosure and ratification in respect of the exploitation of corporate opportunities, the procedures for disclosure and ratification may justifiably differ according to the subject matter being considered. However, it is not clear whether the current rules in Part X reveal a coherent set of justifications. The following different requirements are currently imposed in respect of the provisions of Part X and other relevant legal provisions:

(1) Absolute prohibitions (sections 323 and 330-342).

(2) Prohibitions which may be avoided through disclosure (in some cases prior to, and in other cases within a period following, the transaction) to:

(a) the board (sections 317 and 322B);

(b) the shareholders in general meeting, or via the company accounts, or via a register (sections 314, 318, 324, 325 and 328);

(c) the Stock Exchange (section 329; and certain derogations from corporate governance rules under the Combined Code).

(3) Prohibitions which may be avoided by consent ^[32] (through either approval, in advance, or ratification or release, after the event) of:

(a) the board;

(b) the shareholders (sections 312-313, 315, 319, 320, 322, 322A and 337);

(c) the Stock Exchange

These rules relating to disclosure and consent can be illustrated in tabular form, as follows:

Table

Rules governing disclosure and consent through approval, release and ratification under Part X of the Companies Act 1985

	Disclosure (General meeting) (Notice to shareholders) (Notification to company**) (Company accounts†) (Inspection††)	Consent	Consent	Consent
	Before	After	Before (Approval)	After (Release, Affirmation Ratification)
Board	s 317(1), (2)(a),(3), (4),(8)	s 317(2)(b) s 322B
Shareholders	s 312* s 313(1)* s 314(2)** s 319(5) †† s 337(3)(a)*	s 318†† s 324 and Sched 13, Pt II* s 325 and Sched 13, Pt IV†† s 328(3) * Sched 6, Pt II† ss 343-344††	s 312 s 313(1) s 315(1)(b) s 319(3)-(4) s 320(1) s 337(3)	s 322(2)(c) s 322A(5)(d)
Stock Exchange		s 329

What criteria should guide policy makers in determining whether a particular matter should be prohibited outright, disclosed to the board alone, disclosed to shareholders, disclosed to the Stock Exchange, or approved or ratified by shareholders?

Absolute prohibitions: Sections 323 and 330

3.54

With regard, firstly, to absolute prohibitions, we would suggest that these can be justified only where there is a significant risk that the transactions in question would give rise to a negative externality or third party effect (such as harm to the interests of creditors, sufficient to outweigh the gains to the internal corporate actors) or a significant public interest (such as the need to maintain market integrity). (See paragraph 3.16 above)

3.55

The complete prohibition on certain loans to directors (sections 330-342) is a rare example, in this context, of a mandatory rule. While it is difficult to envisage circumstances where a loan from the company, as opposed to one from a third party, would be justified, the possibility that such circumstances might exist could be respected by allowing ratification under strict limits (such as the need for unanimity). However, if creditors' interests would be adversely affected by this, the presence of such an externality would justify the retention of the mandatory rule. It should also be noted that as the law currently stands, there is an exception for loans made to directors to meet expenditure incurred or to be incurred for the purposes of the company; these may lawfully be made as long as they are approved by the company in general meeting.

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^[35]

The prohibition on directors' options dealings (section 323) raises issues of market integrity in so far as it can be viewed as part of the law governing insider trading. With regard to its role in regulating the internal relationship of directors and shareholders, it is arguable that little purpose would be served by varying the current outright prohibition to allow ratification by the shareholders, given that this form of trading by directors is highly speculative and could be seen as in some circumstances trading against the company. There is also an argument to the effect that it is not beneficial to the company to allow directors to take up short-term trading positions in their companies' shares.

General principles governing disclosure

3.57

With regard to disclosure, the general guiding principle should be that each organ of the company (board, shareholders) should be presumptively entitled to receive from management the information which it needs to have in order to be confident that it has carried out its particular monitoring function.

^[36]

Two further factors place a limit on efficient disclosure; firstly, the need for confidentiality, that is to say, the problem that excessive disclosure of information may destroy the value of that information; and, secondly, the costs incurred in the process of dissemination.

Disclosure to the board: Sections 317 and 322B

In some cases, disclosure of information to the board only is required. Hence, disclosure to the board alone (in the form of a formal declaration) is needed in the case of a director who has an interest in a transaction or proposed transaction with the company (section 317). Under section 322B, in the case of a company with a sole member, contracts between the company and the member which are neither in writing nor set out in the form of a written memorandum must be recorded in the minutes of a board meeting.

3.59

The purpose of section 322B is to provide evidence of a contract which may be important in the context of a winding up or administration order. In the context of a sole member company, it is arguable that the section adequately meets this need.

3.60

The efficiency of requiring disclosure to the board alone under section 317 is unclear, however. Because of the information costs which attach to identifying a case of self-dealing, the shareholders may not even be in a position to know whether the board is acting in the company's interests if disclosure of a conflict of interest to them is not required. Nevertheless, this consideration must be balanced against the need to preserve confidentiality. Disclosure of certain contracts or transactions in which directors have an interest could destroy their value. For this reason, it might be felt to be unfeasible to replace the requirement of disclosure to the board with a rule requiring full disclosure to the shareholders. The degree of shareholder protection would depend, then, on the effectiveness of monitoring of directors by one another.

3.61

Alternatively, this problem could be overcome by the maintenance of a register of such transactions which shareholders could consult if they wished, as is already the case with directors' share dealings under section 324; or legislation could require shareholders to give periodic approval to conduct by directors which would fall under section 317.

3.62

Consideration could also be given to extending section 317 to cover not just cases in which a director or shadow director has an interest in a contract or proposed contract with the company (or its subsidiary), but to other transactions where there is a conflict of interest or which involve the use of a corporate opportunity.

^[37]

The approach to be taken is also affected by the question of how far non-executive directors can effectively perform a monitoring role on shareholders' behalf with regard to conflicts of interest and duty. It is also likely that in many companies, the question of such conflicts is approached through express terms, governing non-competition and the use of corporate opportunities, in directors' service contracts. These are therefore issues which need to be clarified by empirical research.

Disclosure to shareholders: Sections 314, 318, 324, 325 and 328

3.64

A number of provisions in Part X are concerned with the disclosure to shareholders of information concerning the contracts of employment of directors (section 318)

^[38]

^[39]

Monitoring costs are also reduced by the requirement for the compulsory disclosure of directors' share dealings (sections 324-328). Again, as a matter of general principle, this type of provision can be seen as assisting the monitoring of directors by shareholders, in particular from the viewpoint of how far directors are observing the duty to act in good faith in the company's interests.

Approval and ratification by shareholders: Sections 312, 315, 316, 319, 320, 322, 322A and 337

3.66

The approval and ratification provisions of Part X fall into a number of categories. In some cases, prior approval is needed. This is so in relation to directors' service contracts for a term (without notice) of five years or more in length (section 319), although shareholder approval is not required for 'golden parachutes' in service contracts under the Privy Council's decision in Taupo Totara Timber v Rowe.

^[40]

There are substantial costs to approval and ratification, in particular in the case of large listed companies. As a result, then, these rules operate as strict default rules; we would expect there to be only a limited degree of contracting around the rule. Such rules could be justified if there were a risk of particularly extensive damage to shareholders from conflicts of interest, or of unilateral action by the board which goes beyond the limits set by the constitution of the company and thereby exposes the shareholders to a particularly high risk of loss. Transactions involving substantial property interests come into the first category; unconvenanted service payments and transactions beyond the board's powers under the articles of association - and which therefore threaten to undermine the agreed division of powers between the board and the company in general meeting - come into the second.

3.68

The rules relating to long-term service contracts and golden parachutes have the effect, in each case, of protecting shareholders against the consequences of senior managers receiving excessively large pay-outs on the termination of their employment. It is not clear, given their similar purpose, why ratification is currently needed in the case of contracts beyond five years but not (under Taupo) for golden parachutes. In principle, the two sets of rules could be harmonised. Moreover, the question inevitably arises, in this context, of why these particular terms have been singled out for regulation, and not others. In practice, directors can be compensated for the loss of flexibility over these aspects of the contract by increased benefits of another kind.

3.69

Along with other aspects of the remuneration of senior managers, these questions are also dealt in greater detail with by the Listing Rules and by the Combined Code on Corporate Governance. In effect, these provisions impose a set of disclosure requirements for publicly quoted companies which have taken the question of remuneration outside the immediate control of the company in general meeting, and placed the responsibility for monitoring more clearly on the non-executive directors. Although they involve much reduced compliance costs, the standards set by the Combined Code are stricter than those set by Part X of the Act and cover a broader range of issues. Nevertheless, compliance with the Code is, in the end, voluntary, and further empirical research is needed before its effects can be fully assessed.

3.70

Under these circumstances, the question of what purpose is served by having separate statutory standards could usefully be addressed. A coherent scheme of statutory controls could serve as a 'backstop' to the provisions of the Code and the Listing Rules, and would be particularly important, in this respect, for non-listed companies. However, in the absence of clearly agreed criteria for placing any particular limit on senior managers' pay, a regime of disclosure, as opposed to one of ratification, may function adequately to protect shareholder interests.

^[41]

General conclusions on Part X

To conclude this part of the discussion, the provisions of Part X do not constitute a consistent approach to the imposition of disclosure and ratification requirements in cases of self-dealing, conflicts of interest and duty, and directors' service contracts. In particular, it is not clear why, in the context of section 317, disclosure of self-dealing is currently required only to the board, as opposed to being made available to the shareholders through a register or made subject to their periodic approval. Nor do the rules governing shareholders' approval for certain terms of service contracts reveal a coherent scheme, since the basis on which certain terms but not others are singled out for approval is not apparent. This means that the regulatory intent of the legislation can be avoided through contracting, which in itself may be costly and serve no purpose.

3.72

These considerations suggest that there may be merit in moving towards a general principle of disclosure to the shareholders of information concerning self-dealing and directors' contracts. Only in relation to a smaller number of transactions would shareholder approval and/or ratification be required. This would be the case where there was a danger of depletion of corporate assets from particular types of transactions (as is currently the case in regard to sections 320-322) or where the agreed division of powers between the board and the shareholders was in danger of being undermined (as in the case, currently, of section 322A).

Civil remedies for breach of fiduciary duty

3.73

Law and economic scholars have questioned whether an economic justification can be found for the pattern of civil remedies for breach of fiduciary duty, and in particular for the restitutionary basis of the remedy of account of profits. A restitutionary award, it is argued, may under certain circumstances unduly penalise a fiduciary who diverts a corporate opportunity; the result will be over-deterrence of fiduciaries in general. The correct measure of damages from an economic point of view, it is suggested, is that based on the principal's loss, as in the case of damages for breach of contract.

^[42]

Even if the correctness of the basic economic position with regard to the 'efficiency' of certain breaches of contract is accepted,

^[43]

^[44]

More precisely, damages for breach of fiduciary duty should ideally be set 'at the level required both to offset enforcement error and to achieve deterrence'.

^[45]

full

worse off

In practice, however, it is not clear how far the current state of the law in the UK conforms to this analysis, since it is possible that a court would grant the fiduciary an allowance for expenses incurred which would considerably reduce the extent of his or her liability; the manner in which the court calculates the net profits of the fiduciary may also go to reduce their liability and hence the deterrent effect of this type of civil remedy. It should also be borne in mind that for certain types of breach of fiduciary duty involving self-dealing, as opposed to the diversion of a corporate opportunity, a remedy requiring the fiduciary to account to the principal for profits arising from the transaction may not be available.

^[46]

On balance, the presence of a restitutionary element in civil damages for breach of fiduciary duty by directors may be seen as efficient in the sense of helping to overcome difficulties in detecting breaches of duty by directors.

^[47]

Notwithstanding the difficulties facing civil litigants, the present rule could give rise to the possibility of opportunistic litigation by undeserving plaintiffs, and hence of a waste of resources.

^[48]

Regal (Hastings) Ltd

Gulliver

^[49]

^[50]

Regal

^[51]

The efficiency of criminal sanctions for breach of fiduciary duty

^[52]

Economic theory also suggests that criminal sanctions should not be excessively severe where the aim is to overcome problems of detection. Severe sanctions may be levied less often by courts, so reducing the probability of the sanction being applied and, hence, of wrongdoers being deterred.

^[53]

Disproportionate remedies may give rise to perverse incentives on the part of wrongdoers, who may have no reason to pay regard to the threat of further criminal liability if a criminal sanction is attached to a trivial or technical breach of the law.

^[54]

^[55]

The form of a rule is relevant to the application of criminal sanctions. There is a danger of over-deterrence, for example, if criminal sanctions are attached to open-ended standards, such as the general duty of loyalty, as opposed to clearly defined bright-line rules. This point argues against the criminalisation of the general duty of loyalty,

^[56]

These considerations suggest that a role for criminal sanctions in the enforcement of fiduciary duties may be defended on economic grounds. However, this point is subject to certain qualifications: first, the limits of criminal liability must be clearly set, and, secondly, low-level sanctions, such as fines, are probably appropriate.

3.84

Conversely, there would be a strong case for decriminalisation in respect of Part X of the Companies Act 1985 if more effective alternative means were to be found for monitoring and detecting illicit conduct of directors, such as lower-cost civil litigation by shareholders, or improved internal monitoring (for example, by non-executive directors). This would be so, in particular, if it were the case that the criminal sanctions envisaged by Part X were not used in practice, or were not seen as having a significant deterrent effect. These are matters requiring empirical investigation.

The duty of care

3.85

Different economic considerations may apply to the duty of care than those which apply in the case of the fiduciary duty of loyalty. Monitoring of managers' performance is subject, as before, to high information costs and to the costs of specifying a complete set of contractual obligations. However, because lack of care by managers is arguably easier to detect than disloyalty, and the potential gains from breach are less, there is less of a clear justification for a strong prophylactic element in the duty of care or in the sanctions for its breach.

^[57]

^[58]

It has been argued that a good initial case exists for aligning directors' general duties of care with the standard set by section 214 of the Insolvency Act 1986,

^[59]

However, if the standard of care is raised, possible problems are that

directors may be deterred from taking normal business risks; in particular if there are limits to the availability of insurance; non-executive directors may be unable to overcome insider domination by executive directors and officers, so reducing the effectiveness of the board as the principal organ for monitoring the performance of employees; and internal systems of communication, through which the board ensures internal compliance with its general instructions, may break down, again preventing the board from being an effective monitor. We now consider these points in greater detail.

There is empirical evidence from Canada that the introduction of personal liabilities for directors has led to directors' resignations,

^[60]

^[61]

Even if insurance is made available, claims against directors may, for that reason alone, increase.

^[62]

Some second-order effects stemming from a raising of the standard of care can be envisaged, not all of which are necessarily adverse. If directors are to be held liable for failing to adequately scrutinise the performance of employees, it is possible that they will respond by requiring tighter internal monitoring and reporting systems. In principle it is not clear whether this would lead to an improvement in internal reporting, which would assist compliance with external regulatory standards, or to unnecessary costs. Empirical research would be of assistance here.

3.90

In the present state of research in this area, it is not possible to predict with certainty the consequences of restating the duty of care in such a way as to raise the standard of care and skill expected of all directors. Even if insurance is made more generally available, an increase in litigation could have adverse consequences for the willingness of capable individuals to take office as directors. On the other hand, the raising of the legal standard of care could have beneficial effects in terms of improving internal communication and monitoring systems within organisations.

3.91

To avoid possible adverse effects, consideration should be given to the adoption, within a restatement of the duty of care, of a general 'business judgement' defence, the effect of which would be to provide some protection with regard to decisions within the range of normal business risks, that is to say, decisions taken on the basis of a reasonable weighing of the risks involved. A role for more specific limits on directors' personal liability, in the form of checklists for compliance with due diligence, could also be considered here. The content of such 'safe havens' could be informed by auditing standards.

Conclusions

3.92

The main conclusions of this part may be restated:

(1) The contribution of this economic analysis has been three-fold: to identify economic rationales for the existing body of law; to identify possible outcomes of legal reform; and to indicate the main areas in which further, empirical research would be desirable.

(2) Company law can be seen as having a number of economic purposes, in particular: (1) promoting efficient bargaining between corporate actors; (2) protecting the interests of third parties (such as creditors) who may be affected by negative externalities, that is to say, unbargained for costs which are imposed upon them by transactions between others; and (3) providing incentives for cooperation, thereby promoting innovation and competitiveness.

(3) The underlying principle of legal regulation in this area should be the achievement of procedural fairness in the regulation of self-dealing and other conflicts of duty and interest, that is to say the specification of the conditions under which disclosure, approval, release and ratification are needed in order to avoid liability, rather than an outright prohibition on all conflicts of duty and interest.

(4) A restatement of the fiduciary duties of directors should make some reference to the possibility of the avoidance of liability through disclosure, approval, release and ratification.

(5) There is a case for constituting the fiduciary principle in the form of a penalty default rule which places the onus of avoiding liability through disclosure, ratification etc, on the fiduciary.

(6) Absolute prohibitions on certain types of transactions can be justified only where there is a significant risk that the transactions in question would give rise to a negative externality or unbargained for effect imposed upon a third party (such as harm to the interests of creditors, sufficient to outweigh the gains to the internal corporate actors) or where they would harm a significant public interest (such as the need to maintain market integrity).

(7) The guiding principle for disclosure should be to ensure that each organ of the company (board, shareholders) receives from management the information which it needs to have in order to be confident that it has carried out its monitoring function. Hence, the shareholders must have sufficient information to enable them to decide whether the directors are acting in good faith in the best interests of the company. Two further factors place a limit on efficient disclosure; firstly, the need for confidentiality, that is to say, the problem that excessive disclosure of information may destroy the value of that information; and, secondly, the costs incurred in the process of dissemination.

(8) On this basis, the provisions of Part X do not constitute a consistent approach to the imposition of disclosure and ratification requirements. In particular, the rules governing shareholders' approval for certain terms of service contracts do not reveal a coherent scheme, since the basis on which certain terms but not others are singled out for approval is not apparent. This means that the regulatory intent of the legislation can be avoided through contracting, which in itself may be costly.

(9) These considerations suggest that there may be merit in moving towards a general principle of disclosure to the shareholders of information concerning self-dealing and other conflicts of duty and interest and directors' contracts. Shareholder approval and/or ratification etc would be required only in a smaller number of cases, where there was a danger of the depletion of corporate assets from particular types of transactions or where the agreed division of powers between the board and the shareholders was in danger of being undermined.

(10) Under the present state of both English and Scots law, the existence of a restitutionary element in civil damages for breach of fiduciary duty by directors can be justified as providing an efficient incentive against disloyalty.

(11) A role for criminal sanctions in the enforcement of fiduciary duties may be defended on economic grounds. However, this point is subject to certain qualifications: first, the limits of criminal liability must be clearly set, and, secondly, low-level sanctions, such as fines, are probably appropriate.

(12) Conversely, there would be a strong case for decriminalisation in respect of Part X of the Companies Act 1985 if more effective alternative means were to be found for monitoring and detecting illicit self-dealing, such as lower-cost civil litigation by shareholders, or for improved internal monitoring (for example, by non-executive directors).

(13) If the standard of care for directors' duties of care and skill is raised, possible problems are that directors may be deterred from taking normal business risks, in particular if there are limits to the availability of insurance; non-executive directors may be unable to overcome insider domination by executive directors and officers; and internal systems of communication, through which the board ensures internal compliance with its general instructions, may break down, in each case preventing the board from acting as an effective monitor of employees' performance.

To avoid possible adverse effects, consideration should be given to the adoption, within a restatement of the duty of care, of a general 'business judgement' defence, the effect of which would be to provide some protection with regard to decisions within the range of normal business risks. A role for more specific limits on directors' personal liability, in the form of checklists for compliance with due diligence, could also be considered.

Note 1   These types of economic analysis are termed 'normative' and 'positive' analysis, respectively. See A I Ogus, "Economics and Law Reform: Thirty Years of Law Commission Endeavour" (1995) 111 LQR 407.    [Back]

Note 2    The Rt Hon Lord Hoffmann, "The Fourth Annual Leonard Sainer Lecture" (1998) Co Law 194.    [Back]

Note 3   '[I]n designing solutions to legal problems, law reformers should not overlook behavioural responses which may vitally affect the efficacy of those solutions and which economics, in particular, can be used to predict': Ogus, op cit, at p 417. For example, second-order effects may frustrate the redistributive intention of a rule: landlords may respond to rigid rent controls by withdrawing their properties from the market, leaving tenants, as a group, worse off (Ogus, ibid, at p 418). A more positive implication of this type of analysis is that a rule may be designed with the aim of inducing certain desired second-order effects. For example, in the context of commercial relationships, legal rules may have the effect of enhancing the flow of economically valuable information as a preliminary step to further bargaining between the parties. This is a point directly relevant to the law governing directors' duties, to which we will return below.    [Back]

Note 4   We identify in this part certain issues on which empirical research would be useful; see also Part 16, below.    [Back]

Note 5   Rt Hon Lord Hoffmann, op cit. For a valuable review of theories of the firm in economics and their relevance to corporate law (mainly in the US context) see W Bratton Jr, "The New Economic Theory of the Firm: Critical Perspectives from History", in S Wheeler (ed) A Reader on the Law of the Business Enterprise (1994).    [Back]

Note 6   See generally A Berle and G Means, The Modern Corporation and Private Property (1932) (perhaps the prime example of interdisciplinary collaboration between a lawyer and economist in the field of company law).    [Back]

Note 7   The economic terms 'principal' and 'agent' do not bear the same meaning as their juridical counterparts: in English law, directors are agents of the company and not of the shareholders, nor are the officers and employees the agents of the board. The economic concept of 'agency' is concerned with the costs which arise from delegation, rather than with the precise nature of the juridical relationship to which delegation gives rise.    [Back]

Note 8   There is an extensive literature on the role of the law in supporting contractual cooperation. For recent contributions, see D Campbell and P Vincent Jones, Contract and Economic Organisations: Socio-Legal Initiatives (1996); S Deakin and J Michie, Contracts, Cooperation and Competition (1997).    [Back]

Note 9   See our discussion of Part X Companies Act 1985, para 3.51 et seq below.    [Back]

Note 10   See below, paras 3.54-3.56. Another example is the rule that dividends must be paid out of realised profits (Companies Act 1985, s 263).    [Back]

Note 11   As we shall see below, fiduciary duties can, in practice, be modified or excluded by various means, but even then it is arguable that certain residual elements of the director's duty to act bona fide in the interests of the company cannot be excluded. See para 3.29 below.    [Back]

Note 12    R Cooter and B Freedman, "The Fiduciary Relationship: Its Economic Character and Legal Consequences" (1991) 66 NYU Law Review 1045, 1074. See also R Campbell Jr, "A Positive Analysis of the Common Law of Corporate Fiduciary Duties" (1995-96) 84 Kentucky L J 455.    [Back]

Note 13    Cooter and Freedman, op cit 1054-55.    [Back]

Note 14   See paras 3.73-3.78 below for further discussion of civil remedies for breach of directors' duties.    [Back]

Note 15   See V Brudney, "Corporate Governance, Agency Costs, and the Rhetoric of Contract' (1985) 85 Col LR 1403; V Brudney, "Contract and Fiduciary Duty in Corporate Law" (1997) 38 Boston College LR 595; M Whincop, "An Economic Analysis of the Criminalisation and content of Directors' Duties" (1996) 24 Australian Business Law Review 273. The question of whether corporate constituencies other than shareholders can be regarded as the ultimate beneficiaries of directors' fiduciary duties is outside the scope of our present discussion; however, it should be noted that there are economic arguments for acknowledging the existence of duties to take into account the interests of creditors, employees and others under certain circumstances, as, indeed, is currently the case in UK company law. See S Deakin and G Slinger, "Hostile Takeovers, Corporate Law, and the Theory of the Firm" (1997) 24 J Law & Soc 124.    [Back]

Note 16   See T Ghilarducci, J Hawley and A Williams, "Labour's Paradoxical Interests and the Evolution of Corporate Governance" (1997) 24 J Law & Soc 26.    [Back]

Note 17   In practice, the application of these rules is not always very clear: see Shareholder Remedies, Consultation Paper No 142, at paras 5.16-5.17, and (1997) Law Com No 246, at paras. 6.80-6.85.    [Back]

Note 18   See R Daniels, "Must Boards Go Overboard? An Economic Analysis of the Effects of Burgeoning Statutory Liability on the Role of Directors in Corporate Governance" (1994-95) 24 Canadian Business LJ 229; B Chapman, "Corporate Stakeholders, Choice Procedures and Committees" (1995-96) 26 Canadian Business LJ 211.    [Back]

Note 19   R Romano, "Comment on Easterbrook and Fischel, 'Contract and Fiduciary Duty'" (1993) 36 Journal of Law and Economics 446, 450.    [Back]

Note 20   Romano, op cit. It should be noted that Romano's argument is only valid if the market forces to which she refers in fact have an appreciable effect of the kind suggested, which is a matter for empirical research. For recent reviews of the empirical evidence, see Romano, "A Guide to Takeovers: Theory, Evidence, and Regulation" (1992) 9 Yale Journal of Regulation 119; and Deakin and Slinger, op cit. For present purposes, it is sufficient to note the general argument which Romano makes.     [Back]

Note 21   Companies Act 1985, s 310; although, even here, there is scope for derogation as a consequence of the decision of Vinelott J in Movitex Ltd v Bulfield [1988] BCLC 104. On the conflict between s 310 and art 85 of Table A (1985), which, contrary to the Act, appears to envisage ex ante agreements to allow self-dealing by directors, see P Davies, Gower's Principles of Modern Company Law (6th ed, 1997) at pp 623-626.    [Back]

Note 22   Ibid, at pp 620-621 and 645-648.    [Back]

Note 23   See ibid, ch 23, and Shareholder Remedies (1997) Law Com No 246.     [Back]

Note 24   See I Ayres and R Gertner, "Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules" (1989) 99 Yale LJ 87. A further analysis of the different types of default rules within company law and their relationship to property rights lies outside the scope of this paper; for an analysis of these issues see M Whincop, "Painting the Corporate Cathedral: the Protection of Entitlements in Corporate Law" forthcoming, OJLS.    [Back]

Note 25   Table A (1985) is the 'default' set of articles in the sense that it applies where a company fails to register separate articles of its own: Companies Act 1985, s 8(2).    [Back]

Note 26   Ayres and Gertner, op cit, at p 94.    [Back]

Note 27   In other words, here the gain to the contracting parties would outweigh the loss to the third party.    [Back]

Note 28   Davies, op cit, at p 361.    [Back]

Note 29   See F Easterbrook and D Fischel, "Contract and Fiduciary Duty" (1993) 36 Journal of Law and Economics 425, 428.    [Back]

Note 30   This example is given by Easterbrook and Fischel, op cit, at pp 444-445.    [Back]

Note 31   See M Eisenberg, "The Structure of Corporate Law" (1989) 89 Col LR 1461, discussing US practice.    [Back]

Note 32   Consent may, for this purpose, be effective if there has not been adequate prior disclosure, so there may be a considerable overlap between categories (2) and (3).    [Back]

Note 33   Companies Act 1985, s 337.    [Back]

Note 34   Ibid, Sched 6 and, in the case of banks, ss 343-344.    [Back]

Note 35   For a critical analysis of the argument that mandatory rules are needed to protect the interests of creditors, see B R Cheffins, Company Law: Theory, Structure and Operation (1997) p 245.    [Back]

Note 36   This is not to suggest that each organ of the company has the same monitoring function, either in law or in practice. In particular, a distinction may be drawn between directors, who are under a certain legal duty to monitor each other's activity, and shareholders, who monitor the directors out of self-interest rather than legal obligation.    [Back]

Note 37   Disclosure to the board may suffice to avoid liability under the general principles of fiduciary law (Queensland Mines Pty Ltd v Hudson (1978) 18 ALR 1), so giving rise to a general incentive to disclose information concerning corporate opportunities. However, the scope of the judge-made rule is unclear; clarification by statute could be considered to be beneficial.     [Back]

Note 38   Section 318 requires disclosure of the terms of directors' service contracts.    [Back]

Note 39   Officers and senior managers of the company are caught, in principle, by general fiduciary duties, but only directors (and sometimes shadow directors) are affected by Part X.     [Back]

Note 40   [1978] AC 537.    [Back]

Note 41   We do not consider here the question of whether the maintenance of a certain relationship between senior managers' pay and the pay of other employees is conducive to more effective performance within the organisation, and hence in the shareholders' longer-run interests.    [Back]

Note 42   See F Easterbrook and D Fischel, op cit. Their argument would apply a fortiori to the use of proprietary remedies for breach of fiduciary duty, such as the remedial constructive trust, in the context of corporate opportunities. For reasons of space, a full economic analysis of the different remedies which may be available, and the implications of the conceptual distinction between property rights and liability rules in this context (which, it should be noted, does not correspond precisely to the distinction between personal and proprietary claims), cannot be undertaken here. See M Whincop, op cit (forthcoming) for an extended analysis of these issues.    [Back]

Note 43   The economic theory of 'efficient breach' has, indeed, been the subject of substantial criticism, not least by restitution scholars: see GH Jones, "The Recovery of Benefits Gained from a Breach of Contract" (1983) LQR 443, cited with approval by the Court of Appeal in A-G v Blake [1998] 1 All ER 833.    [Back]

Note 44   See Cooter and Freedman, op cit, for further elaboration of this argument.    [Back]

Note 45   Ibid, p 1070.    [Back]

Note 46   Re Cape Breton Co (1885) 29 Ch D 795; see R C Nolan, "Conflicts of Interest, Unjust Enrichment and Wrongdoing", in W R Cornish, R C Nolan, J O'Sullivan and G Virgo (eds)Restitution: Past, Present and Future: Essays in Honour of Gareth Jones (1998).    [Back]

Note 47   For arguments against full restitution in the context of directors' duties, and references to US jurisdictions in which the normal rule has been varied for corporate transactions, see Easterbrook and Fischel, op cit, at p 442.    [Back]

Note 48    The costs which arise from opportunistic litigation are considered in the context of antitrust law by W Baumol and J Ordover, "Antitrust: Source of Static and Dynamic Inefficiencies?", in T Jorde and D Teece, Antitrust, Innovation and Competitiveness (1994).    [Back]

Note 49   [1942] 1 All ER 378.    [Back]

Note 50    Davies, op cit, at p 616.    [Back]

Note 51   See Selangor United Rubber Estates v Cradock (No 4) [1969] 1 WLR 1773, 1776.    [Back]

Note 52   Daniels, op cit.    [Back]

Note 53   Cooter and Freedman, op cit at p 1071, applying the analysis of G Becker, "Crime and Punishment: An Economic Approach" (1968) 76 Journal of Political Economy 169.    [Back]

Note 54   Daniels, op cit, at p 235.    [Back]

Note 55   Ibid, at p 236; for empirical analysis, see J Karpoff and J Lott, "The Reputational Penalty Firms Bear from Committing Criminal Fraud" (1993) 36 Journal of Law and Economics 757.    [Back]

Note 56   See M Whincop, op cit, discussing s 232 of the Australian Corporations Law.    [Back]

Note 57   See Cooter and Freedman, op cit. However, their argument about ease of detection would not apply to carelessness brought about through an omission to act.    [Back]

Note 58   Cooter and Freedman, op cit at pp 1059-1061, consider that this measure of 'perfect compensation' contains an element of punishment since managers found personally liable for negligence will suffer additional reputational losses and, most likely, loss of employment; these punitive elements may be justified, they suggest, since in the case of negligence actions, there is no reversal of the burden of proof as there is, in effect, in cases of breach of fiduciary duty under US law.    [Back]

Note 59   See Re D'Jan of London [1994] 1 BCLC 561; Rt Hon Lord Hoffmann, op cit. For a more sceptical view, see Cheffins, op cit pp 537-548.    [Back]

Note 60   Precisely, this is said to have occurred in order to avoid possible personal liability for back wages owed to employees, in the event of the insolvency of the company: Daniels, op cit.    [Back]

Note 61   R Daniels and S Hutton, "The Capricious Cushion: The Implications of the Directors and Officers' Insurance Liability Crisis on Canadian Corporate Governance" (1993) 22 Canadian Business LJ 182.    [Back]

Note 62   Daniels, op cit.    [Back]

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