The Companies Act 2015 sets out the seven principal duties of directors.
The Companies Act 2015 sets out the principal duties that directors owe to their company. Many of these duties developed over time through the operation of common law and equity, or are fiduciary duties which have now been codified to make the law clearer and more accessible.
Who are the duties owed to?
Section 140 of the Companies Act makes it clear that directors owe their duties to the company, not the members. This means that only the company itself can take action against a director who breaches them. However, it is possible for a member to bring a derivative claim against the director on behalf of the company.
The effect of the duties are cumulative; in other words, a director owes every duty to the company that could apply in any given situation. The Act provides guidance for this. Where a director is offered a bribe, for instance, they will be breaking the duty not to accept a benefit from a third party and they will also not be promoting the company for the benefit of the members.
When deciding whether or not a director has breached a duty, the court should consider their actions in the context of each individual duty in turn.
Who are the duties owed by?
Every person who is classed as a director under the Act owes the company a number of duties. Certain aspects of the duties regarding conflicts of interest and accepting benefits from third parties also apply to past directors. This is to prevent directors from exploiting a situation for their own benefit simply resigning. The courts are directed to apply duties to shadow directors where they are capable of applying. Directors must at all times continue to act in accordance with all other laws; no authorisation is given the duties for a director to breach any other law or regulation.
The duties and the articles
The articles may provide more regulations than the Act, but they may not reduce the level of duty expected unless it is in the following circumstances:
• If a director has acted in accordance with the articles they cannot be in breach of the duty to exercise independent judgement.
• Some conflicts of interest independent directors are permissible the articles.
• Directors will not be in breach of duty concerning conflicts of interest if they follow any
provisions in the articles for dealing with them as long as the provisions are lawful.
• The company may authorise anything that would otherwise be a breach of duty.
The duties of directors
Exercise reasonable skill, care and diligence Avoid conflicts of interest
Not to accept benefits from third parties
Declare an interest in a proposed transaction or arrangement
1. Duty to act within powers (s 142)
The directors owe a duty to act in accordance with the company’s constitution, and only to exercise powers for the purposes for which they were conferred. They have a fiduciary duty to the company to exercise their powers bona fide in what they honestly consider to be the interests of the company. This ‘honest belief’ is effective even if, in fact, the interests of the company were not served.
This duty is owed to the company and not generally to individual shareholders. The directors will not generally be liable to the members if, for instance, they purchase shares without disclosing information affecting the share price.
In exercising the powers given to them the articles the directors have a fiduciary duty not only to act bona fide but also only to use their powers for a proper purpose.
The powers are restricted to the purposes for which they were given. If the directors infringe this rule exercising their powers for a collateral purpose the transaction will be invalid unless the company in general meeting authorises it, or subsequently ratifies it.
Most of the directors’ powers are found in the articles, so this duty means that the directors must not act outside their power or the capacity of the company (in other words, ultra vires).
Ratification is not effective when it attempts to validate a transaction when It constitutes fraud on a minority.
It involves misappropriation of assets.
The transaction prejudices creditors’ interests at a time when the company is insolvent.
Under the Companies Act, any resolution which proposes to ratify the acts of a director which are negligent, in default or in breach of duty or trust regarding the company must exclude the director or any members connected with them from the vote.
This is only one of the powers given to directors that are subject to this fiduciary duty. Others include:
Power to borrow Power to give security
Power to refuse to register a transfer of shares Power to call general meetings
Power to circulate information to shareholders
2. Duty to promote the success of the company (s 143)
It is the duty of duty of directors to act in a way, which, in good faith, promotes the success of the company for the benefit of the members as a whole, was created.
The requirements of this duty are difficult to define and possibly problematic to apply, so the Act provides directors with a non-exhaustive list of issues to keep in mind.
When exercising this duty directors should consider:
• The consequences of decisions in the long term
• The interests of their employees
• The need to develop good relationships with customers and suppliers
• The impact of the company on the local community and the environment
• The desirability of maintaining high standards of business conduct and a good reputation
• The need to act fairly as between all members of the company
The list identifies areas of particular importance and modern-day expectations of responsible business behaviour. For example, the interests of the company’s employees and the impact of the company’s operations on the community and the environment.
The Act does not define what should be regarded as the success of a company. This is down to a director’s judgement in good faith. This is important, as it ensures that business decisions are for the directors rather than the courts.
3. Duty of director to exercise independent judgement (s 144)
A director of a company shall exercise independent judgment
4. Duty to exercise reasonable skill, care and diligence (s 145)
Directors have a duty of care to show reasonable skill, care and diligence.
Section 145 provides that a director owes a duty to their company to exercise the same standard of care, skill and diligence that would be exercised a reasonably diligent person with:
(a) The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out the director in relation to the company; and
(b) The general knowledge, skill and experience that the director has. There is, therefore, a
reasonableness test consisting of two parts:
(a) An objective test
Did the director act in a manner reasonably expected of a person performing the same role? A director, when carrying out their functions, must show such care as could reasonably be expected from a competent person in that role. If a ‘reasonable’ director could be expected to act in a certain way, it is no defence for a director to claim, for example, lack of expertise.
(b) A subjective test
Did the director act in accordance with the skill, knowledge and experience that they actually have?
In the case of Re City Equitable Fire and Insurance Co Ltd 1925
Facts: The Company lost £1,200,000 in failure of investments and the large scale fraud of the chairman, Gerard Lee Bevan. The liquidator sued the other directors for negligence. The auditors were sued too, but the Court of Appeal held they were honest and exonerated provisions in the company’s articles.
It was held that a director is expected to show the degree of skill which may reasonably be expected from a person of their knowledge and experience. The standard set is personal to the person in each case. An accountant who is a director of a mining company is not required to have the expertise of a mining engineer, but they should show the expertise of an accountant.
Rules established in the case.
1. A director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience.
2. A director is not bound to give continuous attention to the affairs of his company. He is not, however, bound to attend all such meetings, though he ought to attend whenever, in the circumstances, he is reasonably able to do so.
3. A director is, in the absence of grounds for suspicion, justified in trusting that official of the company will perform such duties honestly.
The company may recover damages from its directors for loss caused their negligence. However, something more than imprudence or want of care must be shown. It must be shown to be a case of gross negligence.
The company decision of its members in general meeting decides whether to sue the directors for their negligence. Even if it is a case in which they could be liable the court has discretion under the Act to relieve directors of liability if it appears to the court that:
o The directors acted honestly and reasonably.
o They ought, having regard to the circumstances of the case, fairly to be excused.
5. Duty to avoid conflicts of interest (s 146)
Directors have a duty to avoid circumstances where their personal interests conflict, or may possibly conflict, with the company’s interests. It may occur when a director makes personal use of information, property or opportunities belonging to the company, whether or not the company was able to take advantage of them at the time. Therefore directors must be careful not to breach this duty when they enter into a contract with their company or if they make a profit in the course of being a director. This duty does not apply to a conflict of interest in relation to a transaction or arrangement with the company, provided the director declared an interest.
As agents, directors have a duty to avoid a conflict of interest. In particular:
o The directors must retain their freedom of action and not fetter their discretion agreeing to vote as some other person may direct.
o The directors owe a fiduciary duty to avoid a conflict of duty and personal interest.
o The directors must not obtain any personal advantage from their position as directors without the consent of the company for whatever gain or profit they have obtained.
Regal (Hastings) Ltd v Gulliver 1942
The facts: The Company owned a cinema. It had the opportunity of acquiring two more cinemas through a subsidiary to be formed with an issued capital of £5,000. However the company could not proceed with this scheme since it only had £2,000 available for investment in the subsidiary. The directors and their friends therefore subscribed £3,000 for shares of the new company to make up the required £5,000. The chairman acquired his shares not for himself but as nominee of other persons. The company’s solicitor also subscribed for shares. The share capital of the two companies (which then owned three cinemas) was sold at a price which yielded a profit of £2.80 per share of the new company in which the directors had invested. The new controlling shareholder of the company caused it to sue the directors to recover the profit which they had made.
(a) The directors were accountable to the company for their profit since they had obtained it from an opportunity which came to them as directors.
(b) It was immaterial that the company had lost nothing since it had been unable to make the investment itself.
(c) The directors might have kept their profit if the company had agreed resolution passed in general meeting that they should do so. The directors might have used their votes to approve their action since it was not fraudulent (there was no misappropriation of the company’s property).
(d) The chairman was not accountable for the profit on his shares since he did not obtain it for himself.
The solicitor was not accountable for his profit since he was not a director and so was not subject to the rule of accountability as a director for personal profits obtained in that capacity.
Directors will not be liable for a breach of this duty if:
The members of the company authorised their actions.
The situation cannot reasonably be regarded as likely to give rise to a conflict of interest.
The actions have been authorised the other directors. This only applies if they are genuinely independent from the transaction and:
– If the company is private: the articles do not restrict such authorisation; or
– If it is public: the articles expressly permit it.
The company explicitly rejected the opportunity they took up
6. Duty not to accept benefits from third parties (s 147)
This duty prohibits the acceptance of benefits (including bribes) from third parties conferred reason of them being director, or doing (or omitting to do) something as a director. Where a director accepts a benefit that may also create or potentially create a conflict of interest, they will also be in breach of their s 146 duty. Unlike s 146, an act which would potentially be in breach of this duty cannot be authorised the directors, but members do have the right to authorise it. Directors will not be in breach of this duty if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.
7. Duty to declare interest in proposed transaction or arrangement (s 151)
Directors are required to disclose to the other directors the nature and extent of any interest, direct or indirect, that they have in relation to a proposed transaction or arrangement with the company. Even if the director is not a party to the transaction, the duty may apply if they are aware, or ought reasonably to be aware, of the interest. For example, the interest of another person in a contract with the company may require disclosure under this duty if that other person’s interest is a direct or indirect interest on the part of the director.
Directors are required to disclose their interest in any transaction before the company enters into the transaction. Disclosure can be made:
o By written notice
o By general notice
o Verbally at a board meeting
Disclosure to the members is not sufficient to discharge the duty. Directors must declare the nature and extent of their interest to the other directors as well. If the declaration becomes void or inaccurate, a further declaration should be made. No declaration of interest is required if the director’s interest in the transaction cannot reasonably be regarded as likely to give rise to a conflict of interest.
Consequences of breach of duty
Breach of duty comes under the civil law rather than criminal law and, as mentioned earlier, the company itself must take up the action. This usually means the other directors starting proceedings. Consequences for breach include:
Damages payable to the company where it has suffered loss
Restoration of company property
Repayment of any profits made the director
Rescission of contract (where the director did not disclose an interest)
Examples of remedies against directors
Remedies against directors for breach of duties include accounting to the company for a personal gain, indemnifying the company, and rescission of contracts made with the company.
The type of remedy varies with the breach of duty.
(a) The director may have to account for a personal gain.
(b) They may have to indemnify the company against loss caused their negligence, such as an unlawful transaction which they approved.
(c) If they contract with the company in a conflict of interest the contract may be rescinded the company. However, under common law rules the company cannot both affirm the contract and recover the director’s profit.
(d) The court may declare that a transaction is ultra vires or unlawful.
Directors’ liability for acts of other directors
A director is not liable for acts of fellow directors. However, if they become aware of serious breaches of duty other directors, they may have a duty to inform members of them or to take control of assets of the company without having proper delegated authority to do so.
In such cases the director is liable for their own negligence in what they allow to happen and not directly for the misconduct of the other directors.
Directors’ personal liability
As a general rule a director has no personal liability for the debts of the company. But there are certain exceptions.
Personal liability may arise lifting the veil of incorporation.
A limited company may its articles or special resolution provide that its directors shall have unlimited liability for its debts.
A director may be liable to the company’s creditors in certain circumstances.
In cases of fraudulent or wrongful trading liquidators can apply to the court for an order that those responsible (usually the directors) are liable to repay all or some specified part of the company’s debts.
Powers of Directors
The powers of the directors are defined the articles. The directors are usually authorized ‘to manage the company’s business’ and ‘to exercise all the powers of the company for any purpose connected with the company’s business’.
Therefore they may take any decision which is within the capacity of the company unless either the Act or the articles themselves require that the decision shall be taken the members in general meeting.
Exercise of powers
Although directors may have very wide powers they must nevertheless exercise these powers only for the purpose for which they were conferred if directors exercise a power, for an improper purpose or exceed their power, the court may intervene and set it aside, directors must use their powers for the proper purpose and for the best interests of the company and not to further their own interests.
In Piercy –v- Mills & Co. Ltd 1920
The directors made a fresh issue of shares to themselves and their supporters with the object of maintaining control and resisting the election of three additional directors which would have made them a minority on the board.
Held: The issue of shares in order to further their own interests was an improper purpose and therefore invalid.
Powers of the Chief Executive Officer (Managing Director)
The CEO or MD has apparent authority to make business contracts on behalf of the company. Their actual authority is whatever the board gives them.
In their dealings with outsiders the CEO or MD has apparent authority as agent of the company to make business contracts. No other director, even if they work full time, has that apparent authority as a director, though if they are employed as a manager they may have apparent authority at a slightly lower level. Although appointment as CEO or MD has special status, it may be terminated just like that of any other director (or employee); they then revert to the position of an ordinary director. Alternatively the company in general meeting may remove them from their office of director and they immediately cease to be CEO or MD since being a director is a necessary qualification for holding the post.