Chapter 4: Directors’ Duties and Responsibilities Flashcards
The role of directors
This element covers the role of a director in a company.
How directors are appointed and removed from office is dealt with in the next topic.
Introduction
One key point to remember when considering the role of directors is that, as a company is inanimate, it is the directors who on a day to day basis are responsible for managing the company through an agency relationship. The directors are accountable to the company itself rather than to the shareholders directly. The shareholders own the company yet have input only into certain key decisions. It is therefore important to remember the relationship between directors and shareholders:
Directors
- Manage the company on a day to day basis – on an agency basis
- Certain actions can only be taken by directors if the shareholders have given authority
- Owe duties to the company
Shareholders
- Own the company
- Are able to control key decisions through shareholder resolutions eg to give directors authority to change the name of the company
Shareholders
It is common for directors and shareholders to be the same people in a company.
Directors’ authority to manage the company
Directors’ authority to manage the company
CA 2006 reserves certain important decisions for shareholder approval, such as changing the company’s name (unless the articles provide otherwise), amending the articles of association, removing directors and so on. The board of a company with MA is usually free under a company’s articles to make decisions on behalf of the company on all other matters (MA 3).
Directors’ authority to manage the company
The directors can therefore act on behalf of the company to employ individuals (other than directors on long term service contracts) and decide what they will be paid, enter into contracts with customers and suppliers, buy and sell company property, raise funds by borrowing from banks and authorise the company’s assets to be used as security. The directors are also responsible for putting together company accounts and for supplying information to auditors. These are just a few examples of the decisions that directors are free to make without shareholder approval.
The board of a company with MA is usually free under a company’s articles to make decisions on behalf of the company on all other matters (MA 3).
MA 5 allows the Board of Directors to delegate a particular decision to one of the directors or a committee. For example, a HR Director might be delegated decision-making with regards to the HR decisions of a company.
Directors’ accountability
The power delegated to the directors is therefore extremely wide and, if this power were left unchecked and unregulated, the less ethically minded might start using companies as a medium for a variety of corrupt practices. Certain directors may, for example, decide to lend themselves company funds on very favourable terms or even give false or misleading statements in the accounts to make the company look more attractive to investors or banks.
Directors’ accountability
In order to prevent such practices and to ensure companies are run for the benefit of, amongst others, their shareholders and for the protection of the company’s creditors, directors’ actions and powers are restricted and regulated by statute. The key provisions are included in Part 10 of CA 2006, which includes directors’ general duties. We will look at directors’ duties in detail later in this topic.
Directors’ accountability
Directors can be made to account for wrongs done through civil and criminal actions taken against them for breaching the Companies Acts. They may also be found guilty of criminal actions and sentenced under other legislation eg fraud under the Fraud Act 2006, and/or offences under the Theft Act 1968; insider dealing under the Criminal Justice Act 1993; money laundering under the Proceeds of Crime Act 2002.
What is a director?
The term ‘director’ is not defined in CA 2006; instead s 250 CA 2006 states that ‘director’ includes any person occupying the position of director, by whatever name called.
There are a number of categories of director which we consider further:
At law:
- de jure;
- de facto, and
- shadow directors
In practice:
- executive and
- non executive directors
The company’s articles may also provide for alternate directors.
De jure directors and de facto directors
A de jure director is a director who has been validly appointed at law.
Under s 154 CA 2006:
- a private limited company must have at least one director and
- a public limited company must have at least two directors.
Although a company can be appointed as a director, every company must have at least one director who is a natural person (s 155(1) CA 2006) to ensure that for all companies, there will always be one individual in place to aid accountability.
De jure directors and de facto directors
The CA 2006 does not prescribe a maximum number of directors and neither do the MA, but a company can put a maximum number of directors into its own articles.
Under s 157 CA 2006 a person may not be appointed as a director unless they are at least 16 years old. ECCTA has now amended CA 2006 by inserting a new section 159A into CA 2006. This section is effective from 4 March 2024, and prohibits a person from being appointed as a company director if that person is disqualified under director disqualification legislation, unless they have permission of the Court.
A de facto director is someone who assumes to act as a director but has in fact not been validly appointed. The fiduciary duties and liabilities apply to de facto directors as they do to de jure directors.
Shadow directors
Sometimes a person (usually a shareholder) may try to exert influence over the board but without being appointed as a director, in an effort to avoid the duties imposed on directors under CA 2006 and the common law.
Section 251(1) CA 2006 defines a shadow director as ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act’. Section 251(2) makes it clear that professional advisers are not to be regarded as shadow directors eg an accountant providing professional advice on the company’s finances will not usually be a shadow director, even if the directors follow the advice of the accountant to the letter.
Shadow directors
This legislation is designed to ensure that anyone who acts as a director, even if they are not technically appointed as one, is subject to the duties and restrictions which apply to all directors. For example, a friend of a director who gives advice from ‘behind the scenes’, which the directors follow, would be seen as a shadow director. Most of the provisions in the CA 2006 and the Insolvency Act 1986 imposing duties, obligations or restrictions on directors therefore apply equally to shadow directors.
(See for example, s 162(6) in respect of the keeping of registers of directors, s 223 in respect of transactions with directors requiring shareholder approval, and ss 230 - 231 CA 2006 concerning the keeping of copies of service contracts and the wrongful trading provisions under s 214 IA 1986.)
Executive and non-executive directors
The CA 2006 does not differentiate between executive and non-executive directors, but in practice there is a distinction. However, note that the duties, obligations and restrictions placed on directors under CA 2006apply to all directors, executive and non-executive.
Executive directors
An executive director is a director who has been appointed to executive office. Such a director will generally spend the majority, if not all, of their working time on the business of the company and will be both an officer and an employee of his company. Examples include a Finance Director, Managing Director, Marketing Director.
Non-executive directors
A non-executive director is also an officer of the company but will not be an employee of the company. Non-executive directors do not take part in the day-to-day running of the company. Their role is generally to provide independent guidance and advice to the board and to protect the interests of shareholders.
Alternate directors
The office of director is a personal responsibility. However, some companies in their articles provide for alternate directors to take the place of a director where one or more directors are absent.
An alternate director is usually either a fellow director of the company or someone who has been approved by a resolution of the board of directors. The alternate director has the voting powers of the absent director.
The MA do not provide for the appointment of alternate directors and, since it is now possible to hold board meetings over the telephone and to pass board resolutions by means of written resolutions, the use of alternate directors is becoming quite rare.
Whether or not the provisions of CA 2006 apply to alternate directors is a matter of construction, but it is thought that the duties of directors will apply equally to alternate directors.
Company secretary
A company secretary’s main duties are to keep the company books up-to-date, produce minutes of board and general meetings, and make sure that all necessary filings are made at Companies House. It is not a part of their role to take decisions on behalf of the company, which is the domain of either the directors or the shareholders.
In the past all companies were required to have a company secretary. But under CA 2006:
Company secretary
- a private company is not required to have a company secretary (s 270(1) CA 2006) unless the articles require it to have one. If a private company does not have a company secretary, the directors (or any person the directors authorise) may do anything that the secretary was required or authorised to do (s 270(3)(b) CA 2006).
Company secretary
- a public company must have a company secretary (s 271 CA 2006).
Part 12 of the CA 2006 applies to all companies with a company secretary. A public company secretary must have the requisite knowledge and experience, and one of the qualifications set out in s 273(2) CA 2006 (for example, the secretary may be a solicitor or a chartered accountant). The directors appoint the secretary and are required to check that the secretary qualifies under these provisions.
Summary
- Directors are responsible for the day-to-day management of the company.
- Directors are agents of the company.
- Directors who are validly appointed may be referred to as de jure directors. These directors may be executive or non-executive.
- It is possible for other individuals to act as a director where they are not in fact validly appointed as such. De facto, shadow and alternate directors fall into this category.
- Private companies are not required to have a company secretary. If a private company does not have a company secretary, any director may fulfil this role.
- Public companies are required to have a company secretary.
- All the different types of director are governed by the principles of CA 2006.
Appointment of directors
CA 2006 does not stipulate a procedure for the appointment of directors, so this is something that will be governed by the Articles of the company.
The MA deal with the matter simply. Companies with MA may appoint a director: By an ordinary resolution of the shareholders - MA 17(1)(a). By a decision of the directors - MA 17(1)(b)
Appointment of directors
It is usual for the board of directors to appoint new directors under MA17(1)(b) because is easier to put into effect. Unless there is a particular reason for using the ordinary resolution procedure, a director will be appointed by the majority of the other directors.
Of course, companies may instead have custom Articles setting out an alternative procedure for the appointment of directors, therefore you must always check the Articles of a company before advising on the appointment of directors.
Service contracts
An executive director will be an employee of the company. As an employee, they should be given a written contract of employment (otherwise known as a service contract), setting out the terms and conditions of employment including duties, remuneration package, notice provisions etc. There is no automatic entitlement for directors to be paid for their services – this is something that the board can determine, subject to the provisions of the company’s articles.
Service contracts
The Company has an obligation to keep its directors’ service contracts contracts (or, where the contracts are not in writing, memoranda of their terms) at its registered office for inspection by the members (s 228 CA 2006).
The effect of Art 19 MA is that the terms of an individual director’s service contract, including remuneration, are for the board to determine. As a general rule, a director’s service agreement will only require the approval of a resolution of the board of directors. However, shareholder approval is required to enter into long-term service contracts under s 188 CA 2006. You will look at this in the next element.
It is worth noting that one individual can be a director, a shareholder and an employee of a company. These are three separate roles.
Disclosure of identity of directors and secretary
The CA 2006 requires certain details about a company’s directors to be disclosed either publicly or to the members.
Every company must maintain a register of its directors (s 162(1) CA 2006) and secretary (s 275(1) CA 2006) and should keep these registers at its registered office.
Each company must also notify the Registrar of Companies (ie Companies House) of changes relating to its directors (s 167 CA 2006) or secretary (s 276 CA 2006) using forms published by Companies House (eg AP01 for Appointment of Director).
Disclosure of identity of directors and secretary
The particulars which must be registered in relation to directors are specified in ss 163(1) and 164 CA 2006 (and those for secretaries in ss 277(1) and 278(1) CA 2006).
The information kept at Companies House is available for inspection by the public (s1085(1) CA 2006) subject to some very limited exceptions, and, in addition, the register kept at a company’s registered office must be open for inspection by any member of the company without charge and by any other person on payment of a fee (ss 162(5) and 275(5) CA 2006 for the register of directors and secretaries respectively).
Privacy for Officers of the Company
The provisions of CA 2006 allow the directors and secretary more confidentiality than had previously been the case.
Section 163(1) CA 2006 specifies that a company’s register of directors must contain the following particulars in the case of an individual (a) name and any former name; (b) a service address; (c) the country or state in which he is usually resident; (d) nationality; (e) business occupation (if any); (f) date of birth.
Privacy for Officers of the Company
S.277(1) specifies that a company’s register of secretaries must contain the following particulars in the case of an individual (a) name and any former name; (b) address.. This service address can either be the director’s residential address (if they are not concerned with the need for privacy) or could simply be the company’s registered office and will be the only address available to the public generally. Residential addresses that are already on the public register will not be removed automatically.
Individual directors (but not secretaries) will still have to provide their residential address under s 165 CA 2006, but this information will be kept on a separate, secure register. This register is not open to public inspection.
Disclosure required: annual accounts
Section 412 CA 2006 relates to information about directors’ (and past directors’) remuneration and what information will need to be included in the company’s annual accounts. Two SIs currently set out in detail the information which needs to be included in the notes to a company’s annual accounts. This includes information relating to:
- the directors’ salaries, bonus payments and pension entitlements; and
- compensation paid to directors and past directors for loss of office.
Section 412 CA 2006 also requires details to be disclosed of any payments made to, or receivable by, a person connected to such a director or a body corporate controlled by a director.
Disclosure required: annual accounts
Section 413 CA 2006 relates to the disclosure of information on advances and credits given by a company to its directors and guarantees entered into by a company on behalf of its directors. Section 413 CA 2006 applies to a person who was a director at any time during the applicable financial year.
Removal of a director by the shareholders
The ability to remove a director from office is the ultimate sanction that shareholders have against a director. The director may not be performing well in their role or there may be a personality clash or a difference of opinion about company strategy and the best way to expand the business of the company.
Under s 168(1) CA 2006, a company (ie the shareholders) may by ordinary resolution remove a director before the expiration of their period of office.
Under s 168(2) CA 2006 special notice (28 days) is required of a removal resolution.
It is not possible for the Board to remove a director (unless the Articles specifically provide for this).
Directors who are also shareholders are allowed to vote in their capacity as a shareholder on the ordinary resolution to remove them.
You will learn about the process by which shareholders may remove a director in detail in ‘The rights and remedies of shareholders’ topic (‘Removal of a Director’ element).
Vacation from office
The other ways in which an individual may cease to be a director are:
Resignation by notice
A director may simply take the decision to resign from the board by tendering a letter of resignation. This procedure is provided for in MA 18(f). It is usual, although not obligatory, in these circumstances for the board to pass a board resolution accepting the letter of resignation.
Automatic termination
Under MA 18 a person ceases to be a director as soon as:
- the director becomes disqualified from being a director;
- the director becomes the subject of an individual voluntary arrangement (or similar);
- the director becomes bankrupt, or
- a registered medical practitioner who is treating the director states in writing to the company that the director has become physically or mentally incapable of acting as a director and will remain so for more than three months.
- Disqualification - Company Directors Disqualification Act 1986 (‘CDDA’)
- The CDDA is the key piece of legislation regarding disqualification of directors. Under this Act, the court may make a disqualification order against a person preventing them, unless they obtain leave of the court, to be a director, liquidator, receiver or in any other way directly or indirectly involved in the promotion, formation or management of a company. The purpose of such an order is to protect the public against the activities of such a director. Grounds for disqualification include fraudulent or wrongful trading or persistent breaches of company law.
- The period of disqualification is for a maximum of 15 years. If a director has been disqualified under the CDDA, it is a criminal offence to participate directly or indirectly in corporate management without leave of the court.
- Retirement by rotation
- The model articles for public companies require retirement and reappointment of directors by the members every three years. In addition, all directors of listed companies are subject to annual re-election.
- Companies House filing requirements
- When a director leaves office, the company must both update the company’s register of directors and also give notice to Companies House by filing form TM01 (Termination of appointment of director).
Summary
- The appointment of directors and granting of service contracts are governed by the provisions of a company’s articles. In general, the board decides on the appointments and terms of service contracts, although long-term service contracts will require shareholder approval.
- Companies are required to inform Companies House when they appoint new directors or when directors leave office and must keep a register of their directors.
- Directors’ personal details must be provided to Companies House although their residential addresses may be kept private.
Summary
- Certain information relating to financial payments to directors need to be disclosed in the company’s annual accounts which must be filed at Companies House.
- Directors may be removed from office by an ordinary resolution of shareholders.
- Directors may also leave office through resignation, disqualification under CDDA 1986, rotation or automatically if one of the reasons in MA 18 applies.
Duties and responsibilities of directors I
This element considers the duties a director owes to the company under CA 2006 s 171 – 174.
The next element will consider the duties owed to the company under s 175 – 177 and the consequences of breach of duty.
Introduction: Directors’ duties
As you will have seen, it is the directors who on a day-to-day basis are responsible for managing the company (MA 3). In order to protect the shareholders and creditors of the company from directors exploiting or abusing their powers to act in their own self-interest, directors are subject to the extensive duties. Whenever a director is making a decision, they must always consider all the duties to which they are subject.
171-177 CA 2006
The duties of directors were developed by the common law and equity but were codified in CA 2006, specifically ss 171-177 CA 2006. The statutory general duties should be interpreted and applied in the same way as common law rules and equitable principles (s 170(4) CA 2006).
General Duties
The general duties of directors are owed by a director to the company (and not to the shareholders directly). Any breach of duty by a director is therefore a wrong done to the company and it is the company who would therefore be the claimant in proceedings in respect of a breach of duty by a director. Note though that when a company is in financial difficulty, the position changes and the directors’ duties shift to the protection of the creditors. We will look at this in more detail in the insolvency topics.
The general duties of directors ss 170 – 177 CA 2006
The general duties are set out in sections 171-177 CA 2006 and are as follows:
- Duty to act within powers (s 171 CA 2006);
- Duty to promote the success of the company for the benefit of the members as a whole (s 172 CA 2006);
- Duty to exercise independent judgment (s 173 CA 2006);
- Duty to exercise reasonable care, skill and diligence (s 174 CA 2006);
- Duty to avoid conflicts of interest (s 175 CA 2006);
The general duties of directors ss 170 – 177 CA 2006
- Duty not to accept benefits from third parties (s 176 CA 2006); and
- Duty to declare any interest in a proposed transaction (s 177 CA 2006).
We will cover the duties under s 171 – 174 in this element. Sections 175 – 177 are covered in the next element.
Note that directors are also subject to duties under legislation other than CA 2006, egthose obligations contained within the Insolvency Act 1986. You will learn more about the responsibilities of directors of an insolvent company later on in this module.
Section 171 CA 2006: Duty to act within powers
This section effectively sets out 2 separate duties:
- Duty to act within the company’s constitution
The company’s constitution is defined in s 257 CA 2006 and includes everything set out in the company’s articles of association and decisions taken in accordance with the articles (ie shareholder resolutions). A director is in breach of this duty if they act without authority, eg commit the company to borrow more than the articles allow without prior shareholder approval.
- Duty to exercise powers for the purposes for which they are conferred
Directors must not use their powers for improper purposes (eg for personal gain).
Section 172 CA 2006: Duty to promote the success of the company
This duty has been the subject of much debate. It is seen as codifying the previous common law duty requiring directors to act in the ‘best interests’ of the company. It forms the central duty under the new regime.
Section 172 CA 2006 stipulates that a director must act in a way which they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.
Long-term increase in value
The Government has stated that ‘success’ should normally mean, for commercial companies, a ‘long-term increase in value’.
The list of matters to be considered is not exhaustive. It is clear that the list is secondary to the duty to shareholders under s 172 CA 2006, and that the duty is owed to the company and not to the third party.
In exercising this duty, a director is required to have regard to a range of non-exhaustive matters which are set out in s 172(1) CA 2006, including:
Long-term increase in value
the likely long-term consequences of any decision
employees’ interests
the need to foster relationships with suppliers, customers and others
the impact of the company’s operations on the community and the environment
the desirability of the company’s maintaining a reputation for high standards of business conduct
the need to act fairly as between the members of a company
Enlightened Shareholder Value
Although many of these matters were not specifically provided for under the common law, many companies would routinely consider such matters, as a necessary part of good business practice following the concept of ‘enlightened shareholder value’. This is a term used to describe the ‘middle way’ between, on the one hand, running the company purely to maximise shareholders’ interests/profits and, on the other hand, a pluralist approach which involves acting in the interests of a wider group of stakeholders.
Example
The directors of WYZ plc are deciding whether the company ought to install a new oil pipeline. They need to have regard to the range of matters listed in s 172(1) CA 2006, including the environmental implications of the pipeline, because these are mentioned in s172(1)(d) CA 2006.
However, having had regard to those matters, the directors may ultimately go ahead and install the pipeline anyway, causing a degree of environmental damage, if it promoted the success of the company to do so and is not in conflict with the other stakeholder factors to be considered under s 172 or their other duties.
Compliance with s 172 CA 2006
Since the introduction of the statutory duties there has been some uncertainty as to how to balance the various matters in the list, which will inevitably conflict from time to time.
One fear was that companies may feel the need to respond by having more detailed board minutes to document how they have considered each area for every decision made. Another was that the new duty under s 172 CA 2006 may lead to increased litigation. Neither fear has yet come to pass.
