UK: Directors´ Duties & Liabilities Under The Companies Act 2006

Last Updated: 20 July 2008
Article by Paul Salmon

The Companies Act 2006 Has Codified Directors' General Duties - With Some Changes - And Introduced New Provisions On Directors' Liability.

Introduction

Until the Companies Act 2006 came into force, directors' general duties to their company had developed by case law. Now, with a view to providing greater clarity and accessibility, they are for the first time set out in statute, albeit with some changes. In particular, the duty to promote the success of the company is wider than the old duty to act in the best interests of the Company and, from October 2008, it will be possible for the board, as opposed to the shareholders, to authorise a director's conflict of interest, subject to changing the articles of association (public companies) or passing a resolution (existing private companies) to permit such authorisation.

So far as directors' liability is concerned, a new statutory procedure for claims against directors has been introduced. This procedure is intended to make it easier for shareholders to bring claims against directors on behalf of a company and there is a new regime covering directors' liability for statements in reports.

SEVEN GENERAL DUTIES

1. To act in accordance with the company's constitution and only to exercise his/her powers for the purposes for which they were conferred.

2. To promote the success of the company for the benefit of its members as a whole, having regard to:

  • the interests of the company's employees;

  • the need to foster business relationships with the company's suppliers and customers;

  • 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 members of the company;

  • the likely consequences of any decision in the long term;

3. To exercise independent judgement.

4. To exercise reasonable care, skill and diligence.

5. To avoid conflicts of interest – in particular the exploitation of any business opportunities.

6. Not to accept benefits from third parties.

7. To declare to the other directors any interest in a proposed transaction or arrangement with the company.

DIRECTORS DUTIES

The Box "Seven General Duties" above summarises the seven general duties contained in the Companies Act 2006 which are intended to replace the equivalent common law and equitable rules. Most of these provisions came into force in October 2007, however the provisions relating to conflicts of interest, namely items 5, 6 and 7 in the box, come into force on 1 October 2008.

It is not intended to be an exhaustive list of directors' duties. There are of course many specific statutory duties and other duties remain uncodified, such as the duty to consider the interests of creditors in times of a company's threatened insolvency.

Duty to avoid conflicts of interest

A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. This will apply to situations arising on or after 1 October 2008.

This duty applies to all conflicts other than any that may arise due to a transaction with the company, as that is covered by the duty to disclose such interests.

It is, in particular, intended to cover the exploitation of any property, information or opportunity, whether or not the company could take advantage of it.

A classic example of a breach of this duty is where a director sets up in competition with the company by taking advantage of an opportunity that was available to the company or uses company information, such as customer and supplier details. For this reason this duty applies even when a person ceases to be a director so that they cannot circumvent the duty by resigning. However it may be that a director quite legitimately wants to take up an opportunity that the company has refused or a director is, or is connected with, a supplier, customer, shareholder or even a competitor and the circumstances are such that the directors are willing to approve the connection, subject to imposing safeguards to protect the company's interests such as preventing the disclosure of confidential information by providing, for example, that the director in question cannot attend meetings at which the third party, the subject of the conflict, is discussed and cannot receive papers relating to the relationship with that party.

There is a "safe harbour" to the effect that where a company's articles contain provision dealing with conflicts of interest, the general duties will not be breached by anything done, or omitted, by the directors in accordance with any such provision. A company could, for example, provide that a director will not be in breach of his duty if he does not disclose to the company confidential information of a third party which he obtains as a result of an authorised conflict situation.

A company cannot exempt a director from any liability to the company for negligence, breach of duty or breach of trust, but this provision does not prevent a company from including in its articles of association any provisions which are currently lawful for dealing with conflicts of interest.

The duty is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict or if the matter has been authorised by the directors.

In allowing the directors to authorise a conflict of interest, the Companies Act 2006 represents a significant change to the requirement of shareholder approval under the existing law. To guard against abuse the director in question and any other interested director cannot vote or count in the quorum when making any decision to authorise a conflict. In addition, in making any decision to authorise a conflict, directors must act in accordance with their other general duties, such as the duty to promote the success of the company.

Directors of a public company can only authorise conflicts if it is permitted by their articles of association.

In the case of private companies formed before 1 October 2008, directors can only give authorisation if the members have passed a resolution permitting directors to authorise conflicts. For private companies formed after 1 October 2008 directors can authorise conflicts unless their articles of association contain express prohibition.

For listed companies the general view is that shareholders are unlikely to object provided they are satisfied that the company has a good corporate governance structure and record and appropriate procedures are in place for approving and dealing with conflicts. In the case of private companies, whether or not it is acceptable will depend on the individual circumstances.

Companies need to prepare for the change in October 2008 by, for example:

  • changing their articles of association with effect from that date;

  • informing directors of their duty to notify potential conflict situations, for example, as a result of other directorships or through close associates;

  • putting in place procedures and guidance to deal with conflicts.

Duty to declare interests

If a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with a company, he must declare the nature and extent of that interest to the other directors before entering into the transaction.

A director need not declare an interest if (a) it cannot reasonably be regarded as likely to give rise to a conflict of interest (b) the other directors are (or ought reasonably to be) aware of it or (c) it concerns the terms of his service contract for consideration by the board of directors.

Provided a director properly declares his interest, the transaction or arrangement can not be set aside by any legal principle requiring the consent of shareholders, subject to any contrary provision in the company's articles of association. This changes existing law under which shareholders' consent is required, although this is often given in specified circumstances in a company's articles of association.

If circumstances change so that the original declaration becomes inaccurate, a director must make a further declaration. Directors should reserve the right to review any authorisation and the conditions attached to it upon such further declaration.

Declarations may be given orally at a meeting of directors or by way of a specific or general written notice.

Another section of the Companies Act 2006 contains similar provisions requiring a director to declare an interest in an existing transaction or arrangement, as opposed to a proposed transaction or arrangement.

If a company's articles of association contain provisions regarding interests in contracts with the company, it would be sensible to review them in the light of this new law prior to 1 October 2008.

Duty not to accept benefits from third Parties

A director must not accept any benefit from a third party which is conferred because of his being a director, or his doing or not doing anything as a director. This duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict and does not apply to benefits given by the company or other members of its group.

Unlike the other provisions regarding conflicts of interest, there is no ability for the acceptance of benefits to be approved by the directors so shareholder approval must be obtained for the acceptance of any such benefit, unless it falls within the exception mentioned above.

There is concern as to the extent to which corporate entertainment will be caught by this provision. If they do not already have them, companies should consider putting in place guidelines on what can be accepted and what benefits require prior approval.

Duty to promote the success of the Company

A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, having regard, amongst other matters, to the six factors set out in the box "Seven General Duties".

These factors reflect the Government's principle of "enlightened shareholder value" - combining the profit motive with wider expectations of responsible business behaviour by taking into account factors such as the interests of the company's employees and the impact of the company's operations on the community and the environment.

The duties are said to replace the corresponding common law and equitable rules and this duty is presumed to replace the duty to act in the best interests of the company, but the wording is different and of course the six factors to be taken into account are new.

The Government has published some guidance on the interpretation of this section. Success for a commercial company will normally mean long term increase in value, but it is for the members to define the objectives which they wish to achieve in the company's constitution.

There is concern over the weight to be given to each of the six factors. The Government's view is that "the decisions taken by a director and the weight given to the factors will continue to be a matter for his good faith judgement". However, it is not a box ticking exercise. Proper consideration must be given to the factors although they are subsidiary to the overriding duty to promote the success of the company for the benefit of its members.

There has been some debate about the extent to which the six factors should be documented in board minutes. The Government's guidance is that "the clause does not impose a requirement on directors to keep records, as some people have suggested, in any circumstances in which they would not have to do so now". The GC100, an influential group representing general counsel and company secretaries of the FTSE100 companies, has issued guidance which has been endorsed by the Institute of Chartered Secretaries and Administrators. They recommend that the six factors are referred to, if relevant, in the papers prepared for the board meeting but suggest that the board minutes only record the decisions and that it is not necessary to detail how those decisions were reached.

Duty to act in accordance with the company's constitution

A director of a company must act in accordance with the company's constitution and only exercise powers for the purposes for which they are conferred.

A company's constitution for this purpose includes its articles of association, resolutions and agreements affecting the constitution (which may include informal unanimous decisions of the shareholders) and decisions taken in accordance with the articles of association.

Duty to exercise independent judgement

A director of a company must exercise independent judgement.

There are however two exceptions included in the Companies Act 2006. The duty is not infringed by a director acting in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors or in a way authorised by the company's constitution.

The key point of this duty is that directors should not be swayed by the views of the other directors or of, say, the parent company, or allow themselves to be affected by outside interests, but should make decisions independently based on their own appreciation of the benefits and risks that may be involved. They can of course seek professional or other outside advice, but the ultimate decision must be theirs.

The exceptions do recognise the realities of group structures and joint ventures by allowing directors to act in accordance with provisions laid out in the constitution or any agreement entered into by the company. Of course they are still bound by the other duties, such as the duty to promote the success of the company (which cannot be overridden by the articles of association) and accordingly they cannot be absolved from responsibility for any decision by provision in the articles of association or any agreement.

If the directors wish to delegate any function they should ensure that the power is contained in the articles of association so that any delegation falls within the stated exception.

Duty to exercise reasonable care, skill and diligence

A director of a company must exercise reasonable care, skill and diligence.

This means the care, skill and diligence that would be exercised by a reasonably diligent person with:

  • the general knowledge, skill and diligence that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and

  • the general knowledge, skill and experience that the director has.

The first leg is therefore an objective test and the second is a subjective one. The objective test effectively imposes a minimum standard whilst the subjective test will take into account any specific skills of the director in question. For example, a higher standard will be expected of a director with an accounting qualification on a question relating to accounting matters than of a director without such qualifications.

Consequences of breach of the general Duties

The Companies Act 2006 preserves the existing civil consequences of breach of any of the general duties. For breach of fiduciary duties (that is, all the duties except the duty to exercise reasonable care, skill and diligence) the consequences of breach may include:

  • damages or compensation where the company has suffered loss;

  • restoration of the company's property;

  • an account of profits made by the director;

  • rescission of a contract where the director has failed to disclose an interest.

For breach of the duty to exercise reasonable care, skill and diligence, the main remedy would be damages.

Shareholders, can, as at present, ratify most breaches, but a new provision means that in the case of any breach of duty or of trust or acts of negligence or default by a director, the vote of any person who is connected with the director in question must be disregarded. This is a significant change to the principle of majority rule, although it does provide increased protection for minority shareholders.

The definition of "connected person" has been extended under the Companies Act 2006. A person is connected with a director if they are a member of the director's family. That is, the director's spouse, civil partner, any person with whom the director lives as a partner in an enduring family relationship, a child or stepchild of the director, a child or step-child of a director's partner (if living with the director and under the age of 18), or the director's parents. A company is connected with a director if the director (and persons connected with him) is interested in 20% or more of the equity share capital of the company, or can exercise more than 20% of the voting power at a general meeting of the company. There are similar provisions which serve to connect persons to a director in relation to trusts set up for the benefit of that director or his family, and in relation to partners of a director.

There are also criminal sanctions (fines) for breach of the duty to declare an interest in a proposed contract.

As the general duties are owed to the company, it is only the company which can take action against a director for breach. This can of course be as a result of a decision of the majority of the directors, or an action could be initiated by a liquidator or, under the new derivative claims procedure, by one or more shareholders. See below for details.

The New Derivative Claims Procedure

In October 2007 a new derivative claims procedure was introduced by the Companies Act 2006 enabling one or more shareholders to bring proceedings against a director on behalf of the company in respect of that director's negligence, default, breach of duty or breach of trust. The new procedure is intended to make it easier for shareholders to bring claims on behalf of the company. To address difficulties with the previous derivative claims procedure, a claim can be brought even if the director in question has not benefited personally from the breach and it is no longer necessary for shareholders to show that the director or directors in question control the majority of the company's shares.

There is concern that the procedure will be used by pressure groups (eg environmental groups) to challenge directors' decisions on the basis that they have not properly taken into account the factors they are required to as part of the new duty to promote the success of the company. In this regard, the Companies Act 2006 makes clear that a claim can be brought in respect of a cause of action arising before, during or after a person becomes a shareholder, which has given rise to fears that activists could take a small stake just for the purpose of bringing a claim.

In order to alleviate concerns over increased and speculative litigation, provisions are included which require a claimant to present a good case to the court before the action can be continued. If the court is satisfied that a person acting in accordance with the general duty to promote the success of the company would not seek to continue the claim or that the act or omission giving rise to the cause of action has been authorised or ratified by the company, then it must refuse permission to bring the claim. In coming to its decision the court must take into account:

  • whether the shareholder is acting in good faith;

  • whether the act or omission giving rise to the cause of action could be (and in the circumstances would be likely to be) authorised or ratified by the company;

  • whether the company has decided not to pursue the claim;

  • whether the act or omission in respect of which the claim is brought gives rise to a cause of action that the shareholder could pursue in his own right rather than on behalf of the company;

  • any evidence before the court as to the views of shareholders of the company who have no personal interest, direct or indirect, in the matter.

In addition, the court has the ability to make a costs order against an applicant as a deterrent, if appropriate.

Directors Liability For Statements In Reports

The Companies Act 2006 introduced a new liability regime for untrue or misleading statements in a company's reports.

A director will be liable to compensate the company for any loss it suffers as a result of any untrue or misleading statement in, or omission from, the directors' report (including the business review), the remuneration report and information in summary financial statements derived from them.

There is a safe harbour in that a director is only liable if the director knew or was reckless as to whether the statement was untrue or misleading or knew the omission to be a dishonest concealment of a material fact.

Companies may wish to consider the structure of their annual reports to ensure that best use is made of the safe harbour. The provision applies to directors' reports, remuneration reports and summary financial statements first sent to members on or after 20 January 2007.

In addition, companies admitted to trading on the London Stock Exchange's main market and other regulated markets (not AIM) may be liable to compensate third parties who have acquired securities and suffered loss as a result of any untrue or misleading statement in certain reports.

Further information on this aspect of the regime is contained in our earlier newsletter on the Companies Act 2006 a copy of which can be downloaded from here:

Salans' Company Law Update - Companies Act 2006

Directors' Indemnities, Insurance And Defence Funding

Although the general rule is that a company cannot exempt a director from any liability in connection with any negligence, default, breach of duty or breach of trust in relation to the company, it is possible for a company to indemnify a director against certain liabilities incurred by a director to third parties, advance funds for defence of claims in certain circumstances and, of course, obtain insurance against liability both to the company and to third parties. Wider powers of indemnity were introduced in 2005 and these have been largely repeated but the Companies Act 2006 has gone further and it is now possible to provide an indemnity to directors who are trustees of an occupational pension scheme. There have also been some modifications to the rules permitting a company to advance money to a director to fund his defence (subject to repayment if he looses) without having to get shareholder approval in advance. The new provisions now clearly state that advances can be made in respect of regulatory actions and investigations and the new wording permits a company also to advance funds to a director of its holding company. However the wording under the Companies Act 2006 is narrower in one respect - it only permits advances to be made in respect of actions arising from a director's alleged negligence, default, breach of duty or breach of trust in relation to the company or an associated company, unlike the previous rules which covered any civil or criminal proceedings.

It would be prudent for companies to check that any provision in their articles of association covering these areas is consistent with the new law and that appropriate insurance cover is in place.

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.