When appointed to the board of a company, a director has seven general duties codified under the Companies Act 2006 (Act) which are legal obligations owed to the company (Duties).
These Duties are in addition to any obligations owed under the terms of a director's service agreement.
The Duties have developed over time through case law, and a breach of these codified Duties can leave directors exposed to personal liability, both under the Act and other laws and regulations.
As the Duties are owed to the company, only the company can enforce them; however, there are circumstances where members can bring a derivative claim on the company's behalf.
The Duties prescribed by the Act are:
- The duty to act within powers.
- The duty to promote the success of the company.
- The duty to exercise independent judgment.
- The duty to exercise reasonable care, skill and diligence.
- The duty to avoid conflicts of interest.
- The duty not to accept benefits from third parties.
- The duty to declare interest in a proposed transaction or arrangement with the company.
Directors have a legal and ethical obligation to act in the best interests of the company and for the benefit of its members.
They have a responsibility to ensure the company has long-term success and sustainability whilst also adhering to high standards of conduct. They make the strategic and operational decisions of the company and are responsible for participating in board meetings and ensuring that the company meets its statutory obligations.
Our experienced Corporate Lawyers explore the key legal duties of company directors under the Companies Act 2006, highlighting the responsibilities and risks every director should understand.
The duty to act within powers
Directors must act within the powers that have been conferred on them by the company's constitution and only exercise powers for the purposes for which they are conferred.
'Constitution' is widely defined and includes articles of association, resolutions of its members and can even include shareholders agreements.
In Re Compound Photonics Group Ltd[2022], Snowden LJ confirmed any shareholder agreements must be signed by all shareholders to be deemed as forming part of a company's constitution.
An example of where a director could be acting outside of their powers would be deciding to issue and allot further shares in the company without regard to any rights of pre-emption contained in the company's articles of association.
Articles of association are complex legal documents, so it is not always straightforward as to what powers directors have.
Legal advice should always be sought if a director does not intimately understand the company's articles of association.
It is therefore crucial that as a director you are aware of your powers and the restrictions under the company’s articles of association.
Going beyond these powers can result in decisions being reversed and having to compensate the company for financial losses.
The duty to promote the success of the company
Directors must act in a way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.
It is important to ensure this duty is specifically considered in any board meetings to reflect that the directors have duly considered the members' interests as a whole.
In complying with this duty, directors must take into account the interests of all of the company's stakeholders, including its shareholders, employees, creditors, and customers.
Directors should act with the interest of the company and its shareholders in mind and consider the long-term consequences of their decisions. This includes maintaining positive business relationships, keeping the company’s reputation to a high standard and acting fairly to all shareholders.
The duty to exercise independent judgment
Directors must exercise their own independent judgment when making decisions on behalf of the company without subordinating their powers to others.
For example, if a director is presented with a proposal that would benefit a particular shareholder but would not be in the best interests of the company as a whole, the director must not simply approve the proposal on the instruction of the relevant shareholder.
This will be notwithstanding the terms of any shareholders agreement.
This duty does not, however, prevent directors from relying on professional advice insofar as the directors exercise their own judgment in deciding whether or not to follow the advice.
This prevents directors from voting a certain way due to a powerful shareholder, for example, and ensures they are acting in the best interests of the company as a whole.
The duty to exercise reasonable care, skill and diligence
Directors must exercise reasonable care, skill and diligence when making decisions on behalf of the company.
This means that they must act in a way that a reasonable and prudent director would act in the same circumstances.
For example, a director who fails to take reasonable steps to investigate a potential investment before approving it could be found to have breached their duty to 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); and
- The general knowledge, skill and experience that the director actually has (the subjective test).
The subjective test means that a particularly highly qualified or experienced director will be obliged to exercise a higher level of skill and expertise than would otherwise be required.
A person should not take on a directorship unless they are sufficiently qualified or experienced to be able to competently perform the duties for which they are appointed.
This sets a precedent for directors to actively contribute towards the company’s success through responsible decision making.
The duty to avoid conflicts of interest
Without the company's consent, a director must not place themselves in a position where there is a conflict, or possible conflict, between the Duties and either their personal interests or other duties they owe to a third party.
A common example would be where an individual is a director of two different competitor companies or where one company is seeking to obtain goods or services from another, and the individual is a director of both.
This type of situation often arises for non-executive directors with roles in various companies.
It is important to always seek legal advice where a conflict may arise to ensure any conflict is appropriately declared and authorised where possible.
Directors cannot exploit company property for their own benefit or be involved with a competitor in order to make a personal profit. They must act with integrity and with the best interests of the company in mind.
The duty not to accept benefits from third parties
A director must not accept benefits from third parties in return for acting in a particular way.
For example, a director who accepts any benefit from a supplier in return for awarding the supplier a contract could be found to have breached this duty (in addition to other laws, e.g. the Bribery Act 2010.
This applies to any sort of benefit, not just those that are corrupt. For example, this could include gifts from potential business partners or use of company resources/information. It is suggested that companies establish a register of gifts for transparency.
The duty to declare interest in proposed transaction or arrangement with the company
A director is required to declare the nature and extent of any interest that they have in a proposed transaction or arrangement with the company.
This duty applies to any interest, whether direct or indirect, and whether financial or non-financial and the declaration must be made before the company enters into the transaction or arrangement.
Declaration by directors at a board meeting approving a transaction is a vital part of compliance with this duty by ensuring that any director interests are declared.
There is also an uncodified duty owed to creditors that arose in the West Mercia case.
The creditor duty becomes relevant in the context of approaching insolvency, where insolvency proceedings become probable (i.e. this duty can arise before actual insolvency proceedings begin or a formal insolvency process ensues, but there should be more than just a risk of insolvency for the creditor duty to come into play).
Failure to disclose an interest can lead to legal consequences for the director and decisions taken by them at board meetings relating to any such interest, being void.
Additional Operational Responsibilities
Directors also have responsibilities to oversee the company’s operations, ensure compliance and maintain proper records and accurate accounts including balance sheets and profit and loss accounts.
They have a duty of confidentiality to the company and are also responsible for ensuring the company complies with any legislation relating to health and safety, the environment and anti-corruption.
If a director breaches one of these general duties, the company can take action in various ways, including injunctions, damages or compensation. Directors who fail to disclose an interest in certain transactions or arrangements are also at risk of a criminal fine.
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If you are a director, or if you are considering becoming a director, it is important to seek professional advice to ensure that you are aware of your duties and how to comply with them. Contact Myerson's Corporate Team on:
01619414000
Charlotte Peers
Associate
Charlotte is an Associate in our Corporate team. Charlotte assists on a variety of corporate matters including share sales and acquisitions, company reorganisations and incorporations, as well as providing advice in relation to other general corporate matters.
About Charlotte Peers