Directors’ Duties under the Companies Act 2006

by Kidd Rapinet on February 29, 2008

On 1 October 2007 a substantial part of the Companies Act 2006 came into force. Amongst the new provisions are a new codified statement of directors’ duties. These set out for the first time in statute principles of law that previously had to be gathered from case law.

There are seven general duties, set out in sections 171 to 177 of the Act.  Only the first four are so far in force.  The remaining two come into force on 1 October 2008.

1. Duty to act within powers

A director must 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

A director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members (i.e. its shareholders) as a whole, and in doing so have regard (amongst other matters) to:

  • the likely consequences of any decision in the long term
  • the interests of the company’s employees
  • the need to foster the company’s business relationships with suppliers, customers and others
  • the impact of the company’s operations on the community and the environment
  • the desirability of the company maintaining a reputation for high standards of business conduct; and
  • the need to act fairly as between members of the company.

This statutory list of factors is new. There has been much debate as to the extent to which it is necessary for the board of directors to minute their consideration of these factors. The best guidance is probably that from the GC100 group of General Counsel to FTSE100 companies, that:

  • companies should ensure that all directors are aware of their duties under the new Companies Act; and
  • where the nature of the decision being taken by directors is such that it is supported by a formal process, that process need only specifically record consideration of those duties where the particular circumstances make it particularly necessary or relevant. The default position should be not to include these references.

Obviously this does not mean that the directors should fail to consider these factors. Any conscientious director would do so in any case. But it is for a claimant challenging a decision to prove his case, and a detailed minute could potentially lay the directors open to a more detailed challenge on the specifics.

3. Duty to exercise independent judgment

A director must exercise independent judgment. This duty is not infringed by his acting in accordance with an agreement entered into by the company that restricts the future exercise of discretion by its directors, or in a way authorised by the company’s constitution.

4. Duty to exercise reasonable care, skill and diligence

A director must exercise the 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; and
  • the general knowledge, skill and experience that the director has.

This test, which reflects the previous law, is partly objective and partly subjective: setting a minimum standard but taking account of the director’s particular expertise.

5. 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 possibly may conflict, with the interest of the company. This applies in particular to the exploitation of any property, information or opportunity, whether or not the company could take advantage of it.

In a change from the existing law, the board of directors may authorise a conflict of interest, subject to the company’s constitution and to only those independent directors who do not have the conflict voting on it. Previously only the shareholders could authorise this.

6. Duty not to accept benefits from third parties

A director must not accept a benefit from a third party conferred by reason of his being a director or his doing (or not doing) anything as a director. A ‘third party’ for this purpose does not include associated companies or persons to whom the company provides the director’s services. Nor is the duty infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest or duties. This exception would cover trivial matters, such as a supplier buying a director a drink.

7. Duty to declare interest in proposed transaction or arrangement

If a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors. The declaration may be made at a board meeting or by written notice.  It must be made before the company enters into the transaction or arrangement. A declaration need not be made where the matter cannot reasonably be regarded as likely to give rise to a conflict of interest, where the other directors are already aware of it, or where it concerns the terms of his own service contract.

Curiously, there is a separate requirement (in Section 182) to declare an interest in existing transactions or arrangements, where an interest was not declared in the proposed transaction or arrangement. Failure to do this is a criminal offence.

Although it may seem extensive, the above is not a complete statement of a director’s duties. There are other duties in the 2006 Act (e.g. the duties to deliver accounts and annual returns) and some duties remain uncodified (e.g. the duty to consider creditors’ interests if the company is potentially insolvent).

The above duties are owed to the company itself; not to individual shareholders or to any of the third party stakeholders to whose interests the directors are to have regard (as listed in 2. above). They are enforceable by a civil action. The board of the company would therefore need to decide (by a majority) to take proceedings against a director, or former director, considered to have breached his duties. This could happen following a takeover, or other change of management. If the company goes into liquidation, the liquidator could take proceedings.  Or in certain circumstances an individual shareholder could bring a derivative action under the 2006 Act, but any damages would go to the company, and not directly to the shareholder.

All company directors should be aware of their duties, and of the new statutory restatement of them. Engagement letters and service contracts for directors should make specific reference to them, and existing corporate practices should be reviewed to ensure compliance. Specific legal advice should of course be sought where appropriate.