As a director of a company in any sector there are many commercial matters to think about. Whilst focussing on developing your business it is easy for the legal framework governing your duties as a director not to be at the forefront of your mind. However, complying with directors’ duties is mandatory for directors of all UK companies and breaching these duties could result in civil and criminal liability as well as disqualification as a director. This article provides an overview of the general duties applicable to directors.
Directors are subject to general statutory duties, comprised of seven core duties, which are set out in Chapter 2 Part 10 of the Companies Act 2006 (“CA 2006”). Such duties apply to all directors, whether executive, non-executive, ‘de jure’ (those validly appointed at Companies House), ‘de facto’ (any person who acts as if he is a director and is treated as such by the board without having been validly appointed at Companies House), or a shadow director (a person in accordance with whose directions or instructions the directors are accustomed to act).
In general, a director owes his duties to the company of which he is a director and it is usually the company which would enforce the duties. These statutory duties are as follows:
1. Duty to act within powers (section 171 CA 2006)
A director must act in accordance with the company’s constitution and only exercise powers for the purposes for which they are conferred. For these purposes, the company’s constitution includes the company’s articles of association as well as certain resolutions and decisions by the members, or class of members, of the company.
2. Duty to promote the success of the company (section 172 CA 2006)
The duty to promote the success of the company requires a director to 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 members as a whole. What constitutes “success” may differ between companies but for commercial companies it will usually mean the long-term increase in the value of the company. In carrying out this duty, a director must have regard to the following, non-exhaustive, list of factors:
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.
3. Duty to exercise independent judgment (section 173 CA 2006)
This duty is intended to ensure that directors exercise their independent judgment, not mindlessly follow others or fetter their discretion.
The CA 2006 provides that the duty is not infringed by a director acting in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or in a way authorised by the company’s constitution.
4. Duty to exercise reasonable care, skill and diligence (section 174 CA 2006)
A director must exercise reasonable care, skill and diligence. This duty is comprised of both an objective and subjective element. A director must act with the 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 functions carried out by the director in relation to the company, and the general knowledge, skill and experience that the director has.
5. Duty to avoid conflicts of interest (section 175 CA 2006)
A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.
This duty is not infringed if the matter has been authorised by the directors. Alternatively, it is possible for the members of a company to authorise a director’s conflict of interest.
6. Duty not to accept benefits from third parties (section 176 CA 2006)
A director is under a duty not to accept benefits from third parties conferred by reason of his being a director, or his doing (or not doing) anything as a director.
This duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.
7. Duty to declare interests in proposed transactions or arrangements (section 177 CA 2006)
If a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors.
A director does not need to declare an interest if it cannot reasonably be regarded as likely to give rise to a conflict of interest, the director is not aware of their interest or the transaction or arrangement in question, or the other directors are already aware of it.
What are the consequences of breach of the general duties?
Directors’ statutory duties are owed to the company and breach of duty may result in a director being personally liable to the company. For instance, where a director has profited from a breach, he or she may have to account to the company for any profit made. Even if a director has not made any personal gain, he or she may still be liable to the company for any loss it has suffered as a result of such breach.
The remedies available for a breach of directors' duties vary in accordance with the severity of the breach, but possible remedies include damages, injunction, setting aside of the transaction, accounting to the company for any profit and/or disciplinary proceedings.
Can directors be protected from liability?
Breaches of statutory duties by directors can, in some circumstances, be ratified by the shareholders pursuant to section 239 of the CA 2006. An ordinary resolution passed by the shareholders of the company i.e. the holders of more than 50% of the voting share capital (excluding the relevant director and any persons connected to him (such as family members) who cannot vote on such a resolution) would have the effect of absolving the relevant director of any liability for such breach.
Companies are also permitted to purchase D&O (directors and officers) liability insurance for their directors to protect them against any liability attaching to them in connection with any negligence, default or breach of duty by them. In the event such insurance is taken out, the company can fund the legal costs incurred by a director in defending claims against him or her. However, it is likely that a director will have to repay the company if the proceedings are not ultimately concluded in the director’s favour.
Statutory duties on insolvency
In an insolvency situation, the interests of the company’s creditors (as a whole) will become the most significant element in determining how directors should discharge their duty to promote the success of the company under section 172 of the CA 2006. From a practical point of view, it is crucial to regularly call full board meetings if the company is in financial difficulties and to report fully the commercial decisions of the directors in the minutes of all board meetings. Directors of insolvent companies should also be aware of misfeasance (wrongfully performing a normally lawful act), fraudulent trading (carrying on the business of the company with the intent to defraud its creditors) and wrongful trading (carrying on the business of the company when the director knew (or ought to have concluded) that there was no reasonably prospect of the company avoiding insolvent liquidation).
A disqualification order may be made against a director if the company becomes insolvent and the relevant director’s conduct makes them unfit to be concerned in the management of a company. Case law refers to a variety of forms of misconduct, including breach of standards of commercial morality, danger to the public and gross irresponsibility. If such an order is made against a director they would be prevented from becoming a director of any company or directly or indirectly, in any way, being concerned or participating in the promotion, formation or management of a company without the permission of the court for a specified time (typically between two to fifteen years).
Legal advice should therefore be taken immediately if, as a director, you suspect that there is a reasonable prospect of the company becoming insolvent.
When do a director’s general duties come to an end?
In general, a director’s statutory duties to the company come to an end when the director ceases to hold office. However, this is subject to two exceptions. A person who ceases to be a director remains under:
(a) a duty to avoid conflicts of interest as regards the exploitation of any property, information or opportunity of which he became aware while a director; and
(b) a duty not to accept benefits from third parties as regards things done or omitted to be done by him before ceasing to be a director.
If you are already a director of a company or are asked to become a director in the future, it is extremely important to ensure you are familiar with your statutory duties and the consequences of breaching such duties.
Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.