Directors' Duties

What obligations does a director have?

Page 3

Health and Safety

Health and Safety at Work etc Act 1974

Responsibility for health and safety matters is a responsibility of the company rather than of individual directors. However, where a ‘body corporate’ commits a health and safety offence with the consent or connivance of a director or the offence is attributable to his neglect, then he is liable to be prosecuted (section 37 of the Health and Safety at Work etc Act 1974). (In this context, consent means knowing of the circumstances and the risks, whilst connivance means knowing and not doing anything about the risks. Neglect means unreasonable breaching of a duty of care.) If convicted, a director could be imprisoned for up to two years and fined an unlimited amount (Schedule 3A to the Health and Safety at Work etc Act 1974) and a director can also be disqualified from being a director for a period of time (section 2(1) of the Company Directors Disqualification Act 1986).

stethoscope Under the Health and Safety Executive ("HSE")'s enforcement policy statement, one of its purposes is to ensure directors are brought to account before the courts if they fail in their health and safety responsibilities. HSE Inspectors have been asked to consider in particular the management chain and role played by individuals in any health and safety breaches. Organisations and individuals found guilty of health and safety breaches will be named in the HSE’s annual report each year.

The HSE and the Institute of Directors have published guidance as to the health and safety responsibilities of company directors, recommending that each board must:

accept its collective role in providing health and safety leadership in their organisation;
nominate a director to champion health and safety issues;
ensure that each member accepts individual responsibility and makes sure that their actions and decisions at work reinforce the messages in the board's health and safety;
make sure all decisions reflect the intentions in the organisation's health and safety policy;
encourage workers at all levels to become actively involved in health and safety; and
keep up to date with relevant health and safety risk management issues and review its health and safety performance regularly, at least annually.

The recommendations do not have statutory force but failure to implement them could well be taken into account by prosecutors in deciding whether to bring criminal charges against a director in the event of an accident. By contrast, implementation of the recommendations should enable directors to demonstrate that they have complied with the law.

Manslaughter

safety net Companies and individuals (including the directors and managers of a company) are subject to the common law offence of manslaughter by gross negligence, which applies where (according to R v Adomako [1994] 3 All ER 79):

the defendant owed a duty of care to the deceased;
there had been a breach of this duty of care; and
the breach was so grossly negligent that the defendant can be deemed to have had such disregard for the life of the deceased that the defendant's conduct should be seen as criminal and deserving of punishment.

A conviction of an individual for gross negligence manslaughter carries a maximum sentence of life imprisonment.

The Corporate Manslaughter and Corporate Homicide Act 2007 creates an offence of corporate manslaughter (known as corporate homicide in Scotland) in the UK, which replaces the common law offence of manslaughter by gross negligence for companies, partnerships, trade unions and other organisations. An organisation will be guilty of corporate manslaughter if:

the way in which its activities are managed or organised causes a person’s death;
the death results from a gross breach of a duty of care owed by the organisation to that person; and
the senior management had organised or managed the organisation’s activities in such a way to be a substantial element of the breach.

The Corporate Manslaughter and Corporate Homicide Act does not apply to individuals, but if found guilty an organisation will be subject to an unlimited fine.

Insolvency

The following provisions of the Insolvency Act 1986 need to be borne in mind by directors. Although they only apply when a company has gone into liquidation they relate to the conduct of the directors before the liquidation.

Section 214 – Wrongful trading

This section provides that a liquidator of an insolvent company may ask for an order from the courts making a director personally liable to contribute to the company's assets. The liability will arise where a director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation and then failed to take every step with a view to minimising the potential loss to the company's creditors that he ought to have taken.

For the purposes of this section the facts which the person concerned ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known, ascertained or taken by a reasonably diligent person having both the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same function as is carried out by the director (an objective test) and the general knowledge, skill and experience which the relevant director actually has (a subjective test). The effect of this is that an experienced director in a large company with sophisticated accounting procedures and equipment will be required to conduct himself to a greater standard than an inexperienced director in a small company with simpler accounting procedures. But even the inexperienced director in a small company must make sure that he has adequate knowledge and skill and that the company's accounting procedures and equipment are adequate to produce the information required to show its financial position. The section applies equally to non-executive directors as to executive directors.

flow chart The dilemma facing a director of a company which is at significant risk of going into insolvent liquidation is whether to carry on trading or put the company into administration or liquidation or to invite the appointment of administrative receivers. The duty imposed is to minimise the loss to creditors and the steps to be taken will vary from case to case. A careful evaluation of the situation must be carried out with the aid of professional advisers (particularly insolvency practitioners) to establish the best course to take. All decisions taken and the reasons for them should be regularly recorded in board minutes. This section applies to any person who is or was a director of a company which subsequently goes into insolvent liquidation and it is not therefore possible to escape liability simply by resigning.

Section 213 – Fraudulent trading

Any person who is knowingly party to the carrying on of any business of the company with the intent to defraud creditors (including potential creditors) of the company or creditors of any other person or for any fraudulent purpose will be personally liable to contribute to the company's assets. It has been held that an intent to defraud may be inferred if a person obtains credit when he knows that there is no good reason for thinking that funds will be available to pay the debt. However, there must be evidence to justify a finding of actual dishonesty. If this is proved then the director will, in addition to being liable to contribute to the company's assets, be guilty of a criminal offence.

Section 212 – Recovery for misfeasance

The official receiver, a liquidator, a creditor or a shareholder can recover money or damages from officers of the company or those concerned in its management, who have misapplied or retained or become liable or accountable for any money or property of the company, or have been guilty of misfeasance or breach of fiduciary or other duties in relation to the company. This section will cover, among other things, improper payments of dividends, application of monies for an improper or unauthorised purpose, application of monies contrary to the Companies Acts, and unauthorised loans or payments of unauthorised remuneration to its directors. It should be noted that this section applies in addition to the rules relating to common law misfeasance but provides a speedier remedy than is available under the common law.

Sections 238 – Transactions at an undervalue

A transaction at an undervalue occurs when a company disposes of its assets for significantly less than they are worth.

A liquidator can apply to have the transaction set aside if it occurred within two years of the company's liquidation.

Section 239 – Preferences

A preference is a transaction which has the effect of placing a creditor in a better position if the company goes into liquidation than if the transaction had not occurred.

If the transaction occurs within six months before the company's liquidation, the liquidator can apply to have it set aside but he must prove that the directors in entering into the transaction were influenced by a desire to produce the preferential effect.

In the case of a transaction with a creditor who is a connected person (for example any of the company's shareholders, subsidiaries or directors) the period of six months is extended to two years and it is also presumed (unless the contrary can be proved) that there was a desire to prefer the creditor.

Disqualification

A director faces disqualification:

for a maximum of five years for persistent default in various duties to submit documents to the Registrar of Companies; and
for a period of between two and 15 years under section 6 of the Company Directors Disqualification Act 1986 on the ground that he is unfit to be concerned in the management of a company. In determining unfitness the court considers (among other things) whether the director has been a party to the making of a preference, a transaction at an undervalue or to wrongful or fraudulent trading and whether he has failed to comply with the various duties relating to the keeping of books of account and the preparation of annual accounts or has breached any fiduciary or other duty owed to the company.

The disqualification will mean that the director will not be able to be involved in the formation, promotion or management of any company in the United Kingdom during the disqualification period.

Relief from liability, indemnity and insurance

Relief in court proceedings

A court may relieve a director, either wholly or in part, from liability arising from negligence, default, breach of duty or breach of trust, if it concludes that he ‘acted honestly and reasonably, and that having regard to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused’. This section does not apply to liability for wrongful trading.

Indemnity

A company is permitted to indemnify a director against liability incurred;

in defending civil proceedings brought against him by third parties; or by the company or a group company where judgment is given in favour of the director; or
in defending criminal or regulatory proceedings where the director is acquitted.

Articles of association usually contain provision for such an indemnity.

Insurance

A company may obtain insurance against the liability of a director for negligence, default, breach of duty or breach of trust in relation to the company.

September 2011