What are the duties of a company director and what happens if they are breached?
Company directors have a number of duties imposed on them under the Companies Act 2006 as well as under common and other laws. Failure to carry out directors’ duties can result in substantial penalties, including personal liability for any losses suffered by the company, its shareholders and its creditors.
The main directors’ duties are those detailed in the Companies Act 2006 (the Act), although there is substantial additional legislation in other areas, such as insolvency and health and safety, which must also be observed. This article will focus on the obligations included the Act.
Directors’ duties included in the Companies Act 2006
Directors must act within their powers
While directors are given a certain amount of discretion to run the company as they see fit, they cannot act outside of the powers conferred on them by the company’s constitution, primarily its articles of association.
When exercising the powers given to them, they should act in the interests of the company and not in their own interests. For example, allocating too many shares to an individual with views sympathetic to the director may not be in the company’s best interests.
In addition, they may not exceed the limits of the powers and authority given to them.
Directors must promote the success of the company
In making decisions relating to the company, directors should consider whether their actions will promote the company’s success and benefit any shareholders and other stakeholders in the company.
The Act lists six factors that directors must have regard to in reaching decisions which include consideration of employee interests, the long-term consequences of their proposed actions and fostering business relationships with suppliers and customers.
However, where a company’s solvency is in doubt, the directors must consider the interests of the company’s creditors instead of the company itself.
Where a company becomes insolvent, directors can face personal difficulties where they have taken a small or nominal salary but taken additional funds on a regular basis. Such additional funds would be considered a director’s loan and a dividend is usually declared at the end of the financial year to offset the director’s loan. However, dividends can only be paid out of available profits and if the company is insolvent, a dividend cannot be declared and the director may be indebted to the company. For more information, see our article: The treatment of director’s loan accounts in administration or liquidation: Can DLA’s be reclassified as remuneration.
Directors must exercise independent judgement
A director is required to make any decisions independently and not to favour any single shareholder or section of a business, for example, if a business merges and directors are appointed from both former enterprises.
In addition, a director cannot give away their decision-making power to another unless they retain the power to revoke this.
Directors must exercise reasonable care, skill and diligence
There are two parts to this duty. Firstly, a director should exercise the care, skill and diligence that would be expected from someone doing the job to a professional standard.
Secondly, they must act in accordance with the knowledge, skill and expertise that they themselves possess. This means that if a director has in-depth experience in a particular area, they will be expected to use it to the benefit of the company.
Directors must avoid conflicts of interest
A director must not only avoid direct and indirect conflicts of interest, but also possible conflicts of interest. This could include awarding a contract to a friend or family member or using company information to benefit their own personal affairs.
Exceptions exist where the conflict cannot reasonably be regarded as likely to give rise to a conflict of interest and also where the situation has been authorised by the board of directors (excluding the director concerned), provided the company’s articles of association permit such authorisation.
Directors must not accept benefits from third parties
A director may not accept a benefit from a third party where it was offered because of the director’s position in the company or because of any actions they have the power to take as a director.
In practice, this means that a director should not accept a gift or an invitation to a hospitality event from someone who has a contract that may be offered to the company.
If it can be shown that no reasonable person would see a conflict of interest in accepting the benefit, it is acceptable, however, it is not always a clear-cut decision and care should be taken before accepting any benefit.
Directors must declare any interest in a proposed transaction or arrangement with the company
If a director has a personal interest in a transaction, he must disclose this at a board meeting or in writing to each director before the relevant contract is entered into.
This could include making a deal to buy supplies from a business owned by a relative or a transaction with another company in which the director has a shareholding.
Consequences of breach of directors’ duties
If one of the above directors’ duties is breached, action can be taken against the director by the company or by a shareholder if they have suffered loss. This can be by way of court action or in some instances by way of an agreement with the director.
Consequences for the director include the following:
Removal from office
A director can be removed from office in the event that more than half of the shareholders vote for this. Removal can be permanent or temporary, depending on the severity of the breach in the view of the shareholders.
Return of company property
Where property has been inappropriately transferred or taken by a director, its return can be required.
Restitution of profits
Where a company has suffered a loss because of the director’s actions, the court can order that any personal profits made by the director in the transaction that breached his duty to be returned to the company.
The setting aside of a transaction
The court may make an order setting aside a transaction or contract so that the situation is as though it had never been made.
An interim injunction
An injunction can be issued to prevent the director from continuing with the breach of their duty and to prevent further losses.
Damages or compensation
Where a director’s breach of duty has resulted in financial loss, a court can order payment of damages and/or compensation from the director personally. This means that a breach of directors’ duties can expose a director to personal liability and the possibility of losing personal assets, to include their home, as well as a risk of bankruptcy.
A fine under criminal law
Some breaches are considered so serious that they have been criminalised. An example is the requirement to keep and file the required company registers and accounts.
Advice for company directors
Staying within the law as laid out in the Act is not always straightforward and it is sometimes the case that directors’ duties are breached inadvertently. If you have any doubts as to the legality of a proposed transaction, you should seek legal advice before entering into it.
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The above information is for general guidance on your rights and responsibilities and is not legal advice. If you need more details on your rights or legal advice about what action to take, please contact a legal advisor.