Directors Duties

by Vaughan Jones

Over the past few years, many businesses run by sole traders and partnerships have been advised to become incorporated and take on the legal status of a limited company. Although there are, of course, advantages in incorporation, it also brings responsibilities. This month, we’re looking at some of the legal duties of a director. This article does not provide an exhaustive list of responsibilities, but it gives a brief overview of the main duties. A coherent code of conduct for directors is yet to be enacted, so as of now directors have a range of duties which arise from different sources.

Each director owes a duty individually to the Company to act in the company’s best interests and to make proper decisions in addition to the directors’ shared duties (i.e. where the directors act as a board). Non-executive directors have the same responsibilities as executive directors even if they do not have the same day to day responsibilities in the company’s operations.

Fiduciary Duties

Many of a director’s duties are termed “fiduciary” – holding a directorship is akin to the role of trustee. These duties exist under the common law. A director must not:

* “fetter his discretion” e.g. by making promises to a third party as a director regardless of the company’s interests.

* abuse his position in respect of the company or its assets. The safeguarding of confidential information is covered here.

Directors have a responsibility to act in good faith, in what they believe is the best interests of the company. The consideration of shareholders is also essential: a decision on whether to pay dividends at a time when the business has cash needs requires a balancing of the interests of the company and of its shareholders. Giving equal and honest consideration to all shareholders, regardless of the size of their shareholding, is another fiduciary duty.

A director is required to show the level of skill and care that may be reasonably expected from a person with the director’s experience and knowledge in looking after his own affairs. Finally, directors should not make “secret” profits by, for example, keeping to him or herself a business opportunity which properly belongs to the company. Where these duties are not fulfilled, a director, whether executive or non-executive, may be liable to pay damages.

Statutory Duties

The penalties for failing to meet statutory duties are stiff and can include imprisonment as well as fines.

A director must disclose any interest in a contract or proposed contract with the company and give notice to the company of his interests in shares in the company/group members. Shareholder approval is required of contracts (“arrangements”) between the company and a director, his family members or any associated companies. Shareholder approval is also needed where service contracts have a term of more than five years, as well as on certain proposed payments on loss of office.

Most loans by a company to its directors are prohibited. In terms of conduct, a director must act according to the object listed in the company’s Memorandum of Association and within the powers granted by the Memorandum and Articles of Association.

Under the Enterprise Act 2002, what are described as “cartel” offences are prohibited. Such activities include any “horizontal” agreements which dishonestly fix prices or sharing markets, limit supply, or constitute bid rigging.

Where the company has trading difficulties, it is up to the directors to ensure there is no wrongful trading: if a director knows or ought to know there is no reasonable prospect of avoiding insolvent liquidation, he must advise the board and take all steps to minimise loss to creditors.

The director also has responsibilities under company law which dictate internal management processes such as:

* filing of documents (statutory returns and accounts)

* formal approval of accounts

* holding an annual general meeting

* taking minutes of board meetings

Duties to Third Parties

A director’s duties to third parties are mostly statutory. Those affecting employees are included under the Companies Act 1985 while others are encompassed in health and safety legislation. Under the Health & Safety at Work Act 1974 it is a now well-established duty of directors to ensure, so far as reasonably practicable, health and safety at work and take reasonable means to ensure premises and plant are safe.

Failure to act, where there is knowledge of a danger, can give rise to prosecution and a breach of an improvement or prohibition notice can lead to imprisonment. A director may be liable for manslaughter where death is caused by his gross breach of duty of care or negligence. (Prosecutions of companies require an individual to be identified as the “controlling mind”, and there have been few convictions to date. The much publicised Corporate Manslaughter Bill affects companies only, and will not affect the position of individuals). Health and Safety legislation also lays down internal management requirements such as the necessity of producing Health and Safety policy statements which must be reviewed and monitored by the board of directors.

Relief from Liability

A Court may allow a director some relief from liability to his company in the case of negligence, default, breach of duty to company due to failure to show skill or care or breach of fiduciary duty if he has acted honestly and reasonably. Also, some breaches of a directors duties can be ratified by the company’s shareholders. Last April new regulations were introduced under the Companies Act 1985. These regulations extend a company’s ability to indemnify its directors to cover proceedings by third parties (but cannot cover liability of the director to the company itself) and allow the company to pay for a director’s (successful) defence costs. In order to take advantage of the new regulations, the Company’s Articles need to be amended. If you haven’t already done so, now is the time to instruct your solicitor to make these changes.

Forthcoming Changes

The Company Law Reform Bill is moving through Parliament now and is expected to come into force in April 2007. Amongst other measures, this Bill proposes organising a director’s various duties into seven general duties – a statutory set of rules for directors’ conduct which will largely codify the existing common law but will also include new elements of social responsibility. Once the Bill has taken its final shape and become law, its full scope and likely impact will be assessed here.

For further information or advice on directors’ responsibilities, contact Vaughan Jones on 01228 552222. Vaughan Jones is a partner in Burnetts Solicitors’ corporate and commercial law team.

May 2006