Chapter 5 - Test yourself Q&A's - Directors Duties and Powers

Question 1

Where might you find limitations on the directors’ management powers?

Answer 1

1. An Objects clause
2. An Other Article provision which may impose a borrowing limit or require shareholder approval
3. Article provisions allowing the members to give directions to the directors
4. A Shareholder Agreement - which could require shareholder approval for certain types of decisions
5. The CA2006 and listings rules - which both impose requirements for shareholder approval

Question 2

Identify at least two special powers that are usually conferred by the article on the directors?

Answer 2

1. The power to delegate
2. The power to reject transfers
3. The power to pay and fix directors’ remuneration and fees
4. The power to forfeit shares
5. The chairs’ right to a casting vote

Question 3

Is setting the company’s strategy a management decision?

Answer 3

Setting the company’s strategy is a management decision.
It is one of several management decision that, under the UK Code, must be performed through the board. Accordingly, it is wrong to suggest that the board delegates all management responsibility to the executive directors.

Question 4

Can shareholders interfere in the management of the company?

Answer 4

Most articles of association provide a method by which shareholder can give direction to the board (typically passing a special resolution).
Those directions could cover matters regarding the management of the company. However, shareholders do not normally interfere in this way on management issues as its easier for them to secure their objectives by appointing and removing directors.

Question 5

Which of the general duties of directors arise from which of the fiduciary duties of trustees?

Answer 5

DGD - Duty to act within powers in accordance with the company’s constitution (and to use those powers for proper purposes).
FDofT - Duty to act in accordance with the trust deed.

DGD - Duty to promote the success of the company.
FDoT - Duty to act in good faith in the interests of the beneficiaries.

DGD - Duty to exercise reasonable care, skill and diligence.
FDoT - N/A

DGD - Duty to avoid conflicts of interest.
FDoT - A combination of the duty not to place themselves in a position where their own interest conflicts with the fiduciary duties and the duty not to make a profit from their position.

DGD - Duty to not accept benefits from third parties
FDoT - A combination of the duty not to place themselves in a position where their own interest conflicts with the fiduciary duties and the duty not to make a profit from their position.

DGD - Duty to declare any interest in proposed transactions or arrangements.
FDoT - A combination of the duty not to place themselves in a position where their own interest conflicts with the fiduciary duties and the duty not to make a profit from their position.

Question 6

What is a fiduciary?

Answer 6

A fiduciary is a person in a position of trust - like a trustee.

Question 7

What are the remedies for a breach of the general duties?

Answer 7

The remedies available for a breach of general duties by director vary depending on the nature of the breach.

As a general rule, directors can be made to repay any illegal payments they have received or secret profits they have made.

Where there is a breach of the duty of skill and care or the directors have acted beyond their powers, the company can be awards compensation for any losses that it has suffered.

Where the directors have acted outside their powers, the courts cannot normally declare the transaction void. However, where the directors have used their power for improper purposes, the transaction can be declared void.

Where a director has failed to disclose an interest in a transaction, the company can choose whether or not to treat that transaction as void.

Question 8

Why are directors rarely sued for exceeding their powers?

Answer 8

Directors are rarely sued for exceeding their powers because:

1. Recent practice has been to draft any objects clauses very widely so as not to constrain what directors can do.
2. Companies are no longer required to have object clauses and if they do not have one, their objects are deemed to be unrestricted.
3. Even in a company has a restricted objects clause, the company must have suffered a loss for it to be worth suing the directors.

Question 9

Why do you think there are a lot more cases about directors using their powers for improper purposes?

Answer 9

There are probably more cases about directors using their powers for improper purposes because:

1. This happens more often.
2. Directors are not aware of the underlying rule and believe, from a reading of the articles, that their powers are unrestricted in this regard.
3. The remedies that the courts are willing to apply include declaring the improper transaction void.

Question 10

What are the consequences of the directors exceeding their powers and how do these compare with cases where they have used their powers for improper purposes?

Answer 10

Where the directors have exceeded their powers, the transaction is still enforceable by third parties dealing with the company in good faith. However, the directors can be sued for any losses that the company suffered as a result of the breach.

Where the directors have used their powers for improper purposes, the transaction can be declared void.

Question 11

According to the CA2006, what is the purpose of the strategic report?

Answer 11

According to the Act, the purpose of the strategic report is to

1. inform members of the company
2. help them assess how the directors have performed their duty under s172 - to promote the success of the company.

Question 12

What does ‘promoting the success if the company’ mean?

Answer 12

The Act provides that directors have a duty to exercise their powers to promote the success if the company for the benefits of the members. In doing so, they must regard the likely consequences of any decision in the long term and various other matters.
It would appear therefore that success can be equated with what is in the best interests of the company’s members / shareholders.

Directors are allowed to take other interests into account however, the interests of shareholders are paramount.

The benefit to the shareholder does not need to be immediate and the directors may not be in breach of this duty if the company fails as long as they believed at the time that their actions would promote the success of the company.

S172 also recognises that a successful company need a contented and committed workforce, good relationships with its customers and suppliers and a reputation for high standards of business conduct. It also recognises that a company’s reputation may suffer if it has an adverse effect in the environment.

Question 13

Do directors need to consider stakeholder interests whenever they make a decision?

Answer 13

Where a decision may impact on the interests of stakeholders, directors must take those interests into account.

Not all decisions will have an impact on stakeholders. Some may only have a very minor (or theoretical) impact. There is no need to record the fact that the board has taken into account the interests of the stakeholders in these circumstances. It is much more important to do so in circumstances where the decision may have a major impact on stakeholders (e.g. shutting down a factory). The fact that such a decision might not be in the interest of the factory workers does not prevent the company from making that decision.

Question 14

What tests should be applied in judging whether a director has breached the duty of skill and care?

Answer 14

Under s174 (2), the standard against which the duty of directors to exercise due diligence, skill and care is judged is that of a ‘reasonably diligent person’ with:

1. The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company

and

2. the general knowledge, skill and experience that the director has

Question 15

To what extent can directors rely on other company officials?

Answer 15

Directors are entitled to trust people in positions of responsibility until there is a reason to distrust them (Norman vs Theodore Goddard 1991).

However, delegation by the directors does not absolve them completely from the duty to exercise due skill and care.

They can be found to be in breach of that duty if they fail to exercise adequate supervision over those performing those delegated functions.

Question 16

What sort of conflict does s175 relate to?

Answer 16

The duty to avoid conflict in s175, applies in particular to the exploitation of any property, information or opportunity.

S175 (3) clarifies that it does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company in which a director has an interest. This type of conflict is dealt with separately by SS177 and 182 of the Act.

Question 17

What are consequences of a breach of this duty?

Answer 17

A director who wrongly makes a profit by exploiting a business opportunity that belongs to the company can be made to repay that profit.

The courts may also rule that a third party acquiring company property through a breach of duty by directors holds that property on behalf of the company as a constructive trustee and as a result, can be forced to return it.

Question 18

Who can authorise a conflict of interest and what is the effect of authorisation?

Answer 18

Under s175 of CA2006, the non-conflicted directors may now authorise conflicts such as the exploitation of business opportunities. This is the case for a private company unless the articles provide otherwise.

In the case of public company, the articles must specifically allow the board to authorise such conflicts. If a conflict has been properly authorised, the duty is not infringed, which means that the director cannot be sued on these grounds.

Question 19

Do directors’ interest in transactions and arrangements need to be authorised?

Answer 19

A conflict of interest that arises out of a directors interest in a transaction or arrangement with the company does not need to be authorised.

The transaction itself may need to be authorised by the board if it is one of the matters reserved for its decision.

However, the fact that the director has an interest in the transaction does not need to be authorised either by the board or the shareholders.

Question 20

Why are directors required to disclose their interests in proposed transcations?

Answer 20

Directors are required to disclose their interests in proposed transactions or arrangements with the company to:

1. Ensure that the other directors are aware of that interest before entering into that transaction or arrangement.
2. Ensure that the chair is able to rule on whether the director can participate in the decision on that matter.

Question 21

Why are they required to disclose their interests in existing transactions?

Answer 21

Directors are required to disclose their interests in existing transactions because:

1. They might otherwise be able to exert covert influence on the continuation or management of that contract or arrangement and
2. A failure to disclose an interest in a proposed transaction becomes a criminal offence under s182 as soon as it becomes an existing transaction. i.e. when the company enters into that transaction and the director’s interest has still not been disclosed.

Question 22

List the general duties of a director under Part 10, Chapter 2 of the CA 2006

Answer 22

171 - To act within their powers in accordance with the company’s constitution (and to use those powers for proper purpose)

172 - To promote the success of the company

173 - To exercise independent judgement

174 - To exercise reasonable care, skill and diligence

175 - To avoid conflicts of interest

176 - Not to accept benefits from third parties

177 - To declare any interest in proposed transactions or arrangements

Question 23

What is a derivative action?

Answer 23

A derivative action is a special court procedure which enables shareholders to bring legal action in the name of the company against a director(s) for breach of duty. If the action succeeds, any compensation is awarded to the company rather than to the shareholders who initiated it.