All directors owe duties to the company of which they are a director. This applies equally to formally appointed directors as well as those who are not formally appointed, but will be deemed directors in law – i.e. shadow directors. The Companies Act 2006 codified the 7 main directors’ duties:
(1) Duty to act within the company constitution powers
This duty requires directors to be familiar with and act within the limits of the company’s Memorandum & Articles of Association (M&A) of a company and any other agreements which might form part of the company’s constitution.
Directors should in particular make themselves familiar with company procedure for decision making and any specific limits imposed on their powers under the company’s objects clause in the M&A should the constitution have such a clause.
The powers must be exercised for a proper purpose, meaning that directors must use the powers for the purpose for which they were given rather than to put any shareholder at a disadvantage or further the directors’ own position.
(2) Duty to promote the success of the company
Directors must act in the long-term interests of the shareholders but must also have regard to other factors including, but not limited to:
- the need to act fairly between the members (i.e. shareholders) of the company;
- the interests of the employees of the company;
- the impact of the company upon the community;
- the impact of the company upon the environment;
- the company’s relationship with third parties, such as suppliers or customers;
- the company’s reputation in terms of its conduct.
- the duty will apply to all of the decisions that the directors make in their day to day running of the company. In particular the directors must act in good faith.
Where a company faces financial difficulties, the company must then also take into account the interests of creditors, and a failure to do so at a certain point may lead to accusations or claims against the directors for wrongful trading (civil action) or, at worst, fraudulent trading (criminal action).
(3) Duty to exercise independent judgement
Directors must use independent judgment. They may of course take appropriate expert advice, but must use their own independent judgement in deciding whether or not to actually take that advice.
(4) Duty to exercise reasonable skill, care and diligence
A director must exercise reasonable skill, care and diligence in its everyday running of the company. The level of skill to be expected from a director is the higher of:
- the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company; and
- the knowledge and skill that the director actually has.
So in essence, the level of skill required a director may depend on their experience. For example, a director who is also a chartered accountant is going to be expected to have a higher level of knowledge and skill in finance matters than a director who has no accounting qualifications whatsoever, and so would be required to utilise that knowledge and skill in conducting the affairs of the company.
(5) Duty to avoid conflicts of interest
During the life of a company, there are likely to be circumstances where a director has, or possibly could have, a conflict of interests with the company. For example, a director may have shares in a competing business. Directors are under a duty to avoid such situations, although in many cases conflicts can be authorised by the directors of the company that do not have a conflicting interest.
In the event of a conflict, or potential conflict, the directors would do well to make sure that any decision which might favour the conflicted director is formally passed as a resolution, or to have the decision ratified by the members (i.e. shareholders) of the company.
Directors should remember that there will be occasions where they will be conflicted as a director, but where they would be entitled to make the decision as a shareholder.
(6) Duty not to accept benefits from third parties
This duty is primarily fiduciary in nature and essentially requires that a director should not use his position for personal benefit or secret profit. Where the duty is breached, the members of the company could seek for the director in breach to account to the company for those profits or benefits.
The directors cannot authorise a breach of this duty, however it can be ratified by the members.
(7) Duty to disclose interests in existing transactions
To the extent that a director has not disclosed an interest in a transaction under their obligation to avoid conflicts of interests as mentioned above, a director must declare their direct or indirect interest in an existing transaction or arrangement entered into by the company. Exceptions to this include where:
- the board is already aware of the director’s interest;
- the interest is in relation to the director’s own service contract with the company which is to be considered by the board;
- the director is not aware of the interest – although this will not include things of which the director ought to be aware;
- the director is the sole director of the company.
As well as the seven core duties, there are other duties are well which a director should be aware of:
- the duty to deliver accounts to HMRC (there will be penalties where accounts are not filed on time);
- duties imposed by regulators in specific business areas;
- duties imposed under the company’s M&A.
Breach of duty and ratification
Breach of these duties is a civil not a criminal matter. The director owes the duty to the company and it is therefore for the company to enforce these in the first instance. Remedies available to a company for breach of duty by directors may include:
- rescinding (nullifying) contracts entered into where a director has failed to disclose an interest.
It is possible for directors (or the company on their behalf) to purchase insurance to indemnify directors against liabilities arising from breach of these duties through negligence. However, there may be circumstances in which a company or its board are prepared to overlook breaches. In such circumstances, it may be possible for the other directors to authorise the breach, or otherwise the shareholders may decide to ratify the decision. Needless to say, whether the board or shareholders are prepared to authorise or ratify a breach of duty is likely to be dependent on the nature and extent of the breach.
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