Directors' duties

Are you a company director? Do you know what that entails? Perhaps you have been a director of a family run business for more years than you care to admit to, or you are a director of a much larger company where there are many other directors. Did you know that, now that the Companies Act 2006 is fully in force, your duties as a director have been set out in full and that they are taken very seriously indeed. Gone are the days when the duties of company directors were not spelt out in writing and depended on the common law (cases already decided by the courts), which often resulted in decisions made on their own peculiar facts and which caused a great deal of confusion as to whether a director was in breach of those (unwritten) duties.

The day-to-day powers of the company will normally be set out in the company’s articles of association. If the company is a large public company (plc) there will usually be a raft of executive and non-executive directors and any number of named directors (eg managing and finance directors etc) and probably a number of committees, but all company directors, including sole directors of small limited companies, have a duty not to exceed their authority (section 171 of the Act) and to act within their powers as both directors and employees.

As well as the new duties under the Act, some older statutory requirements and restrictions continue, including for example the duty to keep proper books, to file accounts and to comply with limitations on entering into restricted company transactions or borrowing from the company. Other laws and regulations concerning insolvency and health and safety also continue in full force and effect.

The Companies Act 2006 (sections 172–177) sets out the general duties owed to the company rather than to individual shareholders, as follows:

  • to promote the success of the company
  • to act in accordance with the constitution of the company and to exercise powers only for the purposes for which they are conferred
  • to exercise independent judgment
  • to exercise reasonable care, skill and diligence
  • to avoid conflicts of interest
  • not to accept benefits from third parties to declare interests in a proposed or existing transaction or arrangement with the company.

In the first of these, ‘success’ is not defined, and it is suggested that directors should consider a number of things – again, not an exhaustive list – including:

  • whether the interests of the company’s employees have been taken into account
  • any long term consequences of decisions made by directors
  • ensuring the continuation of the company’s relationships with suppliers and customers etc
  • whether there will be any impact of the company’s operation on the local community or on the environment
  • maintaining the company’s reputation for high standard of business conduct
  • ensuring the need to act fairly to all shareholders in the capital of the company.

So, for example, if there is a possibility that the company could be trading whilst insolvent, the directors must act not only to ensure the ‘success’ of the company but also not act against the best interests of the company’s creditors.

Each of these duties has been analysed and debated at length since they came into force in 2007/2008. Opinions vary as to the subjective and objective aspect of the duties and to whom they are owed but the case law remains limited, largely owing to the expense of trying to undo something that should never have occurred in the first place if the duties had not been breached.

However, it is very clear that, if you are a company director, you must:

  • ensure that you act in good faith in the company’s best interests, and think about what is relevant and should be taken into account but excluding what is not
  • follow the company’s constitution regarding decisions impacting on the company
  • always act honestly, bearing in mind that company property is owned by the company and not by the directors or the shareholders
  • be watchful, careful and informed about the business of the company, using any particular skills or experience you have as a director
  • ensure all directors’ decisions are noted or minuted and that all reports and returns to Companies House or the taxman are filed in good time
  • remember you are responsible for tasks delegated to others
  • ensure that your actions do not lead to situations that might conflict with the interests of the company. If a conflict could arise, tell other directors or shareholders as soon as possible
  • obtain independent legal or financial advice straight away, especially if the company may be in financial difficulties.

Breach of these statutory provisions may have serious consequences and, in any event, is likely to be expensive and could lead to the company having to be wound up. Numerous remedies are available to those whose interests suffer as a consequence of a director breaching his duties. Directors may be liable for the payment of fines, damages or compensation or they may have to return property inappropriately obtained and account for profits.

Company directors who breach their duties also risk being disqualified as a director for a set period of time (depending on the seriousness of the breach) or face a derivative action brought against the company by disgruntled shareholders if they have been negligent or breached their duties owed to shareholders.

Becoming a company director is a very serious business and one not to be undertaken lightly or unadvisedly. If you are invited to become a company director or are thinking about setting up your own business, it is very important that you understand your responsibilities and the potential consequences of their breach.

If you have any questions regarding directors’ duties please contact Nicola Prior on 020 8761 2302.

Disclaimer: Nothing in this article is intended as legal advice. If you have a particular legal requirement you should take specialist legal advice from a solicitor based on the facts regarding your individual situation.