Director Duties under the Companies Acts

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Directors Duties under The Companies Act 2006

The Companies Acts 2006, CA 2006, contains seven specific statutory Director Duties. These important legal duties are collectively called the “General Duties”. They are conveniently documented as Sections 171 to 177 of the CA 2006. The Companies Acts 2006 is a UK wide law, hence it applies across all parts of the UK, including Northern Ireland and Scotland. There are other business related laws which vary across, for example, England and Scotland. The General Duties are applicable to all Board decisions and all Director activities within all UK companies.

The General Duties are different to the Statement of Director Responsibilities, which refers to the responsibilities of the Directors in the specific context of all financial matters, including their Annual Accounts.

Please click here for more information about the Statement of Director Responsibilities. These are the Financial Responsibilities under the Companies Acts.

Please click here for more information about UK Corporate Governance for Directors.

General Duties of Directors CA 2006

The seven General Duties of Directors under the Companies Acts 2006 are:

  • To act within their powers
  • To promote the success of the company for the benefit of the Members (Shareholders)
  • To exercise independent judgment in all matters at all times
  • To exercise reasonable care, skill and diligence
  • To avoid conflicts of interest wherever possible
  • Not to accept benefits from third parties that might influence decisions or actions
  • To declare any interest in any proposed transactions or arrangements, where a potential conflict of interest could not be avoided

In addition to the seven General Director Duties above, every Director owes Fiduciary duties to the company. These are duties of trust, that require a Director to always act in “Good Faith”(or “Uberrimae Fidei”) and prohibits the making of “Secret Profits.”

The General duties of Directors, which are legally the Directors’ Responsibilities in all contexts, are explained in more detail in the following sections:

S171 Duty to act within powers

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.

The company’s constitution includes its articles of association and shareholder resolutions and shareholder agreements that might impact the constitution. For example a shareholder agreement might specify that proposals which would normally only require an ordinary resolution for approval, might instead need a special resolution.

The second half of the statement above means that even if something is nominally within your powers as a director; it would be outside your powers as a director, if it were not for the benefit of the company. As those powers were only given to you to use for the benefit of the company.

This is more likely to be a potential problem for companies set up before the CA 2006 became effective. As it abolished the previous requirement for the Incorporation documents, specifically the Memorandum of Association, of companies, to include the objectives of the company. In which case any activity outside the objectives of the company would automatically be deemed to be outside your powers as a director, as those powers were only granted to further the legal objectives of the company.

S172 Duty to promote the success of the company

A director of a company must act in the way he/she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:

(a) The likely consequences of any decision in the long term,

(b) The interests of the company’s employees,

(c) The need to foster the company’s business relationships with suppliers, customers and others,

(d) The impact of the company’s operations on the community and the environment,

(e) The desirability of the company maintaining a reputation for high standards of business conduct, and

(f) The need to act fairly as between members of the company.

The s172 duty makes it clear that the primary responsibility of the Directors is to act in the best interests of the shareholders. Except in the event of a potential Insolvency. That is where the company is, or is likely to become insolvent. The Directors must instead act in the interests of creditors of the company. Generally the Directors are then required to shift their focus from protecting the members to looking after the best interests of the creditors.

All of the sections within the CA 2006 are UK law, which must be  complied with. However, the s172 duty is becoming increasingly important. All Strategic Reports must contain enough information to allow the readers to understand how the company has complied with its s172 duty.

“Large” companies are further required to include a s172 statement in their strategic report, that explicitly states how the directors have fulfilled their s172 duty to promote the success of the company for the benefit of its members as a whole, etc.

The s172 factors listed here are all of the factors mentioned in the CA 2006 law, however they are not an exhaustive list. This means that there could be other relevant Stakeholders, which the Board should take into account whenever making a decision. A Stakeholder is any party or group with even a vague vested interest in the success of the company.

If a board decision were ever to be legally challenged, the directors should be able to produce evidence in court, that they did properly consider all of the relevant Stakeholders. This would be helped by full compliance with another section of the CA 2006; that is the legal requirement to keep all Board Minutes for 10 years. It would be prudent for the directors to also keep minutes of delegated committee meetings and any other key board discussions.

S173 Duty to exercise independent judgment

A director of a company must exercise independent judgment.

This duty is not infringed by 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.

This means that the directors must each arrive at their own decisions. They cannot simply rely upon the expertise of their fellow directors by looking to, for example, the Finance Director to tell them which way to vote on all financial matters. They should take any expert opinion provided into account, whether internal or external, but they must ultimately make their own decisions.

This same principle applies to any (even if expensive) professional advice that directors might receive. They should incorporate such professional advice into their personal decision making process but must ultimately still exercise independent judgment to come to their own decisions.

Directors must never allow others to control or exert undue influence over their decision making.

It is easily seen how these sections lead naturally into each other. For example it would be very difficult to exercise true independent judgment regarding a subject area about which you know little or nothing about. This would naturally lead you to find out more about the topic, which is exercising reasonable care, skill and diligence, which is s174 of the CA 2006. In addition it would be impossible to exercise independent judgment if a director were being told what to do by another person or were being bribed to vote yea or nay, which is s176 of the CA 2006.

The “Not infringed by” part of the statement means that independent judgement should be interpreted to mean exercising that independent judgement within any constraints set by the constitution of the company, including its articles of association and any relevant shareholder resolutions. This of course would also apply to exercising that independence of judgement within the constraints of the law and any other relevant rules or regulations.

S174 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 experience 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.

This is a two part test; the first part is essentially an objective measure, whilst the second part is a subjective measure. For the first part, imagine that you know that someone is the Finance Director of British Aerospace. That would create a certain expectation of their abilities, which would be very different from that gained by knowing that the same person is instead the Finance Director of a local garage.

For the second part, imagine that you have the CV of a Finance Director in front of you. If they have 30 years of experience as a Finance Director and a host of impressive qualifications in finance. That would again create a certain expectation of their abilities, which would be very different from that gained by knowing that the same person has only 2 years of experience as a Finance Director and no formal qualifications in finance.

It is worth noting that a lack of substantial experience and qualifications could render it impossible for someone who is the Finance Director of a major corporation to satisfy their s174 Duty to exercise reasonable care, skill and diligence, as they would probably fail the first part of the test; even if they are performing their duties to the best of their abilities. As it might be that the best of their abilities, due to a lack of experience and qualifications, simply cannot live up to the standards expected of the Finance Director of a major corporation.

S175 Duty to avoid conflicts of interest

A director of a company must avoid a situation in which he/she has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. This applies in particular to the exploitation of any property, information or opportunity. It is immaterial whether the company could exploit the property, information or opportunity.

This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.

This duty is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or if the matter has been pre-authorised by the directors. Authorisation may be given by the directors, excluding the “Conflicted Director”; provided nothing in the company’s constitution invalidates such authorisation.

Where a conflict of interest in unavoidable, such as a sibling being appointed to a board position within a competitor, customer or supplier. The conflict of interest must be declared to the board and steps taken to minimise the potential impact of that conflict.

Examples of conflicts of interest:

  • Multiple directorships; if you are also on the board of a major shareholder, a pension scheme trustee, or a competitor/customer/supplier
  • Personal interests; if you are a major shareholder (or advisor) in; the company, a competitor, a customer/supplier, or related to someone who is
  • External profits; if you make personal use of company information, or opportunities, that arise out of your directorship, or if you make any other form of undeclared profit from your directorship

The above would also apply if anyone connected to a director is acting in any of the above capacities.

A director need not declare an interest if it concerns the terms of his service contract that have been or are to be considered by a meeting of the directors.

S176 Duty not to accept benefits from third parties

A director of a company must not accept a benefit from a third party conferred by reason of being a director, or by agreeing to doing or not doing something as director. A “third party” means a person other than the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate. This duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.

This exemption would only apply to benefits of minor commercial value. However, this does mean that there would normally be no breach of the CA 2006, if a director were to have lunch bought for them by a supplier, during a period of time substantially devoted to business discussions. The lunch would have to be modest, and the business conducted would have to be genuine and not simply be a pretext for the occasion of lunch.

The Bribery Act 2010 covers this area much more effectively than the Companies Acts 2006. It is much tougher, wider in scope and has much tougher penalties for directors and companies.

S177 Duty to declare interest in proposed transaction or arrangement

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

The declaration may be, but does not need to be, made at a meeting of the directors, or by notice to the directors. If any historic  declaration of interest becomes, inaccurate or incomplete, a further declaration must be made. Any declaration required by this section must be made before the company enters into the transaction or arrangement.

A director does not not need to make a declaration of an interest of which the director is not aware, or where the director is not aware of the transaction or arrangement in question. For this purpose a director is treated as being aware of matters of which he ought reasonably to be aware.

The next parts are understandably similar to the provisions regarding the s175 Duty to avoid conflicts of interest. A director need not declare an interest if it cannot reasonably be regarded as likely to give rise to a conflict of interest. Nor if the other directors are already aware of it. For this purpose the other directors are treated as being aware of anything of which they ought reasonably to have already been aware of.

A director need not declare an interest if it concerns the terms of a service contract that has already been considered (or is about to be) by a meeting of the directors.

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