Directors Claims & Liabilities

A company incorporated under the Companies Act 2006 has its own existence and legal personality. It is important to recognise that a company’s legal personality is separate from the legal personalities of its directors and shareholders. The acts or omissions of a director in the ordinary course of business will usually be the acts or omissions of the company, so the company is liable. In certain situations, however, there are mechanisms which allow for a director to be pursued in his personal capacity for actions taken as a director of a company. Examples include, but are not limited to:

• Breach of director duties under the Companies Act 2006
• Wrongful trading
• Misfeasance
• Fraudulent trading
• Overdrawn directors’ loan accounts
• Recovery of dividends paid out in excess of distributable reserves
• Directors’ disqualification proceedings
• Personal guarantee claims

Directors duties – an important overview

Directors of a company in the UK are distinct from the business owners, the shareholders, and they have a duty to manage the company (or companies) to which they are appointed, solely in the interest of the shareholders; although they also have responsibilities towards various other stakeholders such as customers and employees.

This apparently simple relationship can, however, lead to various difficulties arising from, for example: confusion between a director’s understanding of his/her duties; their interest as a shareholder; and the interplay between directors to ensure their management of the company is effective. As companies grow and become more successful these various issues can become more complex and challenging and it becomes increasingly important for a director to fully understand their role and their associated responsibilities.

Directors’ duties are known as ‘fiduciary duties’ reflecting the fact that there is a relationship of trust and confidence with the shareholders who are, in effect, entrusting their investment into the hands of the directors.

The Companies Act 2006 sets out the following seven fiduciary duties for company directors:

1. A director must only act within their powers as granted by the company’s constitution.
2. A director has a prime duty to promote the company’s success (unless it is insolvent).
3. A director must exercise independent judgment.
4. A director must exercise reasonable care, skill and diligence in his/her role.
5. A director must avoid conflicts between his/her role and his/her personal interests.
6. A director cannot accept benefits from third parties which arise from his/her role.
7. A director must always declare to other directors his/her personal interest in any transaction or arrangement which the company proposes to enter into.

The first of these duties is that a director must act within their powers under the company’s constitution. The most important part of the company’s constitution is the articles of association. These are an important set of rules for the company and the board and can include:

• restrictions on the ‘objects’ of the company, requiring the company to pursue a particular type of business
• limitations on the powers of directors, such as borrowing money
• rules on the numbers of directors, their appointment and how decisions are taken
• details of any decisions which must be agreed by shareholders.

It’s vitally important that a director is familiar with the articles of association as they may constrain decision-making powers in certain ways. If a director exceeds their powers, then any related decisions could be reversed and they may have to compensate the company for any resulting financial losses.

Promoting the success of the company

The second major duty of a company director is to promote the success of the company. This is probably the best known of the seven duties.

Since 2019, new reporting requirements mean that ‘larger’ companies (two of: more than 250 employees; a turnover of more than £36 million; a balance sheet total of more than £18 million) have to explain how they have fulfilled this duty in their annual report.

The duty states a director must act in a way that they consider – in good faith – would be most likely to promote the success of the company for the benefit of its members or shareholders as a whole.

When making decisions, directors must also consider the likely consequences for various stakeholders including employees, suppliers, customers and communities. They should also consider the impact on the environment, the reputation of the company, company success in the longer term and the needs of all the various members or shareholders (including minority shareholders).

Both in their responsibilities and reporting requirements directors also need to consider a range of other areas of activity for the company such as employee engagement and any specific regulatory or compliance requirements that may relate to their industry, including the relevant accounting standards in force.

For smaller companies there are still significant legal reporting responsibilities including:

Checking and confirming to Companies House, once a year at least, that the information it holds about your business is correct. You do this by filing a ‘confirmation statement’. This replaces the previous annual return. There is a fee to pay with the confirmation statement – although you can update your company’s record as many times as you need to during the year.

Directors are also required to file a copy of the company’s annual report and accounts at Companies House each year. Private company reports and accounts must be filed within nine months. Company reports and accounts for public companies must be submitted within six months.

There are automatic penalties for late filing of annual accounts at Companies House which are doubled for persistent failure to file annual accounts on time.

Other filings which directors are responsible for making with Companies House include:

• changes to the articles of association, and certain shareholder resolutions
• changes to directors or their details
• changes to the registered office address
• changes to the company secretary or their details, if the company has one (company secretaries are optional for private companies)
• a change to the company’s accounting reference date (its year end)
• any issue of shares or changes to the company’s share structure
• if the company grants a mortgage or charge over an asset

Many companies outsource these responsibilities to a specialist service or their professional advisers. However, the directors retain the overall responsibility for compliance.

A duty to promote the success of the company may seem like an obvious task for a director. However, fulfilment of this duty has a number of implications.

As well as their Companies House filing duties and responsibilities directors need to be fully aware of and on top of a range of other areas of their company as they can be held personally responsible for business decisions which are effectively unlawful, for example under the Health & Safety at Work Act.

The directors must ensure that the company complies with all legislation and regulations relevant to its business. At least one of the directors should be familiar with each of the following areas of the law:

• health and safety
• employment
• insurance obligations
• taxation

Board decisions can only be justified by them being in the best interests of the company. They should not be based on what works best for anyone else, such as particular shareholders, executives or other related businesses. Directors need to be broad-minded in the way that they evaluate the various interests – by considering other stakeholders and not just taking a narrow financial perspective. It is also important and prudent that the criteria for various business decisions are properly recorded in the event they need to be referred to or assessed subsequently. Hence the importance of good quality board meeting minutes and all other forms of relevant company documentation.

Independent judgement

The third major duty requires directors to exercise independent judgement. Directors are meant to develop their own informed view on the company’s activities.

Directors should not be delegates who simply implement the commands of other parties (such as major shareholders). Nor should they avoid their responsibility to make independent decisions by relying on the knowledge or judgement of other directors or experts.

A director needs to form their own view, and this may require some effort – especially if they are not already familiar with key aspects of the company’s activities.

Exercise reasonable care, skill and diligence

There was a time when directors could be appointed purely for their name or reputation, without the expectation that they would actually do any work as a board member. Those days are now over due to the duty for directors to exercise reasonable skill, care and diligence in their role.

The benchmark is that of a reasonably diligent person with the general knowledge, skill and experience that could reasonably be expected from a person carrying out the director’s functions. Also, directors with specific professional training or skills (such as a lawyer or accountant) are held to a higher standard in related issues than less qualified colleagues.

Conflicts of interest and personal benefits

The remaining three legal duties of directors relate to the need for directors to avoid or manage conflicts of interest which may affect their objectivity.

Gifts or benefits from third parties are also a potential threat to a director’s objectivity. Most importantly, directors have a statutory duty to disclose any direct or indirect interest in proposed or existing transactions or arrangements with the company.

There are two types of directors’ conflicts of interest – ‘situational’ and ‘transactional’. A transactional conflict would be where you (or a family member) own shares in another company with which your company is planning to do, or doing business.

A situational conflict would be if you were in a situation (or could get into one) where you could exploit company property, an opportunity or information for personal gain. In such a situation the company is not entering into any sort of transaction, rather the situation you are in is creating the conflict.

Situational conflicts are only allowed if the articles of association authorise them or they are authorised by a majority of the independent members of the board of directors who have no direct interest in the matter.

Transactional conflicts are allowed, but a director is legally obliged to declare any transactional conflict of interest to their fellow directors.

Also, unless the interest was declared when it was a proposed transaction or arrangement, a director must declare any existing personal interest in any transaction or arrangement that the company has already entered into. This must be done at either a board meeting or by general notice. Failure to declare an interest in an existing transaction is not a breach of duty, but it is a breach of the Companies Act, making the director liable to a fine.

One circumstance where a conflict of interest is very likely is where someone offers you a benefit because you are a director, or because of something you do (or omit to do) as a director. The most obvious example being a bribe. Accepting benefits in these circumstances is a breach of duty. It also triggers the requirement to declare an interest. There is an exception if the benefit is authorised by the articles of association (or by the members), or if the acceptance of the benefit is unlikely to give rise to a conflict of interest.

Can a company director have private dealings with the company?

This will depend on the company’s articles of association. It may be possible if all the material facts are fully disclosed and, if necessary, the arrangements are formally approved. A company can usually loan money to a director so long as the loan is approved by the shareholders.

Where any deal between a director (or anyone connected with a director) and the company is regarded as substantial (worth more than £100,000 or 10 percent of the company’s net assets), for example the sale or purchase of company assets, it must be approved by the shareholders. The definition of people connected to a director is a wide one and it is wise to take advice in such situations.

Can anyone be a director?

Despite the potential complexity involved in being a fully informed and involved director there are no legal requirements for qualifications, except for certain specific businesses such as an investment company.

Almost anyone can be a director including both individuals and – for the moment – other limited companies, although this may change in the near future*. Exceptions include:

• a company’s auditor;
• persons who have been officially disqualified from acting as a director in the UK and elsewhere;
• undischarged bankrupts (who would need permission from the court); and
• anyone under the age of 16

There is also an obligation for every company to have at least one ‘natural person’ serving as a director.

* (The government proposes to abolish corporate directors. We recommend you take legal advice about the implications around this if you want to have (or already have) a limited company director on your board.)

What are the possible penalties for failing to exercise my responsibilities as a director?

You could be held personally liable for losses resulting from illegal acts, acting beyond your powers, or failing to use sufficient skill and care.

You could become personally liable for company debts if you allow the company to trade while it is (or is likely to become) insolvent. If the company has difficulty meeting its financial obligations the directors should seek advice from an insolvency practitioner.

Some types of conduct can lead to disqualification from being a director. You might also be fined or face criminal prosecution – for example, for failing to keep proper accounting records, for fraudulent behaviour, or for serious health and safety shortcomings.

You are not generally responsible for the actions of other directors if you knew nothing about them and took no part. Directors must, however, keep themselves informed about what is going on in the business and participate in its management, which means they should not sit by and let other directors act without being prepared to challenge them, no matter how dominant those other directors are otherwise the directors are in breach of their duties to their company.

You are also expected to keep yourself informed about what is going on in your company, whether or not it is in an area that is your primary responsibility. It is therefore very dangerous for directors to turn a blind eye to, or fail to pay attention to, anything going on in their company – particularly in relation to the company’s financial situation. Directors can be held jointly and severally liable if they act in breach of their responsibilities.

As far as documents are concerned, a director should be aware of everything which can help them effectively fulfil their role. as a director. As a director, you should always see:

• the annual report and accounts
• board meeting minutes
• strategy documents
• management accounts
• key policy documents , like health and safety
• information on key products, services and people

What meetings do we need to have?

In practice, you will need at least one board meeting annually to approve the annual accounts. As a director, you also need to ensure that the number of board meetings you have (and the matters on the agenda and the way the meeting is conducted), show you are complying with your duties as a director – for example, that each of you is promoting the long-term success of the company and exercising independent judgement.

Of course, these meetings can be supplemented by informal meetings of some or all of the directors for discussions where formal board approval is not required.

The company will also need to hold a shareholders’ meeting (called a ‘general meeting’ in the Companies Act) to take any decisions which require the approval of the shareholders. This might include such things as removing a director or changing the company’s articles of association.

In addition, shareholders with at least 5% of the company’s voting shares can require the board to call a general meeting for a specific purpose.

What are the possible penalties for failing to exercise my responsibilities?

A director could be held personally liable for losses resulting from illegal acts, acting beyond their powers, or failing to use sufficient skill and care.

They could become personally liable for company debts if they let the company trade while it is (or is likely to become) insolvent.

Some types of conduct can lead to disqualification from being a director as well as being fined or facing criminal prosecution. These include, for example: failing to keep proper accounting records, serious health and safety shortcomings or for fraudulent behaviour.

As a director you are expected to keep yourself informed about what is going on in your company, regardless of whether it is an area that is your primary responsibility. It is dangerous for directors to turn a blind eye, or pay insufficient attention, to anything happening in their company – especially relating to the company’s finances. Directors can be held jointly and severally liable if they are in breach of their responsibilities.

Protecting yourself from possible legal action

You need to properly understand your company role, the law relating to your area and you need to take an active approach to fulfilling your responsibilities. You have to be proactive. You cannot just sit and let other directors manage the company, on the assumption they know what they are doing

If you are unhappy with the way the company is being run, you may need to call a board meeting to discuss your concerns. If you disagree with a decision, it is good practice to ensure that this is noted in the minutes of the meeting, along with your reasons. This sort of action is particularly important if the company is in a difficult financial position. If the company subsequently becomes insolvent, a liquidator or administrator has to submit a report on the conduct of each director. This could lead to disqualification and, potentially, personal liability. In certain situations you may find it wise to keep your own private record of situations and decisions, and your part in them.

If you are concerned that things are not as they should be, it is important to take legal advice personally.

You may also want to consider taking out directors’ and officers’ liability insurance. Whilst this cannot protect you from legal action, in various circumstances it can cover the costs of legal advice and any damages that might be awarded against you by a court. Whilst it can be expensive – and the cover can be limited – it can, in certain circumstances, be paid for by the company and it is well worth taking advice on this.

Does a non-executive have the same responsibilities and liabilities as an executive director?

Broadly, yes. Whilst a non-executive director might not be required to show the same degree of care and skill as, for example, a qualified solicitor who acts as the legal director, it would be imprudent to rely on this as a defence in a legal case.

Also you may act as a de facto director even though you have not been officially appointed, and so you may still be held liable. This could also apply if you are regarded as a ‘shadow’ director; that is, you still exert influence over the directors even though you are not on the board.

Whilst you may have resigned as a director, this does not allow you to walk away from what you did when you were a director. You remain responsible for your actions while you were in post; including any actions you did not take that you should have. If the company becomes insolvent the official receiver or administrator is entitled to examine the conduct of the directors during the preceding three years.

It should be pretty evident from the above overview that a director has a broad range of legal duties and responsibilities and that properly fulfilling and complying with them can be a complex and challenging task. There is plenty that can go wrong, often without a director even realising it, and they are, in so many ways, personally responsible for the actions and decisions that they make.

LCF Law’s commercial dispute and insolvency specialists have years of experience in both pursuing and defending high-value and complex claims on behalf of, and against, directors. Our lawyers are industry-recognised for their ability to find client-led solutions and to provide practical and commercial advice.

We can help directors to fully understand their responsibilities, liabilities and circumstances both before and when entering into a company position. We support both individuals and boards of directors, helping them to deal with all aspects of their fiduciary duties and beyond. When there is contention or conflict involved we help directors of companies of all sizes to resolve, defend or execute claims, actions and disputes. We advise and support our clients in all of the following areas, and more:

• Breach of director duties under the Companies Act 2006
• Wrongful trading
• Misfeasance
• Fraudulent trading
• Overdrawn directors’ loan accounts
• Recovery of dividends paid out in excess of distributable reserves
• Directors’ disqualification proceedings
• Personal guarantee claims