Unit 7 - Directors Duties Flashcards
The client is the managing director of a construction company which needed to renew its fire insurance to cover equipment in its storage unit. The renewal application was made using the company’s insurance broker, who had handled the company’s insurance affairs without problems for five years.
The insurance broker e-mailed the insurance application form to the client. As she was busy and the matter was urgent, she did not read the form, but printed it out and signed it and sent it back to the insurance broker, asking him to complete it, trusting the insurance broker to fill the form out correctly. Unfortunately, the insurance broker gave an inaccurate answer to one of the questions on the form which was sent to the insurance company.
Last week a fire broke out in the construction company’s storage unit, destroying its equipment. Due to the inaccurate answer given by the broker on the application form the insurance company was entitled to refuse to pay out under the policy.
Is the client in breach of her duty to act with reasonable care, skill and diligence by delegating the matter to the insurance broker?
A) Yes, because the client could not have honestly believed that she was promoting the success of the company.
B) Yes, because a reasonably diligent managing director would not sign an insurance form without reading it.
C) No, because it was reasonable for the client to rely on the insurance broker’s expertise.
D) No, because busy directors often sign forms without reading them so on an objective test the client had met the required standard of care.
E) No, because on a subjective test, the client had met the required standard of care.
CORRECT ANSWER B
A company has Model Articles for private companies limited by shares unamended.
Which of the following breaches of duty of the directors of the company may be authorised by the board in advance?
A) Breach of the directors’ duty to exercise their powers for their proper purpose.
B) Breach of a director’s duty to promote the success of the company.
C) Breach of a director’s duty to avoid a conflict of interest with the company.
D) Breach of a director’s duty not to accept a benefit from a third party.
E) Breach of a director’s duty to declare an interest in a proposed transaction with the company.
CORRECT ANSWER C
Which of the following statements best reflects the position in relation to the ‘general duties’ of directors contained in Sections 171 to 177 of the Companies Act 2006?
A) The general duties only apply to properly appointed (‘de jure’) executive directors.
B) The general duties of the directors are owed to the company and each of its individual shareholders.
C) The general duties include the duty to declare an interest in an existing transaction with the company.
D) Before a breach of any of the general duties has occurred, it may be authorised by the board of directors.
E) Where a breach of any of the general duties has occurred, the breach may be ratified by a resolution of the shareholders.
CORRECT ANSWER E - Under s.239 CA 2006, the shareholders may by (ordinary) resolution usually ratify a breach of duty (as well as negligence, default or breach of trust) once it has occurred. [Note the wording is ‘may be ratified’ – not all breaches can be ratified, e.g. if there is fraud or a bribe under s.176.]
Option A is wrong. The duties are not only owed by formally appointed (de jure) executive directors but other persons, e.g. non-executive, directors. The position is less clear in relation to de facto and shadow directors, but they may too be liable.
Option B is wrong. The the duties are owed to the company and not the shareholders.
Option C is wrong. The duty to declare an interest in an existing transaction (s.182) is not one of the ‘general’ duties in ss.171 – 177 although the rules are similar to the duty to declare an interest in a proposed transaction in s.177.
Option D is wrong. Authorisation (which must take place before a transaction occurs where a conflict arises) is limited to s.175.
A client has been the sales director of a successful technology company which he set up with five other directors ten years ago. The company has Model Articles for private companies limited by shares without amendment.
The client’s sister recommended an investment scheme run by an offshore company, of which her husband is a director, claiming that the scheme offered a very attractive guaranteed return of 15%. Without conducting any further research or telling them of his connection to the offshore company, the client recommended the scheme to his fellow directors. The directors agreed to invest £100,000 relying only on the client’s recommendation.
Six months’ later the offshore company has gone into liquidation and the technology company has lost its investment.
Which one of the following statements best explains the liability of the client and his fellow directors for breach of their duties as a director?
A) As the company is a technology company, the investment was ultra vires, so all the directors are in breach of their duty to act within their powers.
B) As the client’s experience is in sales, he will not be liable for breach of his duty to exercise reasonable, care skill and diligence.
C) The client is in breach of his duty to declare his interest in the proposed transaction, but no other duties.
D) The client is in breach of his duty to declare his interest in the proposed transaction and his duty to declare his interest in an existing transaction.
E) The client will be in breach of his duty to avoid a conflict of interest.
CORRECT ANSWER D - By not disclosing his interest at the time of the transaction, the client has breached his duty to disclose an interest in the proposed transaction (s.177). Once the company entered into the transaction, the client would be breach of his duty to disclose his interest in an existing transaction (s.182).
Option A is wrong. The company was set up ten years ago under the Companies Act 2006 and so the ultra vires rule will not apply.
Option B is wrong. The client (and all the other directors) may be liable for breach of the duty under s.174 to act with reasonable care, skill and diligence by investing a large sum of money without fully investigating the scheme. It is irrelevant that the client’s experience is in sales. It would be reasonable to expect any director to investigate an offshore investment scheme before investing a large sum of money. With ten years’ experience as a director, the subjective as well as the objective standard expected would be high.
Option C is wrong. The client is in breach of his duty to declare an interest in a proposed transaction. Failure to disclose the interest may also amount to a breach of s.172, and it is likely that the client is in breach of his duties under ss.174 and 182 (as above). (Note that breach of s.174 would not in itself would be a breach of the s.172 duty to promote the success of the company, if the directors honestly believed that the scheme was in the best interests of the company).
Option E is wrong. The duty to avoid conflicts of interest does not apply to a conflict of interest arising in relation to a transaction with the company. (s.175(3)).
A client is the sole director of a car repair company. He and his friend are the shareholders. The company is not a very successful business. To save money, a month ago, the client ordered a large consignment of parts from a company which he found on the internet. The spares cost less than half the amount that they would have done if the client had bought them from his regular supplier.
The client placed the order over the phone and paid up front without making any enquiries about the internet company. The spares never arrived. The client has now made some enquiries about the internet company, and it seems that this was a scam. The internet company does not exist.
Has the client breached his duty to act with reasonable care, skill and diligence?
A) Yes, because the test is entirely objective, and no reasonable director would have ordered the spares without making enquiries into the internet company.
B) Yes, because both subjectively and objectively, the client would be expected to make reasonable enquiries into the internet company before placing the order.
C) No, because the client should have asked his friend before going ahead with the purchase.
D) No, because the test is entirely subjective, and the client believed that he could save the company money.
E) No, because the client is the sole director of the car repair company, there are no other directors to whom he owes a duty of reasonable care, skill and diligence.
CORRECT ANSWER B - The standard of care imposed by s.174 imposes a subjective and an objective test. On both tests, it would be reasonable to investigate the company before placing the order for a large consignment.
This makes Options A and D wrong. (Note that as far as Option D is concerned, the fact that the client believed that he could save the company money may save him from breach of s.172, but not s.174).
Option C is wrong. The purchase of spares for a business is within the powers of the directors (MA3) and there is no need for the client to obtain shareholder approval so it would not be reasonable to expect the client to do so. (Note that the client is acting within his powers).
Option E is wrong. The client owes the duty to the company, not to the other directors. It is irrelevant that he is a sole director
A client and his daughter are the only two directors of a successful company. Between them, they own 60% of the shares in the company. The remaining shares (40%) are owned by three other shareholders. The company has Model Articles for private companies limited by shares unamended.
All the shareholders want the company to expand its activities. To do so, the directors propose to borrow £5 million from the bank.
The other shareholders consider that taking on substantial borrowings is risky and want to raise money by issuing new shares. The directors are against this because they wish to retain control of the company and they cannot afford to subscribe for new shares.
Which one of the following statements best reflects the position of the directors in relation to financing the expansion?
A) In deciding to borrow the money rather than issue shares, the directors are exercising their power to borrow for an improper purpose.
B) The directors may go ahead with the loan ignoring the objections of the other shareholders, because borrowing money is within their general powers.
C) In borrowing the money, the directors would breach their duty to promote the success of the company and the other shareholders could bring an action for breach of duty,
D) Borrowing a large sum of money is incompatible with their duty to have regard to the interests of the creditors of the company.
E) The interests of the directors will conflict with the interests of the company and so they cannot go ahead with the loan.
CORRECT ANSWER A - Although the directors do have the power to borrow and give security under the Model Articles, that power, like all directors’ powers and authority, must be exercised for the proper purpose, and borrowing a large amount in order to retain control is likely to be an improper purpose (s.171(1)(b)).
This makes Option B wrong.
Option C is wrong. If the motive of the directors is to retain control, it may be arguable, that they are in breach of their duty under s.172 of the Companies Act 2006 to promote the success of the company but it is the company not the shareholders that must bring an action.
Option D is wrong. Under s.172 there is no requirement for the directors to have regard to the interests of the creditors unless the company is insolvent. The company is ‘successful’ so there is no suggestion of this.
Option E is wrong because the duty to avoid a conflict of interest does not apply to transactions with the company.
A company carries on business as an importer and retailer of cars manufactured in Italy. It is aware that a franchised car dealership is up for sale. After discussions at board level, the consensus amongst the directors is that the dealership is not a suitable target. One of the directors mentions this opportunity to his sister, who decides to investigate further whether or not she would like to purchase the dealership.
Which of the following best explains whether this director is in breach of any duty owed to the company?
A) There is a possibility that the director is in breach of his duties to the company because he is not exercising reasonable care and skill by mentioning the business opportunity to his sister.
B) There is a possibility that the director is in breach of his duties to the company because he is not exercising independent judgment by mentioning the business opportunity to his sister.
C) There is a possibility that the director is in breach of his duties to the company because he is putting himself in a position of potential conflict by providing his sister with the information to exploit the business opportunity.
D) There is a possibility that the director is in breach of his duties to the company, because he is not promoting its success by mentioning the business opportunity to his sister.
E) There is no possibility that the director is in breach of his duties to the company because the situation cannot be reasonably regarded as likely to give rise to a conflict of interest.
CORRECT ANSWER C - Directors must avoid situations in which they have, or can have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company (s 175 of the Companies Act 2006). The duty to avoid a conflict applies in particular to the exploitation of any property, information or opportunity and it is immaterial whether the company could have taken advantage of the opportunity but decided not to do so.
Options A, B and D set out other duties that directors owe their companies, but none are relevant here on the facts.
Option E is wrong as although it relates to the duty of a director not to put themselves into a position where there is a conflict of interest, it is not clear, without more facts, that this is a situation where it cannot reasonably regarded as likely to give rise to a conflict of interest and thus it cannot be said with certainty that the director is not in breach of his duties.
A private limited company is interested in purchasing a piece of land to further its expansion plans. The land is owned by one of the company directors but only some of the other directors are currently aware of this. The proposed purchase is to be discussed at the next board meeting of the company.
The company’s articles of association are the Model Articles for private companies limited by shares with one amendment. This provides that directors may vote and count in the quorum on matters in which they are interested. None of the directors are shareholders in the company.
Which of the following best describes the position of the land-owning director in relation to the proposed purchase of the land?
A) As some of the other directors know that the director owns the land, he will not need to declare his interest in the purchase at the forthcoming board meeting.
B) The purchase must be formally authorised by the other directors so that the land-owning director, by entering into this transaction with the company, is not in breach of the duty to avoid a situation in which he has a direct or indirect interest which conflicts with the interests of the company.
C) As the company’s articles of association include a special article allowing directors to vote and count in the quorum if they are interested in a matter, the director does not have to declare his interest in the purchase to the other directors.
D) The director will be guilty of a criminal offence if he does not declare his interest in the purchase to the other directors.
E) The director must declare the nature and extent of his interest in the purchase to the other directors to avoid being in breach of duty.
CORRECT ANSWER E - because the director must declare his interest in the purchase as it represents a proposed transaction with the company (s177 CA 2006).
Option A is wrong because all the other directors would need to know that the director owns the land, or ought reasonably to be aware of this. The facts say that some of the directors do not know (s177(6)(b) CA 2006). In any event, it is best practice to declare the interest to the other directors.
Option B is wrong because the duty to avoid a situation where the director has an interest which conflicts directly or indirectly with the interests of the company does not apply to transactions with the company (s175(3) CA 2006). Such transactions are covered by the duty to declare an interest in the proposed transaction to the other directors (s177 CA 2006).
Option C is wrong because the special article relates to whether directors can count in the quorum and vote on a resolution they have a personal interest in. It is not relevant to whether they have to declare that interest.
Option D is wrong because criminal liability does not arise from a breach of the duty to declare an interest in a proposed transaction with the company, only breach of duty to declare an interest in an existing transaction.
What is the ‘proper claimant’ rule?
A) Where a wrong has been done to a company, the members may unanimously agree to bring a claim on behalf of the company.
B) Where a wrong has been done to a company, any member who has suffered loss may bring a claim on behalf of the company.
C) Where a wrong has been done to a company, any member or director who has suffered loss may bring a claim on behalf of the company.
D) Where a wrong has been done to a company, only the company can bring an action.
E) Where a wrong has been done to a company, any affected person acting in good faith in the interests of the company, can bring a claim on behalf of the company.
CORRECT ANSWER D - The legal rights of the company as a separate legal person belong to the company and not to the members. This means that only the company can bring an action for a wrong, for example, breach of duty or negligence by the directors.
This makes Options A - C and E wrong. Neither individual directors nor the members (nor other affected parties) have the standing to do so, even if they have suffered loss. This applies even if all or a majority of the members support a claim.
Note that a member may be able to bring a derivative action but this is an exception to the proper claimant principle: it is not the principle itself.
A private company which sells and services lawn mowers has adopted the Model Articles of private companies limited by shares as its articles of association. It has four directors, an engineer, a salesman, a bookkeeper and a buyer, who are also the shareholders.
The engineer owns 30 shares, the bookkeeper owns 15 shares, the salesman owns 20 shares, and the buyer owns 35 shares. There are 100 issued shares in total. The buyer recently exceeded her authority in buying some used lawn mowers for £3,000, thinking that it was a good deal. The agreed limit on directors’ purchases is £2,000.
The salesman is furious with the buyer and believes she should be punished, whereas the engineer and bookkeeper feel that she made a simple mistake and are minded to forgive her. The buyer hopes that the shareholders will ratify her conduct. The board have decided to use the written resolution procedure to obtain the shareholders’ resolution to ratify the buyer’s conduct.
Will the shareholders’ resolution required to ratify the buyer’s conduct be passed?
A) Yes, because an ordinary resolution is required and there will be 45 votes in favour out of a possible 65, the total voting rights of eligible members.
B) No, because a special resolution is required and there will be 45 votes in favour out of a possible 65, the total voting rights of eligible members.
C) No, because a unanimous decision is required and there will be 80 votes in favour out of a possible 100, the total voting rights of eligible members.
D) Yes, because an ordinary resolution is required and there will be 80 votes in favour out of a possible 100, the total voting rights of eligible members.
E) Yes, because a special resolution is required and there will be 80 votes in favour out of a possible 100, the total voting rights of eligible members.
CORRECT ANSWER A - because an ordinary resolution is required to ratify the buyer’s conduct (s239(2) Companies Act 2006). The buyer will not be an eligible member for the purposes of the resolution (s239(3) Companies Act 2006) and therefore the total voting rights amount to 65.
Option B is wrong because an ordinary resolution is required to ratify the buyer’s conduct rather than a special resolution (s239(2) Companies Act 2006).
Option C is wrong because an ordinary resolution is required to ratify the buyer’s conduct rather than a unanimous vote in favour. Additionally, the total voting rights amount to 65 votes, not 100 votes as the buyer is not an eligible member for the purposes of the resolution.
Option D is wrong because the buyer’s votes have been included in the totals for the ordinary resolution and the total voting rights. The buyer is not an eligible member for the purposes of the resolution.
Option E is wrong because the buyer’s votes have been included in the totals for the special resolution and the total voting rights. The buyer is not an eligible member for the purposes of the resolution. Additionally, an ordinary resolution is required to ratify the buyer’s conduct, not a special resolution.
