Clarkslegal LLP - Solicitors in Reading and London

Directors’ Duties

Directors' Duties - Need to Know Guide

Directors’ duties are broad-ranging.  It can be difficult for directors to know all of the obligations to which the law subjects them.  In this note we have tried to identify the key areas with which any company director needs to be familiar.  This note is primarily aimed at directors of private companies, and directors of PLCs should be aware that additional obligations may also apply to them.

Who is a director?

Many different terms are used to describe directors.  An executive director carries out the executive functions of a company and will usually work full time.  A non-executive director typically works as an independent advisor on a part-time basis.  Executive and non-executive directors owe the same duties to the company.

Typically a director will have been appointed formally by a company and recorded as such at Companies House.  Such directors are described as “de jure directors”.

However many of the obligations applying to directors extend beyond de jure directors and also cover:

  • A de facto director who is someone who acts and is treated as a director but has not been validly appointed.
  • A shadow director is not held out as a director of the company but is someone on whose instructions the Board acts.
  • Alternate directors who are generally appointed under a company’s articles to act in place of an absent director.

Duties under the Companies Act 2006

The Companies Act 2006 has created a set of codified duties which are owed by all classes of directors to the company itself. 

  • To act within their powers

Directors must act in accordance with the company’s

articles and may only exercise their powers for proper purposes.  They may not therefore exercise their powers to improve or protect their own position or to gain advantage over the shareholders.

  • To promote the success of the company

A director must act at all times in the way that he considers, in good faith, will be most likely to promote the success of the company for the benefit of its members as a whole.  The factors which the director must take into account include:

  1. The likely long-term consequences of any decision
  2. The company’s relationships with suppliers, customers and others
  3. The impact of the company’s operations on the community and the environment
  4. The company’s reputation for high standards of business conduct
  5. The need to act fairly between the shareholders of the company

Alongside these there is an overriding duty to promote the success of the company.

  • To exercise independent judgment
  • To exercise reasonable care, skill and diligence

The standard by which a director is judged is what 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 therefore both an objective and a subjective test.

  • To avoid conflicts of interest

This is a very wide obligation and covers all conflicts, both actual and potential between the interests of the director and the company.  It also extends to those connected to the director.

  • Not to accept benefits from third parties
  • To declare interest in proposed transaction or arrangements with the company
  • Duty of confidentiality

Although not one of those specifically set out in the Companies Act, a director also owns a duty of confidentiality to the company.

The company can take action to enforce the duties and in some circumstances shareholders can themselves bring a claim (known as a “derivative claim”) on the company’s behalf.

Additional duties in insolvency

Directors become subject to extra duties when a company enters financial difficulty.  These include:

  • Wrongful trading – when a company reaches the point that there is no real prospect of avoiding insolvent liquidation its directors must take all appropriate steps to minimise the losses to its creditors. This will usually mean ceasing to trade.  If the directors fail to take such steps they may be ordered to contribute to the additional losses suffered by the company as a result, thereby losing the benefit of limited liability. 
  • Misfeasance – a company’s Liquidator can take action against its directors to contribute to the company’s losses if the directors’ conduct prior to the liquidation has fallen short of the required standard.
  • Disqualification – directors whose conduct is particularly culpable may be subject to disqualification proceedings. A term of disqualification can be made for between 2 to 15 years. 

Ratification and insurance

A company may vote to ratify a director’s conduct that might amount to negligence or breach of duty.  However, the director in question and any persons connected to the director (such as family members) cannot take part in the vote. 

Companies are prevented from exempting their directors in relation to a director’s breach of duty, breach of trust or negligence, although they can give indemnities in limited circumstances.  A company is also generally permitted to buy insurance for its directors against any liability for acts committed in their capacity as director.

Personal Guarantees

A lender to a start-up or an SME will generally require at least one of the company’s directors to guarantee the loan.  A guarantee is a secondary obligation, which can only be enforced to the same extent as against the company.  It must be in writing and signed by the guarantor.  The lender will typically insist that each guarantor receives independent legal advice.  A guarantee can be enforced via a statutory demand. 

A standard guarantee document will often also require that the director gives an indemnity to the bank.  This is a primary obligation, which requires the director to indemnify the lender against any loss that it suffers as a result of the company failing perform the guaranteed obligation (generally to repay the loan). 

Negotiations for a guarantee / indemnity should cover whether:

  • it is capped at a particular sum or for ‘all monies’ that the company owes from time to time
  • the director will also give security (typically over his / her house)
  • it continues if the guarantor ceases to be a director

Corporate governance and the Bribery Act

Corporate governance focusses on the legal mechanisms that hold directors liable to the company’s shareholders and third parties.  In contrast, corporate responsibility is generally taken to mean areas of good practice that may not have legal status.

The Bribery Act 2010 introduced several new anti-corruption offences. In broad terms these comprise:

  • Giving a bribe
  • Receiving a bribe
  • Bribing a foreign official
  • Failing to take adequate steps to prevent a bribe being given or received.

The Act has worldwide application and carries substantial sentences upon conviction.  Companies should take appropriate steps to guard against a potential breach, which could include training, a review of contracts with third parties and establishing a whistle blowing policy. 

Terminating directorships

A directorship comes to an end by:

  • Resignation – unless the company’s Articles provide otherwise, a director can resign immediately on giving proper notice to the company
  • According to the company’s Articles – the model Articles for public and private companies give a range of circumstances in which a directorship will automatically come to an end
  • By operation of law – in practice this will generally mean the bankruptcy of the director. There is no longer a statutory maximum age for directors
  • By ordinary resolution of the company – this requires a vote of more than 50% of the shareholders and the compliance with the formalities for an ordinary resolution
  • A provision in the director’s service contract requiring resignation
  • By Court Order
  • The director’s death

Service contracts

The Companies Act 2006 requires copies a director’s service contract to be open for inspection to members at the company’s registered office.

A service contract in excess of two years must be approved by the company’s shareholders.  If the director’s employment is terminated before the end of the contact the company may have to pay out the remainder of the term.  This is additional to any claim the director might have for unfair dismissal.  Shareholder approval is also required for any payment for loss of office, although this does not extend to payments for an existing obligation (eg the notice period).

Directors’ transactions with their own company

The starting point is that directors must account to the  company for any profit that they make from their office. However, transactions between a director and a company are generally permitted if proper disclosure is given and the transaction is approved by a resolution of the company’s shareholders.

Specific examples include:

  • Loans – a company may make a loan to its director or give security to a third party lending money to its director provided that (a) it circulates a memorandum with full details of the loan and (b) the loan is approved by resolution. There are some exceptions where these formalities are not required. If the rules are not follow the company may avoid (cancel) the loan and / or claim compensation from the director. 
  • Substantial property transactions – approval by resolution is also required where a director acquires from a company either directly or indirectly a substantial non-cash asset, or vice versa. This is defined an asset worth more than £5000 AND more than 10% of the company’s net assets or exceeds £100,000.  If the transaction is not properly authorised it may be avoided by the company and the director may be required to account to the company for any profit from the transaction.  
  • Directors are entitled to have a personal interest in contracts entered into by the company provided that (a) it does not cause a conflict of interest and (b) the director discloses the personal interest.

Formalities and Company Secretarial / Meetings and Minutes

A limited company must comply with a raft of statutory obligations, which do not apply to partnerships or sole practitioners.  These will typically be dealt with by the company secretary or the directors, if no secretary is appointed. 

  • Meetings – giving notice, minutes and filings
  • Filing of annual return and accounts
  • One off matters – appointment / termination of directors, increase share capital, declaring dividends

Failure to comply with the filing obligations is an offence but, more realistically, can lead to the company being struck off.