Who owes directors’ duties?
The obvious answer to this question is “directors”, by which we usually understand to be those people who have been validly appointed in accordance with the company’s constitution (i.e. its memorandum (if any) and articles of association) and whose appointments have been recorded at Companies House. Such directors are known as de jure directors, however, the remit of people who owe directors duties is wider than this. The general duties in the Companies Act 2006 (the “Companies Act”) also apply to:
- De facto directors: persons who act as if they are a director and are treated as such by the board despite not being validly appointed as such; and
- Shadow directors: persons in accordance with whose directions or instructions the directors of a company are accustomed to act.
What are the duties?
The Companies Act sets out the seven statutory duties of a director:
- Act within his/her powers (section 171, Companies Act): a director must only exercise his/her powers for their proper purpose (the power for which they were conferred) and must act in accordance with the company’s constitution.
- Promote the success of the company (section 172, Companies Act): a director must act in a way he/she considers (in good faith) is most likely to promote the success of the company for the benefit of its members as a whole. The Companies Act sets out several factors that a director must have regard to when making a decision including (without limitation) the likely consequences of any decision in the long term, the interests of the company’s employees and the need to foster the company’s business relationships with suppliers, customers and others. This duty is widely acknowledged as the most important and has generated more commentary and casework than its fellow duties.
- Exercise independent judgment (section 173, Companies Act): a director must not subordinate his/her power to the will of others.
- Exercise reasonable care, skill and diligence (section 174, Companies Act): a director must exercise the care, skill and diligence that would be exercised by a reasonably diligent person with both (1) 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 (the “objective” test); and (2) the general knowledge, skill and experience that the director actually has (the “subjective” test).
- Avoid conflicts of interest (section 175, Companies Act): a director must avoid situations in which he/she has (or could have) a direct, or indirect, interest that conflicts with (or may conflict with) the company’s interests. This does not apply in relation to conflicts of interest arising in relation to a proposed transaction or arrangement with the company (covered below).
- Not to accept benefits from third parties (section 176, Companies Act): a director must not accept any benefit (including any kind of financial instrument or bribe and any non-financial benefit) from a third party that is conferred because of his/her being a director or doing, or not doing, anything as a director.
- Duty to declare interests in proposed or existing transactions or arrangement with the company (sections 177 & 182, Companies Act): a director 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. The director does not need to be a party to the transaction for the duty to apply.
In addition to these duties, a director also has a duty to:
- Consider or act in the interests of creditors generally: particularly in times of threatened insolvency; and
- Maintain confidentiality of the company’s affairs: a director must not (without the authority of the company) disclose any confidential information relating to the company that has been gained by him in his/her position as a director.
Consent, approval and authorisation
In certain circumstances, consent, approval or authorisation may be given to circumstances that would otherwise constitute a breach of duty, for example:
- Conflicts of interest: Where the duty to avoid conflicts of interest (section 175) or the duty to declare an interest in a proposed transaction or arrangement (section 177) is complied with by authorisation by, or disclosure to, the directors (as appropriate), the transaction or arrangement is not liable to be set aside by any common law rule or equitable principle requiring the consent or approval of the shareholders.
- Shareholder approval: The shareholders of a company can relieve the directors of many of their duties by giving authority for anything to be done (or omitted) by the directors that would otherwise be a breach.
Liability of directors
The duties listed above are principally owed to the company. In certain circumstances shareholders may be able to bring a derivative action on the company’s behalf. Any breach of the duties by a director may result in that director being personally liable to the company for his/her acts or omissions. Breach of duty by a director may result in:
- a director being injuncted (to prevent further breach);
- a director accounting to the company for any profit made;
- an affected transaction (e.g. a transaction entered into in breach of requirements on conflict) being set aside;
- property held by a director being restored to the company; and/or
- the director paying damages.
Relief from liability
There are two circumstances in which a director may be relieved from his/her liability:
- Ratification: A company has the option to ratify the conduct of a director amounting to negligence, default, breach of duty or breach of trust in relation to the company. Such decision must be taken by the members without reliance on the votes in favour by the director or any connected person.
- Court relief: Under section 1157 of the Companies Act, the court has the power to relieve a director from liability if it can be shown that:
- the director acted honestly and reasonably; and
- considering the circumstances of the case, he/she ought to be excused.
Indemnities and insurance
A company is permitted to indemnify its directors against certain liabilities owed to third parties and the company can fund the legal costs incurred in defending claims against any of its directors or costs incurred in an application for relief under section 1157 (above), provided that the director repays the costs if he is unsuccessful. Such an indemnity is usually provided for within a company’s articles of association.
Companies should be wary that any provisions exempting directors from liability for negligence, default, breach of duty or breach of trust in relation to the company is void (section 232). However, this does not prevent the company from purchasing directors & officers liability insurance for its directors (and those of associated companies) against any liability as a result of a breach of duty in relation to the company of which they are a director.