All of the provisions of the Companies Act 2006 relating to directors’ duties are now effective. Against a background of increasing scrutiny of corporate governance by regulatory bodies, fears of shareholders flexing their muscles as a result of changes introduced by the 2006 Act and the courts’ willingness to hold directors to account for breaches of duty, it is more important than ever that directors of companies are aware of their duties.
The directors’ duties are owed to the company. However, the Act arguably widens the circumstances in which a shareholder can bring a “derivative claim” – effectively a claim on behalf of the company - against a director for losses suffered as a result of the director’s negligence, default, breach of duty or breach of trust and certainly makes it easier for shareholders to take directors to court.
In this article we give an overview of the general duties. In the next edition we will consider the circumstances when a derivative claim may be made and the evidence that may assist in the prosecution or defence of the claim.
There are seven general duties which broadly reflect and codify the law which was in existence prior to the 2006 Act. These are as follows:
To act within the powers of the company (in other words, to adhere to the provisions contained with the Articles of Association);
- To promote the success of the company;
- To exercise independent judgement;
- To avoid conflicts of interest;
- Not to accept benefits from third parties;
- To declare any interest in proposed transactions or arrangements with the company; and
- To exercise reasonable care, skill and diligence.
Some of the duties are self explanatory but a number merit closer scrutiny.
The duty to promote success
The central duty is the duty to act in a way that the director considers, in good faith, would be most likely to promote the success of the company for the benefit of members as a whole. This effectively replaces the preexisting duty to act in the best interests of the company. However, the new duty has added a list of factors which a director must consider in whether a proposed action is most likely to promote the success of the company. The six factors are as follows:
- The likely consequences of any decision in the long term;
- The interest 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, business conducts; and
- The need to act fairly as between members of the company.
The list of duties is not exhaustive. For example, the interests of the company’s creditors must be considered in the event that a company is insolvent or near insolvency.
Duty to avoid conflicts of interest
The obligation to avoid conflicts of interest is contained in section 175 of the Act. It applies where interests, whether direct or indirect, “possibly may conflict”. Such conflicts most frequently arise where a director holds a number of directorships with different companies. There are provisions in the Act allowing specific authorisation for any conflicts. However, directors will need to ensure that they make certain that proper authorisations are in place which recognise and permit any potential conflicts of interest. Further, to take advantage of the provisions, the articles of the company may require amendment.
Duty to exercise reasonable care, skill and diligence
The duty is both an objective and a subjective test. The director must exercise the reasonable care, skill and diligence that 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 actually has.
In other words, a higher duty would be expected of a CEO of a PLC as compared to an inexperienced director, starting out with a new business venture.
Exclusion of Liability
It is not possible to exclude a director’s liability to the company or (apart from in certain defined circumstances) obtain indemnities from the company in respect of liabilities to a third party. However, it is possible to obtain director and officer insurance.
Going forward it is essential that directors are aware of the general duties. Further, directors should:
- Consider, if relevant, each of the six listed factors, bearing in mind that those six factors are not exhaustive. In many situations, it would be necessary to have regard to other factors; and
- Have a record of the reasons for their decisions in light of the weight of the decision to be made; and
- Consider, if relevant, whether the company’s articles require amendment to permit authorisation of conflicts; and
- Where appropriate, seek advice.