The directors of a company have duties imposed on them by law. Directors’ duties before the Companies Act 2006 (the Act), were built on equitable principles of law. The effect of the duties is to regulate the way directors behave and hold them accountable for any failure or breach of the duties.
The duty is not owed to the shareholders of the company or the creditors, it is owed to the company itself. Whilst there are limited circumstances in which shareholders can bring a derivative action claim, for the most part, the company itself brings a claim against the individual director.
Companies Act 2006
Section 171 – Duty to act within powers:
A director of a company must follow the rules/constitution of that company and if a director is given power under the company’s rules he must only use that power for the purposes for which he was given them.
For example, a director enters into a contract for the company to pay £11,000 for goods where the rules of the company state, he can only enter into contracts not exceeding £10,000 for goods. This is a clear breach of Section 171.
A more complex breach is where a director may issue himself more shares in order to control the actions of the company. Whilst it may be within his powers as a director to issue shares, the purpose of those powers was not to issue shares to himself in order to control the company.
Section 172 – Duty to promote the success of the company:
This is the most important duty of a director, this section, in particular, codifies the fiduciary duty, which directors owe to the company.
The Act provides a list of factors which are non-exhaustive, for directors to consider when running the company, these are:
(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 supplier, customers and others,
(d) The impact of the company’s operation on the community and the environment,
(e) The desirability of the company maintaining a reputation for high standards of business conduct, and
(f) The need to act fairly as between members of the company
This duty does not require a director to act in such a way that the court would consider to be promoting the success of the company but rather a way in that particular director honestly believes to be most likely to promote the success of the company.
In practice, this particular section is hard to prove as although a director may make a poor decision, as long as he honestly believed it to be the right decision to promote the success of the company, he is not in breach. Without any evidence showing the director knew the decision to be a poor one and dishonesty from that director, it is very difficult to claim a breach.
Section 173 – Duty to exercise independent judgment:
This section seeks to ensure that a director must not fetter his own discretion or restrict the exercise of his own judgment.
This section is not a prohibition on a director taking advice, such as advice from an accountant or a solicitor.
The object of this duty is to prevent a director acting in a way governed by another, for example, a director voting in a particular way in a board meeting because the shareholder who appointed him requested him to.
Section 174 – Duty to exercise reasonable care, skill and diligence:
This Section secures that a director will act sufficiently competently and carefully. If then, a director acts negligently or is completely incompetent and is below the expected standard of a person carrying out the functions of a director, this Section will have been breached.
Section 174(2)(a) sets out that the care, skill and diligence which must be shown by the director in question is the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the directors in relation to the company. This is an objective test which allows the courts to set a minimum standard required by directors.
Section 174(2)(b), looks at the individual director in particular. Therefore if a director is an expert in a particular area then they will be held to a higher standard, e.g. an accountant will be held to a higher standard as a director.
Section 175 – Duty to avoid conflicts of interest:
This duty provides that a director must not put himself in a position where his personal interests and his duty as a director of a company conflict (except where a company permits it).
This applies in situations where a director might find out about a lucrative contract because of his being of a director of a company and the company do not, for whatever reason, do not take up the same contract. If the director then takes up the contract in his personal name, this would be a breach of Section 175, as if he was not a director, he would not have known about the contract and to take advantage of that information, without consent of the company, he would be in breach of his duty.
Section 176 – Duty not to accept benefits from third parties:
This duty particularly relates to corporate hospitality, a director must not accept benefits from third parties unless it cannot reasonably be expected to give rise to a conflict of interest. A company’s rules can permit the acceptance of corporate hospitality. However, a director should take care in such circumstances as benefits can fall within the ambit of the Bribery Act 2010.
Section 177 – Duty to declare an interest in a proposed transaction or arrangement with the company:
This section is similar to Section 182, the duty to declare an interest in an existing transaction or arrangement with the company.
The purposes of both 177 and 182 are to ensure that directors have all of the information possible about a transaction before deciding to enter in it. The board need to be aware of all matters which could affect that transaction. An example of such a conflict is where the company may be purchasing some equipment from a director in his personal capacity. The director will want the best price possible for his equipment and on the other hand, the company will want the lowest price. This clearly gives rise to a conflict of interest.
This could also affect the quorum in the meeting and the voting rights of directors depending on the rules of the company. In practice, the board minutes will reflect that a director has declared his interest and exceptions to the rule may apply where the transaction is not reasonably likely to give rise to such a conflict or the director is not aware of the conflict.
Breaches
Ratification:
In practice, if a breach is not detrimental to a company, the company may wish to ratify the breach in order to protect the director from future liability.
Court Relief:
A director can apply to the court for relief from a breach, on the basis that he acted honestly and reasonably, a director can do this before a claim has been brought.
Conclusion
Directors duties need to be considered at all times when running a company and can arise at any time, during any transaction. If you are a director who seeks to bring an action against another director for his breach of the statutory duties, a director who requires advice on a potential breach or a director who requires advice on the day-to-day running of the company, please do get in touch and we would be happy to advise you in relation to any query you may have.