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Directors' Duties

In the words of one judge “being a director is not an easy matter, and requires a responsible approach. The degree of regulation can catch even the most sophisticated of directors unawares and most directors do not have the requisite level of sophistication and skill to cope unaided with the extensive statutory framework to which they are subject, or the niceties of the company’s constitution. Many become directors of companies to take advantage of limited liability, so as to exploit their entrepreneurial skills and instincts, and may not be temperamentally suited to statutory control or constitutional restraint. There is a strong public interest in encouraging entrepreneurial activity. There is equally a strong public interest in combating abuse which limited liability too often engenders”.

Introduction

It has often been said that being a director is easy, but being a responsible one is not. Over the last few years directors' duties have been in the spotlight and this article looks at some of the legal issues facing directors when carrying on their business and highlights some of the steps that directors can take to comply with their duties and to avoid incurring personal liability.

The rules governing the duties directors owe their companies have been codified in the Companies Act 2006 (the Act). The Act also introduced a new statutory right for shareholders to sue directors for breach of these duties in the company's name in some circumstances (a 'derivative action').

This article sets out these duties and in also gives particular attention to two of the key principles; the duties to promote the success of the Company and to avoid conflicts.

Some have expressed concern about the possible impact of these changes on companies and their boards, but there are practical solutions to many of the issues that may arise, and these, and directors' liabilities, are also addressed below.

So what are these director's duties?

The Act sets out seven general duties:

Duty to promote success

One of the biggest differences between the common law regime and the statutory provisions is in the treatment of the directors' duty of loyalty to their company. The common law requires directors to act in good faith, in the interests of their company. The statutory provisions oblige a director to "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" (subject to certain exceptions, which require directors to consider, or act in the interests of, the company's creditors, in insolvency situations).

This meaning of this statutory provision raises many questions, but the Act does give some assistance in setting out various non-exhaustive factors to be taken into account, namely the:

Although all of these factors must be considered in all decisions (whether formal or not) it will often be enough for the board to conclude that a particular factor is not relevant, and leave it at that. This new provision was intended to reflect what was already widely regarded as good practice amongst boards.

Duty to avoid conflicts

The key change in the conflicts provisions is to allow advance board authorisation where a director has an actual or potential conflict of interest or duty. The new rules make little practical difference to directors provided that they identify, disclose and, where necessary, seek authority for actual and potential conflicts and comply with any conditions the board imposes.

However it may be necessary for the company to operate more formal procedures for conflicts than it has in the past and the board has to consider whether to authorise an actual or possible conflict.

There are rules for conflicts that arise in connection with a transaction or arrangement with the company, and separate rules for conflicts that arise in other cases (sometimes called 'situational conflicts').

A director is not under a duty to avoid interests in transactions or arrangements with the company. However, he must disclose any interest in a transaction or arrangement that the company is proposing to enter into or that has already been entered into, whether his interest is direct or indirect. Once declared, no authorisation is required and this is the same as the position before the Act. The old rules required a director to declare an interest in a transaction or arrangement with the company at a board meeting, or by a general notice that he was interested in a specified body corporate or firm or was connected with a specified person. The new provisions also allow the director to declare a particular interest by written notice to his fellow directors, rather than at a board meeting. As before, the nature and extent of the interest must be declared. In any case not involving a transaction or arrangement with the company, the new rules require a director to avoid a situation in which he has, or can have, a direct or indirect interest (or duty) that conflicts or possibly may conflict with the interests of the company, unless the board has already authorised the matter concerned.

In the case of a public company, the articles must contain express permission before the board can authorise conflicts. Private companies incorporated before 1 October 2008 must have passed a shareholder resolution to allow the board to authorise conflicts.

How can directors protect themselves?

Liability

Taking commercial decisions are part of a director's job, and from a legal point of view they should not be held accountable for mere errors of judgment. This principle has not been changed by the Act and while a Court may relieve directors from liability for breach of their duties if they acted honestly and reasonably it will only do so if, in its opinion, they ought fairly to be excused. It is in the director's interest to act prudently, and to take all reasonable steps to prevent any liability arising, and taking into account those factors mentioned above should help achieve that objective.

For an update on directors’ duties please click here

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This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.

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