Directors’ Duties Under
The Companies Act 2006

Guidance Note

Introduction
The Companies Act 2006 (“2006 Act”) represents a major overhaul and consolidation of existing company law and has introduced a statutory statement of directors’ duties which replaces many existing commonlaw and fiduciary duties. Most of the relevant provisions came into force on 1 October 2007 although those dealing with conflicts of interests will not come into force until 1 October 2008.
It should be noted that this is provided as a guide only for the purposes of summarising duties owed by directors. Directors will, however, have many other duties, both under the 2006 Act and under a wide variety of other laws and regulations, breaches of which may impose criminal and civil liability on directors personally. If you have any questions on any of those matters or on any of the matters covered below, whether now or in the future, please contact Amanda Cantwell or Evelyn Adfield at Boyes Turner on 0118 952 7263.

Directors Generally
The business and affairs of a company are managed on its behalf by its board of directors. The directors are agents of the Company and are appointed by the shareholders to manage its affairs, usually with the benefit of very wide powers conferred by the articles of association or shareholder resolution.

Every company should be headed by an effective board which is collectively responsible for promoting the success of the Company. The board’s role is to provide entrepreneurial leadership of the Company within a framework of prudent and effective controls which enable risk to be assessed and managed. The board should set the Company’s strategic aims, ensure that the necessary financial and human resources are in place for the Company to meet its objectives and review management performance. The board should also set the Company’s values and standards and ensure that its obligations to its shareholders and others are fully understood and met.

If the directors fail to ensure that a company’s obligations are discharged, penalties may be imposed on both the Company and the director individually.

Duties
There are seven general directors’ duties introduced by the 2006 Act. These are owed to the Company as a whole and therefore the basic position is that only the Company can enforce them, although in limited circumstances members may be able to pursue a derivative claim against the directors. The 2006 Act does not contain all the necessary details on directors’ duties and the law which has developed through previous cases will need to be considered in interpreting and applying them:

Duty to promote the success of the Company (Section 172, 2006 Act)
A director must act in the way he considers, in good faith, would be most likely to promote the success of the Company for the benefit of its shareholders as a whole. In doing so, each director must have regard (among other matters) to:

• 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 the members of the Company.

This duty is subject to any requirement on the directors to consider or act in the interests of others, for example, the creditors of the Company where the Company is insolvent.

It should be noted that the above list is not exhaustive. Directors should have regard to other matters relevant to the duty to promote the success of the Company including the duty to exercise reasonable care, skill and diligence in carrying out their duties, meaning that in some cases, to satisfy this duty, it may be necessary to seek expert advice.
Current opinion suggests that it will be sufficient for the minutes of any board meeting to state that the directors have taken the listed factors into account in carrying out their duty for the purposes of proving compliance with the law. Where any factor is particularly relevant to a decision, whether or not listed above, the minutes should reflect points made during discussions and for significant or potentially controversial decisions, briefing papers prepared by management should address each listed factor. 

Duty to act within powers (Section 171, 2006 Act)
A director must act in accordance with the Company’s constitution and must only exercise his powers for their proper purpose.
A Company’s constitution includes, its Company’s Memorandum and Articles of Association, decisions taken in accordance with the Articles, other decisions taken by the members of the Company and any resolutions and agreements affecting the Company’s constitution.

Liability is strict here. If a director’s substantial purpose was not the purpose for which a power was conferred, it will not matter if he exercised the power in good faith or in the belief that it would promote the success of the Company for the benefit of the members as a whole.

Duty to exercise independent judgement (Section 173, 2006 Act)
A director must exercise his powers independently of third party instruction. This duty means that directors must not fetter any future exercise of their discretion in any way. The duty will not prevent directors relying on advice, as long as the directors exercise their own judgement in deciding whether or not to follow the advice, nor will it prevent them from delegating their powers, provided they do so in accordance with the Company’s constitution.

Duty to exercise reasonable care, skill and diligence (Section 174, 2006 Act)
A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both:

• the general knowledge, skill and experience which may reasonably be expected of a person carrying out the functions carried out by the director in relation to the Company (the “objective” test). and
• the general knowledge, skill and experience that the director actually has (the “subjective” test).

As a minimum, a director must display the knowledge, skill and experience set out in the objective test, but where a director has specialist knowledge, the higher subjective standard must be met. In applying the test regard will be had to the functions of the particular director, including his specific responsibilities and circumstances of the Company. 

Duty to avoid conflicts of interest (Section 175, 2006 Act) – to take effect 1 October 2008
A director must not, without the Company’s consent, place himself in a position where there is a direct or indirect conflict, or possibility of a conflict, between the duties he owes the Company and either his personal interests or other duties he owes to a third party. This duty applies, in particular, to the possibility of exploitation of property, information or opportunity coming to an individual through his role as a director of a company. This duty will not be infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest or, in the case of a private company, if authorisation has been given by directors who are genuinely independent to the transaction, unless the Company’s constitution prevents such authorisation.

Under the 2006 Act, a situational conflict is capable of sanction by the non-interested directors and for private companies incorporated before 1 October 2008 shareholders must pass a one-off ordinary resolution to enable the new situational conflicts regime under the Act to apply. Consideration should also be given as to whether the articles should be amended to expressly reflect the new provisions of the Act and to ensure that the directors are not prohibited from authorising conflicts of their fellow directors.

Duty not to accept benefits from third parties (Section 176, 2006 Act) – to take effect 1 October 2008
Unless shareholders have specifically consented, Directors are prohibited from exploiting their position for personal benefit. The duty will not be infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. Benefits conferred by the Company, its holding company or subsidiaries and benefits received from the person who provides the director’s services to the Company, are excluded from this duty.

Duty to declare interest in proposed transaction or arrangement with the Company (Section 177, 2006 Act) – to take effect 1 October 2008
Directors must disclose any interest in a transaction with the Company to the Board before the Company proceeds. Directors must declare to the other directors the nature and extent of any interest, direct or indirect, in a proposed transaction or arrangement with the Company. The director need not be party to a transaction for this duty to apply. In addition, the declaration by a director of an interest in an existing transaction or arrangement must include the nature and the extent of the interest.

Scope and nature of duties
The general duties will apply to all the directors of a Company - whether executive or non-executive, which includes any person occupying the position of director, by whatever name called and without distinction between executive and non-executive directors. All companies should therefore ensure that the directors are aware of their duties under the 2006 Act and some practical steps to ensure this are set out below:

• ensure that they are aware of their duties under the 2006 Act by way of thorough briefing and/or training.
• consider amending terms of appointment and description of the role of any director to specifically refer to his duties.
• ensure that both management and employees responsible for preparing business reviews and others involved in governance, are also aware of the new duties of directors.
• review the Company’s policies in areas such as human resources, ethics, compliance and corporate responsibility and determine how the duty to promote the success of the Company will be complied with and documented against the background of the new duties.
• familiarise themselves with the constitution of the Company, in particular any limitations on the powers of the Company or the directors.
• determine whether the Articles of the Company should be amended to permit independent director authorisation of conflicts of interest.

Where more than one duty applies in a given case, the directors must comply with each applicable duty. For example, the duty to promote the success of the Company will not authorise directors to breach their duty to act within their powers, even if they consider that action would be most likely to promote the success of the Company. These general duties also do not require or indeed authorise a director to breach any other law.

Consequenses of breach

Action by the Company
The remedy against a director for breach of Section 174 of the 2006 Act (duty to exercise reasonable care, skill and diligence) would usually be damages, whilst remedies for breaches of other general duties may, in addition, include:

• an injunction;
• setting aside of a transaction, restitution and account of profits;
• restoration of Company property held by a director. or
• termination or the director’s service contract.

Relief from liability
Directors may seek relief from liability arising against them in the following limited circumstances:

• ratification by the Company. and/or
• relief granted by the Court where a director has acted honestly and reasonably and, considering all the circumstances of the case, he or she ought fairly to be excused.

Indemnity and insurance
A company is not able to exempt a director from liability for negligence, default, breach of duty or breach of trust in relation to the Company. However, it may indemnify a director against defence costs, or costs incurred in an application for relief (provided the director repays the costs in full if he is unsuccessful). In addition, a company is permitted to purchase insurance for its directors (and those of an associated company), against any liability attaching to them in connection with any negligence, default, breach of duty or breach of trust by them in relation to the company of which they are a director.

Quick reference
In its guidance notes on Duties of Company Directors¹ published in June 2007, the DTI produced the following quick reference guide for use by company directors which provides a useful point of reference:

• Act in the Company’s best interests, taking everything you think relevant into account.
• Obey the Company’s constitution and decisions taken under it.
• Be honest and remember that the Company’s property belongs to it and not to you or to its shareholders.
• Be diligent, careful and well informed about the Company’s affairs. If you have any special skills or experience, use them.
• Make sure the Company keeps records of your decisions.
• Remember that you remain responsible for the work you give to others.
• Avoid situations where your interests conflict with those of the Company. When in doubt disclose potential conflicts quickly.
• Seek external advice where necessary, particularly if the Company is in financial difficulty.

¹ Companies Act 2006, Duties of Company Directors, Ministerial Statements, DTI June 2007 (Crown Copyright)