Directors

Directors’ duties under the Companies Act 2006

UK statutory directors have a number of legal responsibilities under the Companies Act 2006 which must be complied with. There are many other specific duties and obligations which must be observed in connection with this role like filing accounts and ensuring compliance with a wide variety of further laws and regulations such as those relating to insolvency. The below is a non-exhaustive guide to the general standards a statutory director must adhere to and the facts of each circumstance and context in which a statutory director acts are also salient points to consider when applying the following these duties:

Directors must act within their powers

A director of a company must act in accordance with the company’s constitution and only exercise his/her powers for the purposes for which they have been conferred.

Duty to promote the success of the company

A director must act (in good faith) in a way which would most likely to promote the success of the company for the benefit of its members as a whole. In so doing, the 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 the members of the company.

The duty is subject to any enactment or rule of law requiring directors in certain circumstances to consider or act in the interests of the creditors of the company.

Accordingly, the duty is displaced when the company is insolvent, and may be modified by an obligation to have regard to the interests of creditors as the company nears insolvency.

Directors must exercise independent judgment

Directors must exercise their powers independently, without subordinating their powers to the will of others.

For example, a director could not agree with a third person (such as his or her appointing shareholder) to vote at board meetings in any particular way, even if voting in that way would not otherwise have breached his or her duties to the company.

This duty will not prevent directors relying on advice, as long as the directors exercise their own judgment in deciding whether or not to follow the advice.

Directors must exercise reasonable care, skill and diligence

A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both:

• 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).
• The general knowledge, skill and experience that the director actually has (the subjective test).

So, at a minimum, a director must display the knowledge, skill and experience set out in the objective test, but where a director has specialist knowledge, the higher subjective standard must be met.

Directors must avoid conflicts of interest.

A director must avoid situations in which they have or can have a direct or indirect interest that conflicts with, or may conflict with, the company’s interests. That applies, in particular, to the exploitation of property, information or opportunity, and whether or not the company could take advantage of the property, information or opportunity.

The duty will not be infringed:

• If the situation cannot reasonably be regarded as likely to give rise to a conflict of interest.
• If authorisation has been given by directors who are genuinely independent (in the sense that they have no direct or indirect interest in the transaction); and
• authorisation may be given unless the company’s constitution invalidates such authorisation.

Directors must not accept benefits from third parties

This is the fiduciary rule prohibiting the exploitation of the position of director for personal benefit.

Directors must not accept any benefit (including a bribe) from a third party which is conferred because of his or her being a director or doing or not doing anything as a director.

Directors must declare any interests in a proposed transaction or arrangement

Directors 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 need not be a party to the transaction for the duty to apply.

The declaration must be made before the company enters into the transaction or arrangement.

No declaration will be required:

• Where the director is not aware of his or her interest or where the director is not aware of the transaction or arrangement, but directors will be treated as being aware of matters of which they ought reasonably to be aware.
• If the interest cannot reasonably be regarded as likely to give rise to a conflict of interest, if the other directors are already aware of it, or if it concerns the terms of the director’s service contract which have been (or are to be) considered at a board meeting or board committee.
• Where the company has only one director.

What is a Non-Executive Director?

There is no statutory definition of a Non-Executive Director (NED), but they are usually required to devote part of their time and affairs to a company as an independent adviser, e.g. by attending regular board meetings.

Companies recruit NEDs for a number of reasons, including:

• the addition of particular expertise to the board;
• to achieve growth in the company; or
• to seek an exit.

NEDs are usually senior, experienced individuals who offer a wider perspective on matters under discussion. As a director, they are subject to the statutory duties under the Companies Act 2006. NEDs appointed to listed companies are also subject to the UK Corporate Governance Code.

Recruiting a Non-Executive Director

Finding the right person to become a NED of a company can be complex and time-consuming for the existing board. Not only does the NED need to have appropriate experience, but they also need to accept the culture of the company and be able to support its goals and objectives.

Further complications can arise when agreeing on the role and obligations of the NED and negotiating their remuneration package, especially with regards to giving shares in the company.

You can see more information on recruiting a non-executive director here.

Non-Executive Director Employee Rights

It is also important to consider a NED’s status. By definition, a NED should not be an employee nor have an executive capacity. However, a NED will have specific duties and, occasionally, these can increase to such an extent that the NED can claim that they are entitled to the protection of worker or employment rights. This can include unfair dismissal rights, the right to paid holidays and protection against discrimination. Therefore, the scope of the appointment should be clearly defined. It is also useful to make clear in the appointment documentation that, whilst being a director of a company, the NED is not an employee.

Types of Shares for Non-Executive Directors

It is common (but not required) for a private limited company to issue shares to a NED on appointment or grant them the right to acquire shares at a future date pursuant to an option agreement. The type of shares or share options issued will be subject to certain tax considerations relating to both the company and the NED.

The type of share that is issued will also vary depending on the NED’s role and objectives, which may lead to different classes of share being issued by the company, for example:

• Growth Shares – these are shares of a specific class designed to allow the holder to benefit only from the growth of the company over and above the value of the company after the date of issue of the shares. For example, if the company is currently valued at £2m, the shares would only entitle the holders of them to participate in any value over and above £2m. This allows the existing shareholders of the company to lock in this value for themselves.

• Hurdle Shares – these are similar to growth shares, but only allow the holders to benefit from the growth of the company over and above a specific amount in addition to the current value of the company. For example, if the company has a current value of £2m, a class of shares which only allows the holders to participate in growth over and above £3m would be classed as hurdle shares. These allow the shareholder to retain the existing value but also to motivate the NED to grow the company above a target level.

There are benefits to the NED in each of growth and hurdle shares as the amount payable for them by the NED will be nominal as at the date of issue. This is because they will have no or little value as they are excluded from participating in the current value of the company.

• Ordinary Shares – the shares issued may be the same class of shares as the existing shareholders which means that the NED will simply share in any growth they would receive on a future exit over and above what they paid for the shares. This is a far simpler structure which allows the NED to share in the current value of the company, but would normally involve the NED paying market value for such shares at the time of issue.

The timing of the issue of the shares will also be the subject of discussion, i.e. are some of the shares issued on appointment and more at a later date or are all of the shares to be subject to an option which is only exercisable upon the satisfaction of certain agreed conditions. Again, this will be subject to tax considerations and the role and objectives of the NED.

If you are considering appointing a NED or are a NED seeking a new appointment with a company, we have years of experience in assisting clients with the relevant processes and ensuring that the terms agreed are suitable to all parties.

As well as giving you advice, there are also a number of legal documents that we can assist in preparing or reviewing, including:

• Letter of Appointment – this sets out all the terms relating to the appointment of the NED, including duties, role and remuneration;
• Shareholders Agreement and/or Articles of Association – if shares are to be issued, these documents will be needed to ensure that the correct rights attach to the shares; and
• Option Agreement – if shares are to be issued pursuant to an option, a legal binding option agreement will be needed.