Case Study

Directors' Duties and Responsibilities

Tuesday 24th June 2008

 

Directors have the power to make and influence business decisions for the Companies in their care and control. The 2006 Companies Act replaces and codifies the existing Statutory and Common Law duties imposed upon Directors to ensure that the Company's interests are protected.

 

The 2006 Act, which received Royal Assent on 8th November 2006, seeks to clarify the fiduciary duties as well as the Common Law duties of care and skill into a statutory statement of seven general duties.  These are:

 

  • 1. To act in accordance with the Company's Constitution and exercise their powers for the purposes stated.

 

  • 2. To act in a way that the Directors consider is in good faith and most likely to promote the success of the Company.

 

  • 3. To exercise independent judgement.

 

  • 4. To exercise reasonable care, skill and diligence.

 

  • 5. Not to accept benefits from third parties.

 

  • 6. To declare interests in proposed transactions and arrangements.

 

  • 7. To avoid conflicts of interest.

 

Taking these in turn, we have summarised the seven general duties which are listed in Sections 170-181 of the 2006 Act below:

 

1.         Duty to act within their powers

  

This Rule codifies what is the existing Common Law Rule - that Directors should exercise their powers for the proper purposes only.  The Director's powers are derived from the statements made in the Company's Constitution, that is, what is contained within the Memorandum and Articles of Association (Section 171).

 

2.         Duty to promote the success of the Company

 

This is a new duty obliging Directors to act in a way that they consider in good faith most likely to promote the success of the Company.  This duty is owed to the membership as a whole and when exercising the duty, the Director is required to have regard to various factors identified in Section 172, including:

           

  • The long term consequence of the decision
  • The interests of the Company's employees
  • The relationships with suppliers and customers
  • The impact of the Company's operations on the community and environment
  • Desirability of maintaining a reputation for high standards of business conduct
  • The need to act fairly as between members of the Company

 

The inclusion of this duty has been seen by some as the most controversial change introduced by the 2006 Act as it introduces wider corporate, social, responsibility into the decision making process.  Only time will tell how Directors are required to balance these sometimes conflicting factors in their decision making and, indeed, how the term "success" is judged.

 

In practical terms, Directors should ensure they receive adequate papers prior to and at Board Meetings to allow them to give due consideration to all of the abovementioned factors and thought should be given as to how the decision making process is recorded in Minutes (Section 172).

 

3.         Duty to exercise independent judgement

 

Directors have to act independently. This hits out at Sleeping Directors who leave decision making to others on the Board.  Directors have a duty not to act in accordance with the will of others but must exercise their own independent judgement.  This Rule does not prevent Directors from properly delegating matters to Committees or appropriate individuals, nor to seeking independent advice as long as they continue to exercise their managerial control of same, actively and independently (Section 173).

 

4.         Duty to exercise reasonable care, skill and 

            diligence

  

This is codification of the Common Law duty of care and skill.  The Act now prescribes the degree of care, skill and diligence that is expected from a Director ie that which would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may be expected of a person in that role in addition to any general knowledge and skill which that Director has.

 

This is the same test that is imposed per Section 214 of the Insolvency Act 1986 in the context of a Director's wrongful trading.

 

The subjective test requires the Director to carry out this duty with the general knowledge and skill he actually possesses and thus a Director who has more experienced knowledge and skill has a higher threshold in discharging this duty (Section 174).  It is important Directors of charitable companies note this duty as it is at variance with the concept that all charity trustees have to exercise the same level of care and diligence.

 

5.         Duty to avoid conflicts of interest

 

The duty is imposed on the individual to avoid any situation that would give rise to a conflict of interest, either directly or indirectly with the interests of the Company.  Conflict of interest provisions were previously contained in Part 10 of the Companies Act 1985.  The purpose of the 2006 statement is to simplify the provisions and make them more user friendly.  This specific duty relates to transactions between a Director and a third party, in particular dealing with property information or business opportunities, it does not extend to transactions as between a Director and his own Company, where a different Rule applies.

 

            The Act allows Directors to enter into transactions with third parties when Directors' interests conflict with the Company's interests.  Previously, shareholders' approval would have been necessary.  Now, these are permitted where:

 

            (a)         the situation cannot reasonably be regarded as likely to give conflict;  and

 

(b)        where the matter has been authorised by the Board of Directors (without the conflicted Director voting).

 

In circumstances described above, Board authorisation may be given only if:

 

(i)         in the case of a public company, its Articles of Association expressly permit authorisation of conflicts by the Board and in the case of a private company, there is nothing in the Articles of Association which would invalidate such Board authorisation;

 

(ii)         any quorum requirement is met without counting the interested or conflicted Director(s);  and

 

(iii)        authorisation is given, excluding any votes cast by the interested / conflicted Director(s).

 

It has been thought that this duty might impact on Directors who hold a multiplicity of Board positions, particularly as these individuals will be subject to a duty of confidentiality to one or more of these Companies.  If in doubt, Directors should seek independent legal advice as to whether a conflict of interest exists.

 

6.         Duty not to accept benefits from third parties

  

This provision is effectively a re-statement of the existing Rule that a Director cannot accept a benefit from a third party by reason of his being a Director or his actings or failing to act in his capacity as a Director.  The obligation continues beyond the point where a Director ceases to hold office and a person can be held liable for things that he did, or failed to do, whilst he held the office as Director.

 

Benefits include both monetary and non-monetary items.  A Director will not however be deemed to be in breach of this duty if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.  There is no minimum threshold to the duty.  Companies should give consideration as to what practical guidance they should issue to their Board members on what is generally accepted as benefits that can be received, particularly as there may be invitations to corporate hospitality and the like to consider.

 

7.         Duty to declare interest in proposed transactions

            and arrangements

  

A Director is obliged to disclose his interest to the Board of the Company when a transaction is proposed between a Director and his Company.  This re-states the provision in the 1985 Act.  However, the new obligation goes further, requiring the Director to declare the nature and extent of the interest to his fellow Directors.  The Board Member should be aware that disclosure extends to persons connected with the Director, for example, a spouse, civil partner, parent, child, step-child, partner in an enduring family relationship and a partner's children or step-children (if under 18 and living with the Director).

 

A Director will not be found to have breached this duty where he was not aware and could not be reasonably deemed to have been aware of the interest, or the matter could not reasonably be regarded as giving rise to a conflict situation, or if, and to the extent that the other Directors were, or ought reasonably to have been aware of the interest, or if it concerns his Service Contract which has been considered at an appropriate Board Meeting. 

 

This duty is codified in Section 177 of the Act but Section 182 of the 2006 Act declares that Directors must intimate an interest in any existing transaction or arrangement with the Company as failure to make such a declaration could result in a criminal offence having occurred.

 

The codification of Directors' duties and responsibilities became effective on 1st October 2007 with the exception of the three duties relating to conflicts of interest and the Section 182 obligation.  These come into force on 1st October 2008 and Boards should be considering now how they guide their Board to manage same.