What obligations does a director have?
Becoming a director gives status and a direct impact on the strategy and success of a business. How free is a director to act alone? What obligations and duties should a director bear in mind?
This note summarises the general duties and potential liabilities of a director of an English private company (which is not in a group with a PLC).
Day-to-day management of a company is delegated to the directors by its shareholders. Directors are initially appointed by the shareholders and can usually themselves appoint additional directors up to any limit set by the articles of association.
The decisions of the directors are taken collectively by the board of directors. A director cannot act as a director on his own unless only one director has been appointed. Decisions are either taken by majority vote at board meetings or by the signing by all the directors of a written resolution.
The director's role and his powers are primarily defined in the company's articles and, if he is also an employee, in his service contract.
The mere fact of appointment does not normally give a director any executive powers. Most directors are, however, also employees of the company with specific powers delegated to them. A managing director usually has extensive powers to take day-to-day decisions on behalf of the company. Other directors such as sales directors or finance directors will have a more limited role.
Directors owe a duty to the company and, if insolvency threatens, to creditors. Certain key duties of directors have been placed on a statutory footing under the Companies Act 2006 (the "Act"). These duties are owed to the company.( See Duties.)
Directors are also subject to a number of other statutory requirements and restrictions. These include a duty to keep proper books and records and restrictions on entering into certain transactions with the company or accepting loans from the company. Breach of these duties and requirements can result in a director being disqualified from acting as a director and in many cases can lead to the director incurring personal liability. Insurance can be obtained to cover some cases of personal liability.
The directors act as a board but the board may (if the articles permit, as they generally will) delegate powers to a committee of board members or to an individual director.
Non-executive directors are, as their name implies, directors to whom no executive powers have been granted by the board. Although they have no executive powers, they can vote at board meetings and have the same duties as executive directors.
Executive directors are generally employees with specific powers delegated to them either by a resolution of the board or under their service contracts.
Most companies have a managing director (sometimes called a chief executive). He is granted more extensive executive powers by the company's articles or by board resolution.
Directors should not act outside the scope of the powers delegated to them. Major contracts and commitments should always be authorised by board resolution. A director who exceeds his powers (for example, by signing a contract not authorised by the board) may incur personal liability for the performance of the company's obligations under that contract. However, he will be relieved from such personal liability if the board subsequently ratifies his actions.
If a director is liable for conduct amounting to negligence, breach of duty, default or breach of trust, the power to ratify such conduct lies with the shareholders. The shareholder resolution ratifying such conduct must be passed without counting the votes of the director concerned (if a shareholder) or those of any connected person.
A director's general duties are owed to the company and not to individual shareholders. The Act codifies certain key duties, as follows:
Duty to act within powers (section 171)
A director must act in accordance with the company's constitution (which includes its articles of association and shareholder resolutions) and must only exercise his powers for their proper purpose.
Duty to promote the success of the company (section 172)
A director 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. In doing so, the director must have regard (amongst other matters) to:
- the likely consequences of a 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 the members of the company.
Directors must exercise reasonable care, skill and diligence in having regard to this non-exhaustive list of factors, which may sometimes conflict with each other, but the overriding consideration is the success of the company. This duty is subject to the existing common law duty to creditors which will override almost all other interests if the company is, or is at risk of becoming insolvent.
Duty to exercise independent judgment (section 173)
A director must exercise independent judgment. This duty does not prevent a director from acting in accordance with an agreement entered into by the company or in a way authorised by the company's articles of association. Directors may continue to delegate certain matters to other directors or employees with specialist expertise, but must exercise independent judgment in deciding to delegate and in deciding whether or not to follow their advice.
Duty to exercise reasonable care, skill and diligence (section 174)
A director owes a duty of skill and care to the company. The degree of care required is the standard of care which a person would exercise on his own behalf.
A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both:
- the general knowledge, skill and experience that may reasonably be expected of a person performing the functions carried out by the director in relation to the company; and
- the general knowledge, skill and experience that the director actually has.
Therefore, the degree of skill required is that which would be expected of a person with the director's knowledge and experience. Where a director has particular skill or experience, such as a professional qualification, the standard expected of him will be higher than that required of a person without such skill or experience.
Duty to avoid conflicts of interest (section 175)
A director must not, without the company's consent, place himself in a position where there is a conflict, or possible conflict, either directly or indirectly, between the duties he owes the company and either his personal interests or other duties he owes to a third party. That applies, in particular, to the exploitation of property, information or opportunities, and whether or not the company could take advantage of the property, information or opportunity.
The duty to avoid conflicts of interest will continue to apply after a person ceases to be a director as regards the exploitation of any property, information or opportunity of which he became aware when he was a director.
This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.
The duty in section 175 will not be infringed:
- if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest;
- in the case of a private company formed on or after 1 October 2008, if authorisation has been given by directors who are genuinely independent (in the sense that they have no direct or indirect interest in the transaction), unless the company's constitution prevents such authorisation; or
- in the case of a private company formed before 1 October 2008, if authorisation has been given by the independent directors (provided the members have resolved that authorisation may be given in accordance with the provision).
Board authorisation will only be effective if the required quorum is met without counting the director in question or any other interested director and if the conflicted directors have not participated in the taking of the decision or if the decision would have been valid without the participation of the conflicted directors.
The members of a company may, in principle, authorise conflicts of interest that would otherwise be a breach of this duty; also the company's articles may, in principle, contain provisions for dealing with conflicts.
Duty not to accept benefits from third parties (section 176)
Directors must not accept any benefit (including a bribe) from a third party which is conferred because of his being a director or his doing or not doing anything as a director. This therefore prohibits the exploitation of the position of director for personal benefit.
The duty will not be infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. Benefits conferred by the company, its holding company or subsidiaries, and benefits received from a person who provides the director's services to the company, are excluded.
The members of a company may, in principle, authorise the acceptance of benefits that would otherwise be a breach of this duty; also the company's articles may, in principle, contain provisions for dealing with conflicts.
The duty will continue to apply after a person ceases to be a director in relation to things done or omitted by him before he ceased to be a director.
Duty to declare interest in proposed transaction or arrangement (sections 177 to 185)
A director must disclose any interest in a proposed transaction or arrangement (section 177) or an existing transaction or arrangement (section 182).
Under section 177, if a director is 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 board before the company enters into that transaction or arrangement.
Existing transactions and arrangements are covered by section 182, which provides that a director must declare the nature and extent of his direct or indirect interest in an existing transaction or arrangement entered into by the company, to the extent that the interest has not been declared under section 177.
Where a declaration of interest under section 177 or section 182 proves to be, or becomes inaccurate or incomplete, a further declaration must be made.
It should be noted that the Act treats the obligation to declare interests in proposed transactions or arrangements as a fiduciary duty, carrying civil consequences for breach, including the possible unenforceability of the transaction by the director and a duty of the director to account for any profits. By contrast, the Act treats the obligation to declare interests in existing transactions or arrangements as a statutory duty where breach is a criminal offence but does not of itself affect enforceability.
How should a declaration of interest be made?
The procedure by which the director has to make the declaration is the same under both section 177 and section 182 and there are three different methods by which the declaration can be made. (Section 177 also leaves open the possibility that a director could declare his interest in a proposed transaction in another way.) The three specified methods are:
- at a board meeting;
- by written notice sent to the other directors or sent in hard copy form (or, if the recipient has agreed, in electronic form) or sent by hand or by post (or, if the recipient has agreed, by electronic means). The notice will be deemed to form part of the proceedings at the next board meeting and, therefore, it must be minuted at the next board meeting;
- by a general notice in which the director must state the nature and extent of the interest in the company or firm or the nature of the connection with the specified person. That general notice will not be effective unless it is given at a board meeting or the director takes reasonable steps to ensure that it is brought up and read at the next board meeting. Simply sending in a general notice is not enough; the director has to present it at the board meeting or make sure it is raised at the next board meeting.
When is a declaration not required?
A declaration under section 177 or section 182 is not required in four circumstances:
- if the director is not aware of the interest or the arrangement in question (but bear in mind he will be treated as being aware of the matters of which he ought reasonably to be aware);
- if the matter cannot reasonably be regarded as being likely to give rise to a conflict of interest;
- to the extent that the other directors are aware of the matter giving rise to the conflict; and
- to the extent that it concerns terms of his service agreement which has been or will be considered by the board or by a committee of the board.
The interest of anyone connected with the director may be taken into account, so consideration needs to be given to all family members and connected companies, etc. Therefore, steps should be taken to make sure that anyone connected with the director is aware of the disclosure obligations and is asked to notify the director as the potential conflict arises.
A director can give a general notice to the board of an interest in another company or firm, or that he is connected with certain people, which will satisfy his requirement to make the appropriate declaration.
Other (non-statutory) general duties
Other, non-statutory duties which a director may owe to a company include:
- Duty not to misapply the company's property
A director who has misapplied or taken anything belonging to the company, must return it or compensate the company for the resulting loss. Where he has used the company's money for purposes which the company has not sanctioned, he must replace it, however honestly he may have acted.
A director must not take for his own benefit or pass to a third party a business opportunity which arises out of the company's business.
- Duty of confidentiality
A director owes a common law duty of confidentiality to the company of which he is a director. This duty overlaps with the statutory duties to promote the success of the company and to avoid conflicts.
- Authority exceeded
A director who causes the company to act beyond its powers will be guilty of misfeasance and will be personally liable to the company for any resulting loss. Such acts will not be capable of ratification. However, acts of a director which merely exceed the authority granted to him by the articles or by resolution may be ratified by the shareholders. (See Powers and authority.)
A transaction to which a director or any person connected with a director is a party, and which exceeds the authority granted by the articles, may be voidable by the company. Further, the party to the transaction and any director who authorised the transaction will be liable to account to the company for any profit made on the transaction and to indemnify the company against any loss resulting from the transaction.
An act of a director carried out without authority is not always invalidated (for example, the issue of shares, without authority from shareholders under section 550 or 551 of the Act, remains valid although the director will be liable for permitting the issue).
"A director owes a duty of skill and care to the company. The degree of care required is the standard of care which a person would exercise on his own behalf."
"A director 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."
"A director who causes the company to act beyond its powers will be guilty of misfeasance and will be personally liable to the company for any resulting loss."