What are the duties of a Director?

A company acts either through its shareholders or its board of directors. The directors are agents of the company appointed by the shareholders to manage the company’s business, make strategic decisions and ensure the company complies with its statutory obligations.  The responsibilities and duties of directors are different from those of shareholders so it is important for directors to understand them when “wearing their director’s hat”. The general duties are owed to the company the person is a director of and are set out in the Companies Act 2006 (CA 2006).

General Directors’ Duties

1. Act within the powers

Directors must act in accordance with a company’s constitution (which includes its articles of association, shareholders resolutions and any shareholders’ agreement) and only exercise their powers for their proper purpose.

    2.Promote the success of the company

Directors must act in good faith in a way that is most likely to promote the success of the company for the benefit of the shareholders as a whole. This applies to all decisions taken as a director, not just those at formal board meetings. Success will generally mean a long term increase in value. When making decisions, directors must consider, amongst other things:

• The likely long-term consequences of a decision
• The interests of the company’s employees
• The need to promote business relationships with suppliers and customers
• The impact on the community and environment
• Maintaining a reputation for high standards of business conduct
• Acting fairly between shareholders of the company

Whilst there is some element of subjectivity in deciding whether a particular course of action is appropriate or not having regard to the above factors, it is important that directors must be able to show that they considered them in good faith when making their decisions. It is recommended that the factors are reflected in board minutes to record a clear decision-making process.

    3. Exercise independent judgement

Directors must exercise independent judgement, make their own decisions and not be swayed to vote a particular way by a third party. This does not prevent directors from taking specialist advice provided any resulting decision is taken independently.

   4. Exercise reasonable care, skill and diligence

This requires directors to act as a reasonably diligent person would, with both:

• the general knowledge, skill and experience reasonably expected of someone in their role; and
• the general knowledge, skill and experience the actual director has.

The yardstick thus has both an objective and subjective measure meaning that a director’s actual knowledge may not be enough if more could reasonably be expected of someone in that director’s role.

   5. Avoid conflicts of interests

Directors must avoid situations where they have or could have an interest, direct or indirect, that conflicts with the interests of the company (e.g. as regards the exploitation of any asset, information or opportunity). This duty is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest or if the situation has been authorised in the company’s articles of association, by specific shareholder resolution or the directors who do not have the same conflict. To benefit from the latter, it is necessary to declare a conflict of interest, no matter how small or obvious. Conflict situations can arise in many arrangements including where a director holds multiple directorships, is a competitor of or supplier to the company, is also an advisor to or shareholder of the company or any of the above apply to a close family member of the director.

  6. Not accept benefits from third parties

Directors must not receive a personal benefit from a third party if it could create a conflict of interest.

  7. Declare any interests in a proposed transaction or arrangement with the company

Directors must disclose the nature and extent of any interest, directly or indirectly, in a proposed or an existing transaction with the company. Failure to so disclose may result in any proposed transaction being unenforceable against the company. It is important to record any such declarations in a board minute or notice to the other directors to evidence the discharge of this duty.

Companies can place more stringent duties on their directors but cannot lessen the basic duties set out in law.

These duties apply while a director holds office. Some duties, such as avoiding conflicts of interest, continue after the individual is no longer a director.

Additional responsibilities of directors

The CA 2006 also imposes a number of other specific obligations on directors such as preparing and filing annual accounts and conditions on transactions between themselves/connected persons and his/her company.

If a company is insolvent or is on the edge of insolvency, directors are more exposed to potential personal liability and need to be aware of additional duties. From that point, their general duty to promote the success of the company is modified so as to act in the best interests of its creditors and, if the company continues to trade beyond that point, directors also need to be aware of the risk that a court may require them to contribute to the company’s assets on the grounds that the company has traded wrongfully. Professional advice at that stage is essential.

Consequences of Breach

As these duties are owed to the company, only it or, in an insolvency situation, a liquidator can take action against a director for breach of directors’ duties. Such actions can be lengthy and expensive to defend against.

In some cases and subject to certain hurdles, shareholders can bring a derivative claim on behalf of the company against directors for breach of duty.

Consequences of a breach can be serious for directors. Remedies can include a criminal fine but also a court granting an injunction or ordering that damages be paid, a transaction be set aside or that it stands with the director accounting to the company for profit made. This is the quid pro quo of a company being able to trade under limited liability.

In extreme circumstances, the director could be dismissed or disqualified.

Relief from liability

In certain circumstances, either the company can choose to ratify (consent to) a director’s breach of duty, by a vote of the shareholders or a court can grant relief if the director acted honestly and reasonably. Companies can purchase insurance against a breach of duty by its directors or indemnify the directors for costs incurred in successfully defending a breach of duty claim.

If you would like any advice relating to directors’ duties, the FSP corporate team would be delighted to assist.