The duties and responsibilities of company directors

There are various duties imposed on company directors by the Companies Act 2006 (which codified some of the existing common law and equitable duties) as well as by insolvency and health and safety legislation.

The purpose of these duties is to protect shareholders, and others, by ensuring that directors can be held accountable for the way that they manage the affairs of a company. Given the number of new companies being formed each year and the extensive powers that directors hold over a company, these duties play a very important role in protecting a company and ensuring its overall “welfare”.

Company directors can sometimes hold the misplaced belief that they are entitled to ‘do as they please’ in running a company, particularly in the context of smaller managed enterprises (SMEs) and owner-managed businesses where the directors are sometimes the sole shareholders of the company. In our experience, many directors are unaware of the full extent of their duties. It is often the case in reality that in various circumstances and transactions it can be difficult to work out how the various directors’ duties need to be applied; and whether, in fact, they are being properly complied with.

The important legislation covering this is the Companies Act 2006 (along with a couple of references to the Insolvency Act 1986).

If you are a company director and you think that you might be in breach of your duties it is very important that you seek legal advice as soon as possible.

The seven codified duties of directors which are set out in the Companies Act 2006

Under the Companies Act 2006, company directors must do the following:

1. Act within powers - Directors must only use their powers for the purpose for which they were given and act in accordance with the company's constitution.
2. Promote the success of the company - Directors must promote the success of the company for the benefit of its members as a whole. This includes considering the long term consequences of any decisions, employees’ interests, the fostering of broader business relationships and the need to act fairly between members of the company.
3. Exercise independent judgement - Directors must make their own decisions, although this does not prevent them from complying with the terms of any agreement entered into by the company, or in accordance with the company's constitution.
4. Exercise reasonable care, skill and diligence - This is tested on both a subjective and an objective basis, considering (a) the knowledge, skill and experience actually possessed by a particular director and (b) the knowledge, skill and experience to be reasonably expected of a person carrying out the same function.
5. Avoid conflicts of interest - Whether or not a conflict exists or could potentially exist has to be considered based on the particular facts of a situation. However, there will not be a breach of this duty where the conflict has been pre-authorised (by the members, other directors or under the company's constitution), or where an analysis of the circumstances concludes that the situation cannot reasonably be regarded as giving rise to a conflict of interest.
6. Not accept benefits from third parties - This duty covers benefits offered in connection with any action taken/not taken by a director in their capacity as such, or any benefit given because an individual is a director.
7. Declare an interest in a transaction or arrangement - Both the nature and extent of such interests must be declared and the duty applies to both proposed and existing transactions.

Does a breach of directors’ duties actually matter?

In the context of an SME or family business, where the directors may also be the sole shareholders in the business, there is sometimes a reluctance to engage with the regulatory nature of directors duties, particularly as this can result in additional paperwork and professional costs.

The directors might argue – understandably – that because the directors are also members and/or shareholders, that the interests of the owners and the managers automatically align.

However, even in the context where the directors are also the sole shareholders this is, potentially, a very dangerous view.

In the event that the company becomes insolvent, a director may become personally liable for any wrongful or fraudulent trading undertaken by the company. In other words, failure to adhere to directors’ duties could result in directors effectively losing the benefit of limited liability. When the directors have grounds to believe the company may become insolvent, the general duty to act in the best interest of the company’s members changes to a duty to act in the best interest of the company’s creditors. Director-shareholders of an SME or family business might be very laissez-faire about their duties when the company is trading successfully, but if things take a turn for the worse then the implications could be very serious indeed.

Alternatively, if the company is seeking to attract funding or third party investment – or if the director/shareholders want to sell the company – the due diligence process underpinning such a transaction will almost certainly expose any historic breaches of directors’ duties.

On one level this would indicate that the company may not have been run very well, thus discouraging potential buyers or investors from proceeding with the transaction.

A far more serious scenario would be one where there have been historic breaches of directors’ duties (such as entering into transactions without authority) which result in incoming directors (following, for example, a sale or third party investment) seeking to rescind contracts or transactions; or asking previous directors to account for gains made as a result of a breach of their duties.

We help you protect your business

At LCF Law our objective is to help you comply with all the requirements of the Companies Act 2006, in order to protect you and your business. This isn’t a ‘box ticking’ exercise. We use our considerable business expertise and experience to ensure that every piece of advice we give is aimed at protecting and enhancing your commercial position.

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