Directors' Duties

The directors of a company have many duties which historically have been defined by case law.  The Companies Act 2006 has re-stated and extended some of these duties.  Under the new legislation directors are under a duty to:

• Act within their powers Promote the success of the Company
• Exercise independent judgement
• Exercise reasonable care, skill and diligence
• Avoid conflicts of interest
• Not accept benefits from third parties
• Declare any interest in proposed transactions

Of particular importance in this area is the duty to exercise reasonable care, skill and diligence.  This duty imposes an objective test based on 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 a more subjective test based on ‘the general knowledge, skill and experience that the director has’. A more experienced director will be under a higher duty than a first time director with little or no business experience.

These duties also extend a director’s duty to promote the success of the company 'from the principle of 'acting in good faith in the company's best interest' to a more onerous duty to 'act in good faith in a way he considers most likely to promote the company for the benefit of the members as a whole'.  In order to comply with this duty directors must take the following into consideration in any decision-making process:

(a) the likely consequences of any decision in the long term.

(b) the interests of the company's employees.

(c) the need to foster the company's business relationships with suppliers, customers and others.

(d) the impact of the company's operations on the community and the environment.

(e) the desirability of the company maintaining a reputation for high standards of business conduct.

(f ) the need to act fairly as between members of the company.

In order to ensure that directors do not fall foul of these requirements it is anticipated that lengthy board minutes narrating the reasoning behind any decision, taking these factors into account, will be required.

For more information, see our briefing note on Directors’ Duties.

Contact:  Alastair Dunn, Partner / Jeremy Glen, Partner

Companies Act 2006 Director Duties

The Companies Act 2006 (the Act) sets out directors’ duties in a statutory code. This, broadly, brings into statute the common law as it stood before the Act but it also introduces, amongst others, a new duty to promote the success of the company.

Summary of General Duties 

There are seven general duties, as follows:

1.  To act within the directors’ powers (Section 171);

2.  To promote the success of the company and to act in good faith (Section 172);

3.  To exercise independent judgement (Section 173);

4.  To exercise reasonable care, skill and diligence (Section 174);

5.  To avoid conflicts of interest (Section 175);

6.  Not to accept benefits from third parties (Section 176); and

7.  To declare interest in proposed transactions or arrangements (Section 177).

There are many additional specific duties of directors spread throughout the Act, for example, the duty to deliver accounts under Section 441.  However, this paper focuses on the above seven general duties.

1. Section 171: A director must act in accordance with the company’s constitution as defined in Section 257, that is the company’s Articles and any resolutions and agreements. The company, through its Articles, may go further than the statutory duties and may place more onerous requirements on its directors.

2. Section 172: A director must act in a way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members / shareholders. For “not for profit” companies such as charitable companies which are not intended to benefit members, the duty is to promote the success of the company by achieving the relevant purposes of the company.

To do this the directors must consider the following factors:

• The likely consequence of any decision long term;
• The interest of the company’s employees;
• The need to foster the company’s business relationship with suppliers, customers and others;
• The impact of the company’s operations on the community and environment;
• The desirability of the company maintaining a reputation of high standards of business and conduct; and
• The need to act fairly as between members of the company.

The above list is not exhaustive but, rather, identifies those matters that, at the least, directors are expected to take into account. The more significant a decision, the more important it will be to ensure that there is a paper trail showing that the board actively considered how a particular decision was arrived at and how it will affect the company’s employees, customers, suppliers, the environment ,its commercial reputation and any other relevant factors.

3. Section 173: Directors should not, in exercising their duties, be influenced by others. Also, they should not fetter their discretion. However, these duties should not prevent directors from:

• Acting in accordance with the company’s constitution;
• Relying upon advice in areas where this is required (provided that they exercise their own judgement in deciding whether to follow such advice);
• Delegating to appropriate individuals or committees where permitted; or
• Complying with contracts by which the company is bound.

4. Section 174: As previously set out in case law, directors have a duty to exercise reasonable care, skill and diligence. A director owes a duty to his company to exercise the same care, skill and diligence that that would be exercised by a reasonably diligent person with regard to:

• The general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as the director in relation to the company (an objective test); and
• The general knowledge, skill and experience that the director actually has (a subjective test).

It will not be open to a director to claim that his lack of skill and experience prevents him from performing to at least the standards expected of a reasonably diligent person. If, on the other hand, he has a high level of skill and experience, he will be expected to perform to that standard.

Duties on conflicts of interest (Sections 175 – 177) come into force on 1 October 2008:

It will not be open to a director to claim that his lack of skill and experience prevents him from performing to at least the standards expected of a reasonably diligent person. If, on the other hand, he has a high level of skill and experience, he will be expected to perform to that standard.

5. Section 175: A director “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 applies in particular to the exploitation of any property, information or opportunity, and it is immaterial whether the company can take advantage of the property, information or opportunity.

The duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company. The duty is not infringed if the situation cannot be reasonably regarded as likely to give rise to a conflict of interest or the matter giving rise to the conflict has been authorised by the directors (in accordance with the procedure set out in Section 175). For a private company, the directors are entitled to authorise such conflicts unless the company’s constitution prevents this. Currently, only members can give this authorisation.

It should be noted that this duty continues to apply to a person ceasing to be a director as regards to the exploitation of any property, information or opportunity of which he became aware at a time when he was a director.

6. Section 176: This section codifies the rule which prohibits directors from exploiting their position for personal benefit. There is no “de minimis” threshold or minimum monetary value placed on such a personal benefit, and indeed the benefit need not be financial. For example, accepting appointment to an honorary position could be a benefit.

7. Section 177: If a director 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 the interest to the other directors at a meeting of the directors. The declaration must be updated if it proves to be inaccurate or incomplete.

There is no need to declare an interest if:

• The director is unaware of the interest (but he will be treated as being aware of matters  of which he ought reasonably to be aware);
• If the interest cannot reasonably be regarded as likely to give rise to a conflict of interest;
• If the other directors are already aware of it; or
• If the interest concerns the terms of a service contract that have been or will be considered by a board or committee meeting.

Consequences of breach

The consequences for a director who breaches any of the above duties can be very serious. The Act provides that if a breach occurs the consequences are “the same as would apply if the corresponding common law or equitable principle applied” (Section 178). 

Duties 1, 2, 3, 5, 6 and 7 above are fiduciary duties and the common law consequences of a breach of a fiduciary duty include:

1. Damages or compensation where the company has suffered a loss;

2. Restoration of company property;

3. An account of profits made by the director(s); and

4. Rescission of a contract where a director failed to disclose an interest.

It should be noted that a breach of duty 4 (to exercise reasonable care, skill and diligence) is not a fiduciary duty and in that case the remedy is for damages only.

The Act also introduces a statutory procedure allowing members to sue directors on behalf of the company for breach of duty or trust, negligence or default. Such claims are known as derivative actions.

Conclusion

From the above analysis it is apparent that the new regime represents more than a simple codification exercise and raises a number of issues that companies and their directors will need to address.

It is vital for directors to take steps as soon as possible to ensure that they are fully conversant with the new law. Companies should have robust policies and procedures in place in relation to decision making to ensure that the directors’ proper exercise of their duties is capable of being evidenced. 

Contact: Scott Wyper, Partner swy@bto.co.uk / Jeremy Glen, Partner jsg@bto.co.uk / Alastair Dunn, Partner akd@bto.co.uk / Emma Barclay, Partner eba@bto.co.uk / T. 0141 221 8012