The key piece of legislation around director duties is the Companies Act 2006. The Act, which covers a host of legislative areas, imposes the burden of various general duties on directors of UK limited companies.
Here in our latest website blog, I want to explore those duties in more detail and talk through the actions directors should be taking to protect themselves and ensure they stay on the right side of legislation.
Functions of a Director
First up, at its most basic level, when we view a company we can see that it mainly acts through two classes of people. The first class is the directors who are responsible for the general day-to-day operations of the organisation. They will attend meetings and look to improve the functions of the firm as well as ensure that its obligations (both legal and otherwise) are met.
The second class of people are the shareholders, who have certain powers and own the company. Directors and shareholders can of course be the same people – often a company is owned and operated by one director/shareholder.
The directors are agents of the company and have significant control over its direction and the decisions it makes.
Duties imposed by the Companies Act 2006 (CA 06)
As mentioned above, there are seven general duties which the CA 06 requires of directors. These are as follows:
1. Duty to act within powers
Acting in accordance with the company’s constitution, exercising powers instilled for the purposes for which they were given.
Directors are required to act in compliance with their company’s constitution (being defining documentation, including company resolutions, articles of association and constitutional agreements, i.e. shareholder agreements / joint venture papers). All directors of the business will need to know these documents and their implications in order to act properly – and also in a way which does not prejudice the company or its stakeholders.
2. Duty to promote the success of the company
Framed from the perspective of benefitting its members as a whole i.e. not just individual members or classes of shareholders, directors need to act in good faith in promoting the success of the company.
It can be somewhat subjective as to what success will mean in relation to a particular company, but generally this will be measured in terms of medium to long-term financial increases on the balance sheet, regardless of what the company was incorporated to do.
The CA 06 provides guidelines for what ought to be included within the decision-making process when trying to promote the company’s success:
- The likely consequences of any decision in the long term.
- The interests of the company’s employees.
- The need to foster the company’s business relationships with suppliers, customers and others.
- The impact of the company’s operations on the community and the environment.
- The desirability of the company maintaining a reputation for high standards of business conduct, and;
- The need to act fairly as between members of the company.
Depending on the size of the company in question, the directors may be required to prepare a strategy report (provided to shareholders) which provides details to allow the shareholders to take a view as to how the directors have acted to promote the success of the company. For the largest companies, there is an obligation to include a statement in the report which examines each of the above items and describes how the directors feel they have complied.
One might look at the points provided by the CA 06 and question how they can evidence that the factors have been taken into account (and how this can be done without incurring a significant administrative burden and loss of time to work on the firm’s main purposes). In practice, board minutes are used to state that the factors have been considered, without needing great detail. This is generally acceptable, although where one factor is very key to a decision made or a process followed, it is prudent to ensure that this is outlined and made clear and obvious.
Important to note: where it is reasonably considered that the firm might be facing insolvency, this duty ought to be modified to ensure that increased regard is had to the creditors of the company rather than its members.
3. Duty to exercise independent judgment
Directors should exercise their independent judgment when making decisions
Compliance should not prevent:
- Seeking professional help/advice (provided that in following it, the director does exercise their independent judgment) or, :
- Acting in accordance with the constitution of the company (as outlined).
4. Duty to exercise reasonable care, skill and diligence
As per s174 in the CA 06, directors are required to exercise the same care, skill and diligence that would be exercised by a reasonably diligent person with:
- The general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as you in relation to the company.
- The general knowledge, skill and experience that you actually possess.
The crucial point to take away from this statutory standard is that there is both an objective and a subjective element. If a director has been put in a position that is far beyond his actual capabilities, this might come back to haunt him if he acts in a way which prejudices the interests of the company. He cannot solely hide behind his inexperience due to the objective element of the standard.
5. Duty to avoid conflicts of interest (a conflict situation)
Avoiding circumstances in which a director has or might have an interest that is in conflict with, or may conflict with, the interests of the company.
This duty applies, in particular, to the exploitation of any property, information or opportunity, regardless of whether the company could take advantage of it.
This duty is not infringed:
- If the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or
- If the matter has been authorised by the directors.
When might a conflict arise?
Unfortunately the CA 06 does not provide a list of potential conflict-related circumstances, although the below examples provide the key four areas:
- Personal interests – a director holds significant shares in the company itself, or a competitor company, or has an interest in property in which the company is interested in purchasing.
- Director elsewhere – such as being on the board of a competing firm, a customer or supplier of the company.
- Other benefit – such as personal use of company data/information or perceived opportunities, wanting to take up an opportunity declined by the company or in any situation where a director is able to profit as a result of their role.
- Connected persons – if any of the above situations apply to a person connected with the director (examples include: spouse, partner, parent, child or other close relative).
Steps to take
It might feel daunting at first but a director ought to:
Approval/authorisation – approach other members of the board in order to inform them of the conflict / potential conflict. They may be in a position to authorise, provided:
- where the company is a private company and nothing in the company's constitution invalidates such authorisation, by the matter being proposed to and authorised by the directors; or
- where the company is a public company and its constitution includes provision enabling the directors to authorise the matter, by the matter being proposed to and authorised by them in accordance with the constitution.
Review the articles of association – these might contain helpful provisions as to conflicts, such as items which allow for pre-authorisation (a list of circumstances), or items which outline the conduct expected of a director when they find themselves in the same / a similar position.
Consider the appropriate action – authorisation will clearly operate to remove any animosity that might arise should the board later discover a conflict, but it is important to recognise that there is still an overriding duty on a director to promote the success of the company.
6. Duty not to accept benefits from third parties
This relates to benefits received either due to agreeing to do something, or agreeing not to do something.
However, there is no infringement if acceptance cannot reasonably be regarded as likely to give rise to a conflict of interest.
7. Duty to declare interests in proposed or existing transactions or arrangements with the company
This duty has a broad scope and includes a director being, per s177 in the CA 06, “in any way, directly or indirectly, interested in a proposed transaction or arrangement” then they must “declare the nature and extent of that interest to the other directors”.
In the case of a proposed transaction you must make this declaration before the transaction is entered into. In the case of an existing transaction you must do this as soon as reasonably practicable.
There is no infringement, per s177:
- If it cannot reasonably be regarded as likely to give rise to a conflict of interest
- If, or to the extent that, the other directors are already aware of it (and for this purpose the other directors are treated as aware of anything of which they ought reasonably to be aware); or
- If, or to the extent that, it concerns terms of his service contract that have been or are to be considered:
- by a meeting of the directors, or
- by a committee of the directors appointed for the purpose under the company's constitution.
A director might ask whether they only need to consider one duty at a time. More than one duty may apply in any situation. For example, you will need to apply your duty to act with reasonable care, skill and diligence when considering whether a course of action is likely to promote the success of the company. Similarly, you are required to act in accordance with your company’s constitution even if a contrary course of action could be seen to promote the success of the company.
General duties – owed to whom?
A director will owe the duties to the company at which they are registered as a director (which is a separate legal entity / person). A breach will give rise to enforcement brought in the name of the company itself, either at the behest of the board of directors, by a liquidator (in insolvency situation) and / or, less usually, by an individual shareholder or group of shareholders under a derivative action.
Penalties for breach(es)?
These can take the form of:
- injunction; and/or
- damages; and/or
- or, compensation.
Where a director has not disclosed their interest in an existing transaction or arrangement this can lead to a criminal fine.
Relief for breaches?
These protections might be available when a breach takes place:
- Ratification of the breach by resolution of the company’s shareholders;
- Court relief if it is determined that the director acted honestly and reasonably;
- Insurance for the benefit of directors, and;
- Indemnity provided by the company in favour of directors, shielding against costs incurred in successfully defending a claim for breach of duties owed to the company.