The Companies Act 2006 imposes certain general duties on a director of a UK limited company. Our guide provides directors with an overview of these fundamental duties.
What is my role as a director?
A company acts through two bodies of people - its shareholders and its board of directors. The board of directors are in charge of the management of the company’s business; they make the strategic and operational decisions of the company and are responsible for ensuring that the company meets its statutory obligations. Your role as a director is to participate in board meetings to enable the board to reach these decisions and make sure that the company’s obligations are fulfilled.
The directors are effectively the agents of the company, appointed by the shareholders to manage the company’s day-to-day affairs. The basic rule is that the directors should act together as a board but typically the board may also delegate certain of its powers to individual directors or to a committee of the board.
You may also be a shareholder or an employee of the company (or both) and, if so, may have additional rights and duties going beyond those purely connected with your office as a director. It is crucial that you draw a distinction between these separate roles and “wear the right hat for the job”. This guide does not deal with the separate rights and duties which you may also have as a shareholder or an employee.
What are my general duties under the Companies Act 2006?
As a director you must:
1. Act within powers
You must act in accordance with the company’s constitution, and only exercise your powers for the purposes for which they were given.
The company’s constitution includes its articles of association and resolutions and agreements of a constitutional nature (for example, shareholder or joint venture agreements). It will be important for you to be familiar with the terms of the relevant documents forming the company’s constitution.
2. Promote the success of the company
You must act in the way you consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.
This is a key duty and is often the focus of discussions around directors’ duties. It is typically referred to as the “section 172 duty”.
“Success” in the context of this duty will generally mean a long-term increase in the value of the company but fundamentally it is up to each director to decide, in good faith, whether it is appropriate for the company to take a particular course of action.
When considering what is most likely to promote the success of the company, the legislation states that a director must have regard to:
- 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.
- The need to act fairly as between members of the company.
This list is not exhaustive but is designed to highlight areas of particular importance to responsible business behaviour. These factors should be properly considered – directors should not treat them as just a box-ticking exercise. Other relevant factors should also be properly considered.
The significance of this duty in the context of stakeholders’ interests is reflected in its link to various reporting obligations placed on many companies. Those companies (size dependent) required to prepare a strategic report must use it to provide shareholders with information to help assess how the directors have performed this section 172 duty. For large companies, things are taken a step further with an obligation to include a specific statement in the strategic report describing how the directors have had regard to the listed matters when performing this duty.
There is some debate around how directors should document their compliance with this duty, in particular their consideration of the listed factors. In practice, it is typical for board minutes to state that the directors have taken the factors into account in carrying out their duty, without detailed discussion of each individual factor. Where a factor is particularly key to a decision it may be prudent to minute the discussion around it. Likewise, where a decision is controversial or significant, or the company’s reporting obligations call for it, it may be helpful if board papers capture a more detailed consideration of the listed and other relevant factors. Consistency may be the best approach generally – a detailed record of how the factors were considered for one decision and a lack of detail for another may suggest that no, or inadequate, thought was given to the factors in the latter.
As referred to in more detail below, this duty may be modified when a company is insolvent or at risk of insolvency to include an obligation to have regard to the interests of creditors.
3. Exercise independent judgment
You must exercise independent judgment and make your own decisions.
This does not prevent you from acting in accordance with the company’s constitution or an agreement which the company has entered into. This does not prevent you from taking professional advice but if you do, you should use your own judgment as to whether to follow it.
4. Exercise reasonable care, skill and diligence
You must exercise the same 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 same functions as you in relation to the company
- the general knowledge, skill and experience that you actually possess.
The expected standard is measured against both objective and subjective yardsticks. A director’s actual understanding and abilities may not be enough if more could reasonably be expected of someone in his or her position.
5. Avoid conflicts of interest (a conflict situation)
You must avoid a situation in which you have, or could have, an interest that conflicts, or may conflict, with the interests of the company.
This duty applies, in particular, to the exploitation of any property, information or opportunity, regardless of whether the company could take advantage of it.
This duty is not infringed if:
- If the situation you are in cannot reasonably be regarded as likely to give rise to a conflict of interest. On a proper analysis of the circ*mstances, consider whether there will actually be a conflict or potential for conflict with the interests of the company.
- If the situation has been pre-authorised. Authorisation may be given in the articles of association, by specific shareholder resolution or, in certain circ*mstances, by the other directors who do not share the same conflict.
Examples of conflict situations
There is no convenient set of rules to determine which situations will or will not give rise (or potentially give rise) to a conflict of interest. The following are examples of arrangements which may potentially give rise to a conflict situation:
- Multiple directorships – you are also on the board of a major shareholder, the pension scheme trustee company, a competitor or a customer or supplier of the company.
- Personal interests – you are a major shareholder, a competitor, a customer or supplier of the company or you own property adjacent to the company’s property which could be affected by the company’s activities.
- Advisory positions – you have another hat as an advisor (for example, accountant or consultant) to the company or to a competitor of the company.
- Other profits – you make personal use of the company’s information or opportunities, want to take up an opportunity declined by the company or are in any situation where you can make a profit as a result of your directorship.
- Connected persons – if any of the above situations apply to a person connected with you (for example, a spouse, partner, parent, child or other close family member).
Steps to take
If you think you may be in a potential conflict situation you should:
Seek approval – potentially a conflict situation can be approved by the other members of the board. If the board does not have the power to authorise conflicts or is otherwise unable to approve the conflict situation it could refer the matter to the shareholders for approval.
Check the articles of association – the company’s articles might contain provisions relating to conflicts of interest, including:
- “Pre-authorised” common conflict situations – these might list a limited set of circ*mstances allowing you to put yourself in a situation which could otherwise give rise to a potential conflict of interest without obtaining specific approval. Typical examples include cross-directorships of group companies or positions relating to the company pension scheme.
- Conduct provisions – these might set out how you are expected to conduct yourself in relation to an authorised conflict and might also confirm that you will not be in breach of other duties to the company if you act accordingly. These typically deal with:
- protecting the confidential information of the company and the third party;
- inclusion or exclusion from board meetings and receipt of board papers;
- any benefit received as a result of the authorised conflict.
Regulate your behaviour – even if a potential conflict situation has been authorised or is permitted by the articles of association you should still act appropriately, remembering your obligation to promote the success of the company. You must take care to act in accordance with the articles of association and any terms and conditions attached to the authorisation.
6. Not accept benefits from third parties
You must not accept a benefit from a third party given because you are a director or because you do (or do not do) anything as a director.
This duty is not infringed if your acceptance cannot reasonably be regarded as likely to give rise to a conflict of interest.
7. Declare interests in proposed or existing transactions or arrangements with the company
If you are in any way, directly or indirectly, interested in a transaction or arrangement with the company, you must declare the nature and extent of that interest to the other directors.
In the case of a proposed transaction you must make this declaration before the transaction is entered into. In the case of an existing transaction you must do this as soon as reasonably practicable.
This duty is not infringed if:
- your interest in the transaction cannot reasonably be regarded as likely to give rise to a conflict of interest; or
- an interest has not been declared because you are unaware that you have the interest or the other directors are already (or ought reasonably to be) aware of it.
Are the general duties mutually exclusive?
No, more than one duty may apply in any situation. For example, you will need to apply your duty to act with reasonable care, skill and diligence when considering whether a course of action is likely to promote the success of the company. Similarly, you are required to act in accordance with your company’s constitution even if a contrary course of action could be seen to promote the success of the company.
Who do I owe my general duties to?
Your general duties are owed to the company which you are a director of and not any other group companies or individual shareholders. It is the company itself which can take enforcement action against a director if there has been a breach of duty. The decision to start proceedings against a director would be made by the board or, in an insolvency situation, a liquidator. In certain circ*mstances and subject to certain hurdles, an individual shareholder or group of shareholders can also bring a claim against a director for breach of duty on behalf of the company (this is known as a derivative action).
What penalties are there if I breach my general duties?
A breach of a general duty typically gives the company a number of potential remedies including an injunction, damages or compensation. Failure to disclose an interest in an existing transaction or arrangement with the company also carries the risk of a criminal fine.
Is there any form of relief for a breach of the general duties?
If a director finds that they have acted in a way which breaches the general duties owed to the company the following help may be available:
- in certain circ*mstances the breach may be ratified by resolution of the company’s shareholders;
- in certain circ*mstances the court may grant relief if the director acted honestly and reasonably;
- the company may have arranged insurance for the benefit of its directors;
- the company may offer to assist the director by indemnifying them against costs incurred in successfully defending a claim for breach of duties owed to the company.
Do I have any other responsibilities under the Companies Act 2006?
The Companies Act 2006 imposes an array of other obligations on you as a director. Some are personal in nature and are specifically addressed to the directors. Others arise from the responsibility of the directors to ensure that the company carries out its obligations (where both the company and the directors may face liability in the event of a failure). Potential penalties depend on the specific obligation breached but typically involve a fine or rarely, for the most serious offences only, imprisonment.
Probably the most significant are the duties of the directors relating to the preparation, content, circulation and filing of the company’s annual reports and accounts where many of the obligations fall directly on the directors.
Some other key obligations relate to the restrictions and conditions placed on transactions between a director and their company and loans made by the company to a director.
What about other duties and obligations?
Obligations are also imposed on you as a director from other sources beyond the main companies legislation. Some examples are:
- A director owes, under common law principles, a duty of confidentiality to their company and must use or disclose the company’s confidential information only for the benefit of the company.
- Directors are responsible for ensuring that the company complies with its obligations relating to the health, safety and welfare at work of its workers, under health and safety legislation.
- Similarly, obligations arise under environmental, competition and anti-corruption legislation.
What are my responsibilities on insolvency?
Where a company is in financial difficulties the directors should seek independent advice as soon as possible if they are to avoid potential personal liability under insolvency legislation. The potential risks for a director in this area are complex and include the risk of being disqualified from holding the position of director or being involved in the promotion or management of a company for a period of up to 15 years.
This guide does not look at this area in detail as the relevant factors for each director will always depend on the applicable circ*mstances. However, some of the key issues for a director of a company which is insolvent or approaching insolvency are:
- Modification of the general duty to promote the success of the company – when a company is insolvent, at risk of imminent insolvency or when an insolvent liquidation or administration is probable, the general duty is modified to include an obligation to have regard to the interests of creditors. It is crucial for directors to remain informed about the financial position of the company as the road to insolvency is not always linear and the extent to which directors are required to take into account the interests of creditors will depend on where the economic interests lie. Where the financial difficulties of the company are less severe, the duty may be discharged by giving creditors’ interests appropriate weight and balancing them against the interests of members (where they conflict) but if insolvency becomes inevitable, the interests of creditors will be of paramount importance.
- Wrongful trading – a director can be ordered by the court to contribute towards the general pool of assets which are available to a company’s creditors where they:
- knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation or administration; and
- continue to allow the company to trade after they knew or ought to have so concluded; and
- do not take every step they ought to from that time to minimise the potential loss to creditors.
A director does not need to have been dishonest to be liable for wrongful trading and they cannot avoid responsibility by resigning from the company when potential difficulties are spotted. This is a particularly thorny area for directors to navigate and proper advice should always be sought.
- Fraudulent trading –this involves a degree of dishonesty on the part of the director as the offence requires an intention to defraud the company’s creditors or some other fraudulent purpose. If found liable, a director may be required to contribute to the company’s assets available for distribution to creditors or may face criminal proceedings.
- Misfeasance – a director can be guilty of this if they have misapplied or retained company assets or wrongly exercised their authority. It does not necessarily involve moral blame. A director in breach may be ordered by the court to repay money or contribute to the company’s assets available for distribution to creditors.
Can the company indemnify or insure me against claims?
A company may (but is not obliged to) indemnify you in respect of certain proceedings brought against you by third parties. An indemnity can potentially cover both the cost of the claim itself and the costs involved in defending it but never the following:
- the unsuccessful defence of or fines imposed in criminal proceedings; or
- penalties imposed by regulatory bodies.
It is common for a company to take out directors’ and officers’ (D&O) insurance on behalf of its directors. Policy cover and terms vary but typically deal with directors’ liabilities arising from claims of negligence, breach of duty or other default. Standard policy exclusions include fraud, dishonesty and criminal behaviour but the directors should ensure they understand any limitations on cover and that insurance policies are kept under regular review.
For more information, please contact our Corporate team.
