UK: Directors And The Law - Doing Your Duty

Last Updated: 17 March 2008
Article by Robert Paterson

Company directors are duty-bound to the companies which employ them – inescapably so. These duties arise automatically out of the very essence of corporate existence under the law. The company can, if it wishes, make them more onerous (under its articles of association), but there is nothing to be done about watering them down. Now, directors’ duties have been put on a statutory footing for the first time. This article takes a closer look at what this will mean in practice.

Traditionally directors' duties included: exercising skill and care; acting in good faith and in the best interest of the company; acting within the powers set out in the company’s memorandum and articles (as well as using those powers for proper purposes); avoiding conflicting interests and conflicting duties; and not making a secret profit.

In this context ‘the company’ refers to its collective shareholders and so the duties owed to a company by its directors could be enforced only by the company or its shareholders. Shareholders could also bring what was known as a ‘derivative action’ on the company's behalf.

These duties applied to all directors and some extended to shadow directors. Certain duties, such as the duty to avoid conflicts of interest, applied even to former directors who had already resigned, moved on, or retired.

But, traditionally, these duties were not contained in statute; they had evolved through case law. If a dispute arose a court had to analyse previous case law to decide which duty, if any, had been breached.

Companies Act 2006

In an effort to simplify company law for the benefit of shareholders these traditional definitions have now been revamped and for the first time set out in an Act of Parliament, the Companies Act 2006.

The new duties are not intended to tell directors what to do, but to set out a code of conduct governing how directors are expected to behave. The original intention was to start with a clean slate, but old case law will still be used to interpret the new Act.

Broadly speaking there are seven ‘new’ duties.

1. To act within powers

Directors do not have unrestricted freedom to do as they please – even if they believe it is in the best interests of the company. They have to act at all times within the powers set out in the articles of association and these powers must be used for their "proper purpose". For example, issuing new shares may well be allowed by the articles, but if this is done merely to dilute an unpopular member's shareholding it would fail the "proper purpose" test.

2. To promote the success of the company

This is aimed at increasing the long-term value of the company for its shareholders. Directors are supposed to act in good faith and in ways in which they believe will "promote the success of the company for the benefit of the members as a whole". ‘Success’ (according to the parliamentary record Hansard) means a long-term increase in share value. In other words, the core principle of this duty is to swell the company's coffers for shareholders.

This is also the part of the Act where Parliament added what is arguably the most controversial aspect of the revamp; in promoting the company's success directors must have regard to the following:

  • the likely consequence 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; and,
  • the need to act fairly as between members of the company.

That’s a lot to think about when taking a business decision! In fact the new legislation requires directors to have regard to these factors "amongst other matters". Parliament quite naturally wants companies to focus on responsible business behaviour and better relationships with customers, suppliers, employees and planet earth. But most of these factors – community, environment, high standards of conduct, acting fairly between members – are new requirements. Where will it all end? There appears to be no statutory limit to the things directors must bear in mind. Which should be given priority? What if they conflict?

The Government's guidance notes say that the key is to act in good faith at all times. Directors should consider the relevance of each factor. They can decide in good faith that some are irrelevant and disregard them in a particular instance. They should always use their skill and judgment before doing what they think is appropriate.

That said, remember that the primary duty is all about long-term gains for shareholders; the six "factors" are secondary to that. So, for example, closing a loss-making factory is unlikely to be in the interests of employees, but it might help shareholders and even benefit the environment, so the closure could still be justified. The key is to consider all six elements before arriving at a final decision.

3. To exercise independent judgment

It sounds obvious, but directors must exercise independent judgment and not submit to the will of others or act in ways which will restrict their future decisions.

There are, however, a few exceptions to this general principle:

  1. directors will be affected by terms of commercial contracts which the company has made with suppliers, customers, etc. (trading would be impossible otherwise);
  2. directors may delegate their powers to more junior employees, providing the delegation is reasonable;
  3. the company's articles may fetter directors' independence; and,
  4. directors may take professional advice from consultants, accountants and lawyers, etc. – though they must still exercise their own judgment as to whether to take that advice.

4. To exercise reasonable care, skill and diligence

This is not a new duty but it is now formally divided into two ‘limbs’.

  • An objective limb – all directors are expected to have a certain level of competence in terms of knowledge, skill and experience;
  • A subjective limb – the actual knowledge, skill and experience of the individual director is taken into account.

Thus a solicitor or accountant may be held to a higher standard than a director whose career began as an apprentice tradesman. However, the objective minimum standard applies whether or not the director has prior experience or relevant qualifications.

5. To avoid conflicts of interest

Directors should avoid situations in which they have an interest (direct or indirect) which may conflict with the interests of the company. The new Companies Act anticipates that conflicts may arise where directors:

  • make personal use of information, property or opportunities belonging to the company;
  • enter into a contract with the company; or,
  • make a profit whilst a director and without the company's knowledge.

This duty covers all conflicts, actual or potential. There is an exception – if the situation "cannot reasonably be regarded as likely to give rise to the conflict of interest" – but directors wishing to rely on it would be sensible to record their reasoning.

Shareholders can ‘authorise’ conflicts and, from 1 October 2008, so can the directors not involved in the potential conflict unless the articles say otherwise (for private companies) or unless the articles do not expressly permit it (for PLCs). However, authorisation by directors is only valid if the conflicted director does not vote and is not counted for quorum purposes.

This duty also applies to former directors in relation to knowledge gained whilst in office.

Where one individual is a director of several group companies, he/she may find that certain duties – such as that of confidentiality – clash with the need to act in the best interests of each company respectively. In these situations directors may need to absent themselves from board meetings; in extreme cases they may need to consider resigning from one or more boards. Directors in this position should seek independent legal advice.

6. To accept benefits from third parties

This simply means that directors cannot accept benefits for doing/not doing something in their capacity as director. It is intended to prevent directors exploiting their position for personal benefit. Benefits do not have to be money – for example, an honorary position would qualify. Benefits given by the company, a holding company and/or subsidiaries are not prohibited.

There is no problem if accepting the benefit could not reasonably be regarded as likely to cause a conflict of interest. But again, we recommend that directors record why they believe this to be the case before they accept the benefit.

7. To declare interests in proposed transactions or arrangements

This is simply an extension of the conflict of interest duty. It applies to proposed transactions where the director is indirectly or directly involved. The nature and extent of the director's interest must be disclosed to the other directors.

From 1 October 2008 specific shareholder approval will no longer be required in this context, but what will be required is that directors disclose their interest before the transaction is completed.

Disclosure can be made at a board meeting or by written notice to the other directors. If the nature of the transaction changes the disclosure may require updating.

There is no need to disclose anything which the other directors already know about or ought reasonably to know. The duty will be breached, however, if the director fails to declare something he ought reasonably to have known.

For practical reasons this duty does not apply in sole director situations, and no declaration is required if a director's interest cannot reasonably be regarded as likely to cause a conflict.

Service contracts are excluded, but note that separate disclosure duties arise under the substantial property transaction rules and under section 182 of the Companies Act 2006. These are outside the scope of this article, except perhaps to note that breach of section 182 is a criminal offence.

Finally, and on a general note, since these duties can easily overlap, great care is needed in striking a balance, one against another. For example, directors considering the duty to promote the company's best interests and in so doing choosing actively to disregard the environment might need to be able to show that they had exercised reasonable care in so doing if they are to avoid liability.

When do they come into force?

The first four duties listed above became law on 1 October 2007. The remaining three will follow on 1 October 2008, thus providing a useful window of opportunity within which companies can amend their articles accordingly.

How should directors respond?

As we’ve seen, the new duties require directors to consider a large number of factors whenever they make a decision, even though many of these duties can conflict and directors can be forgiven for feeling a touch perplexed at this prospect.

Government guidance notes emphasise the need for directors to use good faith in reaching all decisions. Board minutes have only ever been a summary of the actual discussions at a board meeting and the new legislation should not change this. In recognising that the creation of an exhaustive paper trail is neither required by the Act nor likely to be practical in most situations, where directors are torn between different factors (such as employees, the community, the environment, shareholder value) it would nonetheless be wise to record the reasons for deciding that certain factors outweigh others.

Often decisions are made by a single director (not the whole board) or even employees, and companies may wish to issue standardised instructions to cover such scenarios. But these would never be more than guidelines and so no substitute for exercising independent judgment in good faith.

What if I breach my duties as a director?

The new Companies Act does not codify the consequences of getting it wrong; in this respect the old law still applies. Breach of the duty to exercise reasonable skill, care and diligence would give rise only to a damages claim, but the other six could lead to one or more of a number of legal remedies:

  • damages and compensation;
  • a court order to return company property/money;
  • an order for an account of profit (ie, repayment of ill-gotten gains);
  • rescission (setting aside a contract);
  • a court declaration that a director's action breached his/her duties;
  • injunctions (in extreme cases).

Unlucky directors on the wrong end of a claim may have a complete or a partial defence under Section 1157 of the new Act. This enables the courts to relieve directors of liability if they have acted honestly and reasonably and ought fairly to be excused. Courts always have discretion in this.

Finally, directors can mitigate their risk by obtaining directors' and officers' insurance cover or indemnities from their company. There is also the possibility of amending the articles in certain ways.

Companies in financial difficulty

We began by explaining that directors' duties are owed to the company/shareholders. But if a company is insolvent, what then? Shares lose their value in a formal insolvency situation because administrators and liquidators must repay creditors before shareholders and then the interests of creditors over-ride those of shareholders so that directors' duties also shift away from them and towards creditors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.