Directors' Duties - A Quick Guide

posted by KeithDaniel

While every contract of employment contains an implied term that an employee will serve their employer with good faith and fidelity, if an employee is also a director there are additional duties, known as directors’ general duties (set out in the Companies Act 2006 (CA 2006), ss 171-177) that directors need to be mindful of, which we set out below.

The general duties are not intended to be an exhaustive list of all of the duties owed by a director. There are other directors' duties that arise, as well as various legal requirements that a director must comply with in order to avoid liability, e.g. a director should be mindful of:

  • Other duties they may have under the CA 2006, such as the duty to call meetings required by members or the duty to keep accounts;
  • Potential liabilities in an insolvency situation (when they may need to take into account the interests of creditors), e.g. liability for fraudulent trading, wrongful trading, transactions that were carried out at an undervalue;
  • Potential liabilities under environmental legislation, e.g. offences committed with the consent, connivance or neglect of any director, manager, secretary or other similar officer of the body corporate, or a person who was purporting to act in any such capacity;
  • Potential liabilities under the Data Protection Act 1998; and
  • Potential personal liability under the Bribery Act 2010.

In addition, as the general duties are not a comprehensive statement of all the duties imposed on directors, common law rules and other legal principles that have been developed by the courts, those remaining laws and principles still exist and catch directors to the same extent as they did before.

Who are directors?

Directors are the agents of a company who manage its day-to-day business. They include any person occupying the position of director, whether or not they have that title.

A shadow director of a company is a de facto director even if they do not have the formal position. There are some limited exceptions, but basically a person whose directions or instructions the directors of the company are accustomed to act in accordance with.

What are the general duties?

The general duties are owed to the company and are:

  • The duty to act within powers -- this duty requires a director to act in accordance with the company's constitution (i.e. the company’s articles of association, and any resolutions and agreements affecting a company’s constitution) and only exercise powers for the purposes for which they are conferred;
  • The duty to promote the success of the company -- this duty is to act in a way the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to a non-exhaustive list of matters including the impact of the company's operations on the community and the environment;
  • The duty to exercise independent judgment -- this duty is not infringed by acting in accordance with an agreement duly 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;
  • The duty to exercise reasonable care, skill and diligence -- this duty comprises two tests: it requires a director to 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 of the director in relation to the company (objective test) and to use the general knowledge, skill and experience that the particular director has (subjective test);
  • The duty to avoid conflicts of interest -- this duty requires a director to avoid a situation in which the director has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company and is subject to various exceptions.

Liability

Generally, shareholders can bring an action against the directors in certain circumstances, as follows:

  • Shareholders can, subject to obtaining court approval, bring a derivative claim on behalf of the company against the directors for negligence, default, breach of duty or breach of trust.
  • Minority shareholders can bring an "unfair prejudice" claim seeking relief against the acts of the controlling directors of the company. Alternatively, the shareholders may, on grounds of oppression, seek the winding-up of the company on a just and equitable basis.
  • Where the shareholder has a personal cause of action against the director (for example, as a result of a direct contract between the director and shareholder).
  • Where, in exceptional circumstances, the director has breached the company's constitution and the action is incapable of ratification by the shareholders. In such cases, the shareholder can seek to enforce the relevant constitutional provision.
  • Directors may also be liable to creditors in insolvency situations.

The liability of directors cannot be limited or excluded. Any provision that purports to exempt a director from liability for negligence, default, breach of duty or breach of trust in relation to the company is void (Companies Act 2006). In practice, when a claim is brought against a director for any wrongdoing, the director can either seek indemnification from the company if permitted under the company's articles or if an indemnity is in place) or from the company's directors' and officers' (D&O) liability insurance policy.

Conflicts of interest

Directors' duties include the duty to avoid situations in which a director has, or can have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company (situational conflicts) (Companies Act 2006). Such situations can be authorised by the board of directors (provided, in the case of a public company, that its constitution permits such authorisation). The authorisation is effective provided that any quorum requirements for the meeting are met without counting any interested directors, and their votes are not counted.

In addition, directors must declare the nature and extent of conflicts of interest arising out of a proposed transaction or arrangement with the company (transactional conflicts). The declaration can be made at a board meeting or by written notice to the directors, and must be made before the company enters into the transaction or arrangement. The declaration must be updated if the interest changes. There are exceptions to this rule, including where:

  • The interest cannot reasonably be regarded as giving rise to a conflict.
  • The transaction concerns the terms of a director's service contract that has been or is to be considered by the directors.

A company's articles often contain provisions that allow the relevant director to take part in and vote on the matter giving rise to the conflict (subject to declaration of the conflict).

For more information, please contact our corporate team on  corporate@berrysmith.com or 029 20 34 55 11