7 Duties company directors cannot afford to ignore
In last month’s e alert we looked at how to set up a limited company. Once this has been done, it is necessary to ensure that the team leading the company understand their obligations and comply with their legal duties. Here we look at the definition of a director, their duties and the consequences of breaching those duties.
Who is a company director?
Before looking at a company director’s duties, it is first necessary to ascertain who actually is a company director. There are various different types of company directors:
- Executive director: a person who carries out the business of the company, and is usually a full or part time employee of the company.
- Non-executive director: someone who is not employed by the company or holder of an executive office, but who often is an independent advisor or mentor to the company.
- De Jure director: a person validly appointed as a director.
- De Facto director: someone who hasn’t actually been formally appointed as a director, but is treated as such by the board and acts as if they are one. They must carry out functions that only a director, not a manager, would do.
- Shadow director: a person “in accordance with whose directions or instructions the directors of the company are accustomed to act” (s251(1) CA 2006). This does not mean that all the directors of the business must follow the shadow director’s advice, but that the majority do something under the instructions of that person. An example of a shadow director is where a majority shareholder in a company may not sit on the board, but may give directions to the board that are followed, although they take no formal part in the management of the company.
7 General duties company directors must take into consideration
The Companies Act 2006 codified some of the fiduciary duties owed by directors to their company. The act sets out the seven general duties that apply to all company directors:
- To act within their powers. These are the powers conferred upon them by the company’s constitution, including articles of association and any company resolutions and agreements. Power should be exercised for proper purposes only.
- To promote the success of the company. This replaced the fiduciary duty to act in good faith and in the best interest of the company. Directors must act in a way that will promote the success of the company as a whole, which will include the interests of the employees and shareholders but also the impact the company will have upon the community and the environment. There has been much debate over the definition of “success”, which in this case will normally mean the long term increase in value of the company.
- To exercise independent judgement. Directors must not subordinate their powers to the will of others.
- To exercise reasonable care, skill and diligence. Directors will be expected to carry out work to an objectively reasonable standard, but where a director has specialist expertise then the standard of care expected will be higher. In short, if you are not qualified or competent to carry out the role, do not take it on in the first place.
- To avoid conflicts of interest. Directors must avoid placing themselves in situations where they will or may have a conflict with the company’s interests; particularly when it comes to utilising property, information or opportunity that they have obtained as a result of their association with the company. This is an objective test, and is not dependent upon the director being aware that what they are doing is a breach of this duty. Of course if a company declines a business opportunity, then a director goes on to independently take up that opportunity then it is unlikely to be deemed a conflict. Similarly, if consent to act in a certain way is obtained from the board, it may also be possible to avoid allegations of a conflict of interests.
- Not to accept benefits from third parties. Directors must not accept any benefits, including bribes from a third party. This duty is unlikely to have been breached if its acceptance cannot reasonably be expected to give rise to a conflict of interest.
- To declare an interest in a proposed transaction or arrangement. 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. This should be done before the company enters into the deal.
In general these duties will cease once a director resigns their post. However, there are certain aspects that remain:
– The duty to avoid conflicts of interest will continue to apply as regards the exploitation of any property, information or opportunity of which they became aware of at the time that they were a director.
– The duty not to accept benefits from third parties will continue to apply as regards to things done or omitted by them before they ceased to be a director.
What are the consequences of breaching the duties?
These duties are owed to the company not the shareholders per se, so it is only the company that can enforce them. Where a director is alleged to have committed an actual or proposed act or omission involving negligence, default, breach of duty or trust of a director of the company the shareholders may choose to bring a derivative claim on behalf of the company. There is no requirement that a director has benefited personally from the breach. Of course shareholders must bear in mind that if they lose their action, then they will be liable to pay the costs involved. If successful any financial award made against the director will go to the company not to the shareholders.
Where negligence or breach of duty is alleged, if a court finds that the director has acted honestly and reasonably, and considering all the facts of the case they should be excused, then they will not be found liable for any breach.
If a director is found to have breached their duty then a court may grant an injunction, or order them to restore company property held by the director, pay damages to the company, set aside a transaction, restitution and account of profits.
A breach of duty can also result in the termination of employment or in some circumstances disqualification from acting as a director in the future.
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Julia Furley, Barrister