Directors’ General Duties under the Companies Act 2006

This briefing is intended to give you an overview of the general duties set out in the Companies Act 2006 and to provide some practical guidance to help you comply with those duties.

Every director of a company owes a number of duties to the company they are appointed to. Compliance with each of the general duties is the personal responsibility of each director. The main directors’ duties are set out in statute in sections 171 to 177 of the Companies Act 2006 (the CA 2006). The failure by a director to comply with any of the general duties has potentially serious consequences for that director.

Under the CA 2006 any person occupying the position of director, whether or not they are actually named ‘director’ and or have been validly appointed, will be a director of the company and will be subject to the general duties. In addition, shadow directors may also be subject to the general duties. A ‘shadow director’ is a person who has not been appointed as a director of the company but in accordance with whose directors or instructions the directors of the company are accustomed to act.

The general duties are:

  • a duty to act in accordance with the company’s constitution and only exercise powers for the purposes for which they are conferred;
  • a duty to act in the way the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole and in doing so have regard to various specified matters;
  • a duty to exercise independent judgment;
  • a duty to exercise reasonable care, skill and diligence;
  • a duty to avoid a situation in which the director has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company;
  • a duty to not accept a benefit from a third party conferred by reason of the director being a director, or his doing (or not doing) anything as a director, and
  • a duty for the director to declare if he is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, and the nature and extent of that interest, to the directors.

It is important to note that any provision in a company’s articles of association, a contract or otherwise, that purports to exempt the directors from compliance with the general duties is void.

A company may, through its articles of association, go further than the general duties by placing more onerous obligations on its directors. However, the articles of association may not ‘dilute’ the general duties.

Duty to act in accordance with the constitution and properly exercise powers

Each director must ensure that they:

  • only exercises their powers for the purposes for which they are conferred, and
  • acts in accordance with the company’s constitution.

For these purposes, a company’s constitution includes (but is not limited to):

  • the company’s articles of association, and
  • any resolution or agreements affecting the company’s constitution.

Every director should ensure that they are fully aware of the content of the company’s constitution and all resolutions and agreements affecting it.

Duty to promote the success of the company

This duty requires that director acts in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. To be able to comply with this duty, the directors should first establish what ‘success’ means for the company.

Duty to exercise independent judgment

A director has a duty to exercise independent judgement, which means that he or she must not blindly follow the advice or instructions of a third party or fetter his or her discretion.

Duty to exercise reasonable care, skill and diligence

A director has a duty to exercise the same 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 has.

This is a two part test, the first part of the test is objective and sets a minimum standard for a director based on their particular role and responsibilities. The second part of the test is subjective and takes into account the particular director’s actual experience, knowledge, skills and specialism.

Duty to avoid conflicts of interest

A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company.

The prohibition relates to the situation rather than the actual conflict, thus, it appears that this duty applies whether or not the director has any influence over the situation and even if the conflict in question is trivial in nature. The scope of this duty is therefore very wide!

This duty is not infringed:

  • if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest;
  • if the matter has been authorised in advance by the directors in accordance with the CA 2006, or
  • where a company’s articles contain provisions for dealing with conflicts of interest, the directors have acted in accordance with those provisions.

Please note that authorisation cannot be given retrospectively and it applies to the conflict situation only and not other breaches of duty.

Duty not to accept a benefit from a third party

A director is under a duty not to accept a benefit from a third party that is conferred because:

  • he is a director, or
  • he has done (or not done) anything as a director.

This duty does not catch benefits accepted by a director from the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate.

There is no definition of what constitutes a ‘benefit’, although it is thought to have a broad meaning that covers benefits of any description, including non-financial benefits.

Duty to declare an interest in a proposed transaction or arrangement

A director who is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company has a duty to declare the nature and extent of that interest to the other directors before the company enters into the transaction or arrangement, except where:

  • the director is not aware of his interest or the transaction or arrangement in question (although for this purpose, the test is objective and director is treated as being aware of matters of which he ought reasonably to be aware);
  • the interest cannot reasonably be regarded as being likely to give rise to a conflict of interest;
  • the other directors are already aware of the interest (and for this purpose, the test is objective and the directors are treated as being aware of matters of which they ought reasonably to be aware), or
  • it concerns the terms of his service contract that are to be considered by a meeting of the directors or a committee of the directors.

The declaration of interest must be made as soon as reasonably practicable after the director becomes aware of the interest.

Breach of a duty

The consequences of a breach of duties may, amongst other things, include:

  • damages or compensation where the company has suffered loss;
  • restoration of the company’s property;
  • an account of profits made by the director, and
  • rescission of a contract.

It may be possible for a director to be protected from liability in the event of a breach of the general duties by:

  • directors’ insurance;
  • an indemnity from the company;
  • ratification by the members of the company, or
  • relief from the court for the breach of duty.

 

The Legal Stop provides several legal documents and contracts aimed at helping you comply with your legal duties as director!

DIRECTORS’ DUTIES UNDER THE COMPANIES ACT 2006

The duties of company directors have, until recently, been defined by case law. The Companies Act 2006 changed this, under the new 2006 Act directors’ duties have been for the first time codified and set out in statute.

WHO IS A DIRECTOR?

Under the 2006 Act any person occupying the position of director is considered to be a director of the company and is subject to the general duties, whether or not they are actually named ‘director’ and or have been validly appointed.

In addition, shadow directors are also subject to the general duties. A shadow director is a person who has not been appointed as a director of the company but in accordance with whose directors or instructions the directors of the company are accustomed to act.

Every director of a company owes each of the general duties to that company. Compliance with each of the general duties is the personal responsibility of each director.

GENERAL DUTIES

The general duties are:

  1. duty to act in accordance with the company’s constitution and only exercise powers for the purposes for which they are conferred
  2. duty to promote the success of the company for the benefit of its members as a whole
  3. duty to exercise independent judgment
  4. duty to exercise reasonable care, skill and diligence
  5. duty to avoid conflicts of interest
  6. duty not to accept benefits from third parties
  7. duty to declare an interest in a proposed transaction or arrangement with the company

Duty to act in accordance with the constitution and properly exercise powers (s 171 CA 2006)

Each director must ensure that they:

  • only exercise their powers for the purposes for which they are conferred, and
  • act in accordance with the company’s constitution.

For these purposes, a company’s constitution includes (but is not limited to):

  • the company’s articles of association, and
  • any resolution or agreements affecting the company’s constitution.

It means that directors should be aware of the content of the company’s constitution, they must act in accordance with the company’s articles of association and must pursue the objectives listed in the Memorandum of Association.

Duty to promote the success of the company for the benefit of its members as a whole (s 172 CA 2006)

To be able to comply with this duty directors need to consider a number of statutory factors, including the long-term consequence of decisions, the company’s reputation and the interests of other stakeholders, such as employees and the community. This list is not exhaustive; it is important that the directors give due consideration to every relevant factor in discharging this general duty.

Duty to exercise independent judgement (s 173 CA 2006)

It means that directors must not blindly follow the advice or instructions of a third party. Advice can be sought as long as the director uses his judgement to decide how to proceed.

Duty to exercise reasonable care, skill and diligence (s 174 CA 2006)

A director has a duty to exercise the same 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 has.

The first part of this test is objective and sets a minimum standard for a director based on their particular role and responsibilities. The second part of the test is subjective and takes into account the particular director’s actual experience, knowledge, skills and specialism.

Duty to avoid conflicts of interest (s 175 CA 2006)

A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company. The prohibition relates to the situation rather than the actual conflict and the duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.

Thus, the scope of this duty is very wide but the CA 2006 also sets out provisions giving directors the power to authorise situational conflicts of interest.

Please note that authorisation cannot be given retrospectively and it applies to the conflict situation only and not other breaches of duty. For example, the fact that a conflict situation is authorised will not absolve a director from a breach of his duty to act with reasonable care, skill and diligence, which the directors cannot authorise.

Duty not to accept benefits from third parties (s 176 CA 2006)

A director is under a duty not to accept a benefit from a third party that is conferred because:

  • he is a director, or
  • he has done (or not done) anything as a director.

This duty does not catch benefits accepted by a director from the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate.

Duty to declare an interest in a proposed transaction or arrangement with the company (s 177 CA 2006)

A director who is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company has a duty to declare the nature and extent of that interest to the other directors before the company enters into the transaction or arrangement, except where:

  • the director is not aware of his interest or the transaction or arrangement in question
  • the interest cannot reasonably be regarded as being likely to give rise to a conflict of interest
  • the other directors are already aware of the interest; or
  • it concerns the terms of his service contract that are to be considered by a meeting of the directors or a committee of the directors.

The declaration of interest must be made as soon as reasonably practicable after the director becomes aware of the interest.

Directors have to declare indirect interests as well as direct interests and it is not necessary that the director is a party to the relevant transaction or arrangement.

What constitutes an ‘indirect’ interest is not defined in the CA 2006, so the directors should consider which interests, if any, might be relevant, which may include the interests of persons connected with them.

CONSEQUENCES OF BREACH     

The consequences of a breach of duty can be severe, and may amongst other things, include:

  • damages or compensation where the company has suffered loss
  • restoration of the company’s property
  • an account of profits made by the director
  • rescission of a contract, and
  • injunction to stop the director from carrying out or continuing with the breach.