A guide to the legal duties of a company director, for companies and directors

23/05/2024

The directors of a company are responsible for the day-to-day management and running of the company. This is an important role and, as such, the Companies Act 2006 imposes various significant legal duties on directors of UK limited companies. Often, company directors are not fully aware of the scope and extent of their legal duties.

This article is intended to serve as a guide for companies and directors, on the fundamental duties and responsibilities of a company director. However, it is not intended to constitute legal advice or to serve as a substitute for such advice. Suitable legal advice should always be sought before taking (or deciding not to take) any significant step in these areas, or in any situation where there are likely to be legal dimensions. The latter might include a company or its shareholders having concerns over a director’s conduct, or where you are a director that has been accused of misconduct.

The difference between directors and shareholders

To put it simply, a shareholder is an owner of the company and is unlikely (unless he or she is also a director or employee) to be involved in the day-to-day running of the company’s business. A director is appointed by the shareholders to manage the day-to-day running of the business, to make strategic and operational decisions and to ensure that the company meets its statutory obligations. The basic rule is that the directors should act together as a board, but typically the board may also delegate certain of its powers to individual directors or to a committee of the board.

Often a person will be both a shareholder and a director of a company (and sometimes also an employee). This is particularly the case for family businesses. However, it is important to appreciate that there is a vast distinction between the role of a shareholder and that of a director. For a person who is both, it is crucial that a distinction is drawn between these two separate roles. This is because directors have many duties and responsibilities that shareholders, in their capacity as such, do not.

What are the duties and responsibilities of a company director?

Statutory duties under the Companies Act 2006

There are seven general duties that are owed by a director of a company to the company (and not to any individual shareholder). These duties are set out in sections 171 to 177 of the Companies Act 2006. A breach of these duties would be a breach of company law, and would entitle the company or its shareholders to bring legal action against the director for misconduct.

The general duties are:

1. A duty to act within the powers given to them (s.171 of the Companies Act 2006)

A director of a company must act in accordance with the company’s constitution and only exercise powers for the purpose for which they are conferred.

The company’s constitution means its Articles of Association and any agreements and resolutions of a constitutional nature. It is therefore important for a director to be familiar with the terms of the relevant documents which form the company’s constitution

2. A duty to promote the success of the company (s.172 of the Companies Act 2006)

A director of a company 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 shareholders as a whole.

“Success” will generally mean a long-term increase in the value of the company but fundamentally it is up to each director to decide, in good faith, whether it is appropriate for the company to take a particular course of action.

In exercising this duty, a director needs to bear in mind (amongst other matters) the following factors:

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
the need to act fairly between members of the company

This duty is often relevant in the context of, or is the itself the subject of, disputes. It is strongly advisable for directors to document their compliance with this duty in board minutes, especially where one of the factors above is clearly relevant to a board’s deliberation and decision.

3. A duty to exercise independent judgement (s.173 of the Companies Act 2006)

A director must exercise independent judgement and make his or her own decisions. If professional advice is taken, then a director should still use his or her own judgement as to whether to follow it.

4. A duty to exercise reasonable care, skill and diligence (s.174 of the Companies Act 2006)

A director must exercise the same 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 same functions in relation to the company; and
the general knowledge, skill and experience that is actually possessed by the director in question

So, the expected standard is measured both objectively and subjectively. A director’s actual understanding and abilities may not be enough if more could reasonably be expected of someone in his or her position.

5. A duty to avoid conflicts of interest (s.175 of the Companies Act 2006)

Directors must avoid a situation in which they have, or could have, an interest that conflicts, or may conflict, with the interests of the company.

This duty applies to the exploitation of any property, information or opportunity, regardless of whether the company could take advantage of it.

This duty is not infringed if the situation has been pre-authorised. Authorisation may be given in the company’s constitutional documents, or by the other directors that do not share the same conflict or potential conflict (as long as the board has the power to authorise conflicts, under the Articles of Association).

If a director thinks he or she may be in a potential conflict situation then he or she should seek approval. If the board does not have the power to authorise conflicts, or is otherwise unable to approve the conflict situation, it can refer the matter to the shareholders for approval.

The director might therefore check the company’s constitutional documents as a first step. The Articles of Association might contain provisions relating to conflicts including granting pre-authorisation in certain limited circumstances.

6. A duty not to accept benefits from third parties (s.176 of the Companies Act 2006)

A director must not accept from a third party a benefit which has been given because that person is a director.

This duty is not infringed if a director’s acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.

7. A duty to declare an interest in any proposed or existing transactions or arrangements with the company (s.177 of the Companies Act 2006)

If a director is any way, directly or indirectly, interested in a transaction or arrangement with the company, then that director must declare the nature and extent of the interest to the other directors.

In the case of a proposed transaction, the interested director must make this declaration before the transaction is entered into. In the case of an existing transaction, the director must do this as soon as reasonably practicable.

This duty is not infringed if an interest has not been declared because the director is unaware that they have the interest, or because the director is aware that the other directors are already (or ought reasonably to be) aware of it.

Other duties and responsibilities of a company director

The Companies Act 2006 imposes an array of other obligations on directors.

Some are personal in nature and are specifically addressed to the directors. Others arise from the responsibility of the directors to ensure that the company carries out its obligations (where both the company and the directors may face liability in the event of a failure).

Probably the most significant are the duties of the directors relating to the preparation, content, circulation and filing of the company’s annual reports and accounts, where many of the obligations fall directly on the directors.

Obligations are also imposed on directors from other sources beyond the main company legislation. Some examples are:

A director owes, under common law principles, a duty of confidentiality to their company and must use or disclose the company’s confidential information only for the benefit of the company.
Directors are responsible for ensuring that the company complies with its obligations relating to the health, safety and welfare at work of its workers, under health and safety legislation.
Similarly, obligations arise under environmental, competition and anti-corruption legislation.

Where a company is in financial difficulties the directors should seek independent advice as soon as possible if they are to avoid potential personal liability under insolvency legislation. In such a situation it is likely that the primary duty of the directors shifts and is to the company’s creditors, rather than its shareholders.

The potential risks for a director in this area are complex and include the risk of being disqualified from holding the position of director or being involved in the promotion or management of a company for a period of up to 15 years.

What can be done if a director is in breach of one or more or their statutory duties?

The director can try to save the situation by arranging for the breach to be ratified by resolution of the company’s shareholders.

In the absence of such ratification, the company itself can take legal action against a director if there has been a breach of duty. The decision to start proceedings against a director would be made by the board or, in an insolvency situation, a liquidator. In certain circumstances and subject to certain hurdles, an individual shareholder or group of shareholders can also bring a claim against a director for breach of duty on behalf of the company (this is known as a derivative action).

The civil remedies that can be sought by the company against an offending director personally include an injunction, damages or compensation.

Early involvement from a commercial dispute resolution lawyer will help in identifying the crux of the issue and any potential solution or remedies to limit the damage caused. It will also ideally promote an upfront discussion between the parties prior to matters escalating to court. The English courts advocate parties exploring alternative means of resolution, such as mediation, and these options can be explored at any stage in the process.

If you have any questions arising from this article or have any issues you wish to discuss, whatever stage these may be at, please contact either Richard Gore ([email protected] or 07916 160387) or Claire Boucher ([email protected] or 07939 288777).

This article is not legal advice, which it may be sensible to obtain before you take any decisions or actions in the areas covered. Please do contact us if you would like an initial discussion of your situation.