1 January 2023
This guide looks at what the Companies Act 2006 means for company directors, with special emphasis on directors’ duties. It is not a comprehensive guide to the Act but a general overview to those aspects of the Act which impact on directors. It is therefore advisable to seek advice relating to any specific areas of concern.
The guide also contains the statutory duties for breach of which directors may be criminally liable under the Act. As this guidance is an overview for directors of private companies, directors of public companies may have additional duties which can be advised on separately.
In addition to the outline in this guidance, Directors should always refer to the Company’s constitution which may also include obligations, limitations or restrictions on their powers.
What is a director?
All companies are required to have at least one director, as a company being an ‘artificial’ legal entities, cannot act themselves – they need to act through other persons.
A company’s directors are the persons to whom the law looks to manage the affairs of a company on behalf of its owners. In the situation where the director and the shareholder are one and the same person, there is still a technical distinction between the interests of the shareholder as owner of the company and the responsibilities of the director as the person who makes decisions on its behalf.
It must be noted that the Companies Act says that the term ‘director’ includes any person occupying the position of director by whatever name called. It means that, in determining whether any person is or has been a director of a company, account must be taken not only of whether a person has been duly appointed and registered as a director, but also of whether that person is or has been exercising the actual legal functions of a director. It is therefore possible for someone to be a ‘de facto’ director without being formally appointed. In addition, someone who is given the title of Director (ie. sales director etc) may also be able to exercise a director’s power to bind the company to contracts or other legal obligations or being held liable as a director. Therefore avoid using the term unless it is a properly appointed board position.
Who can be a director?
- a person who has been disqualified by a court from acting as company director (unless he has been given permission by a court to act as a director in respect of a particular company)
- a person must be at least 16 years of age on appointment
- persons who are undischarged bankrupts or subject to a bankruptcy restrictions order may not act as directors of limited companies.
- while a company may still act as a director of another company, this will only be possible under the Act if there is at least one other serving director who is a ‘natural person’, ie an individual human being
articles of association, place additional restrictions on who may and may not act as directors.
Types of directors
De jure & De facto A de jure director is one who has been validly appointed as a director via standard procedure. A de facto director differs from a de jure director in that he or she will not have been validly appointed as director via any accepted standard procedure.
Executive Director A full-time basis director for the company, whether or not this is under a contract of employment. Usually dealing with particular aspects of the business such as a Finance Director, HR Director and usually an employee.
Non-Executive Director Usually appointed because of particular skills and are expected to offer, a more detached, objective and comprehensive view of how the company’s affairs ought to be directed than might be possible if the company’s board consisted solely of executive directors. See the Combined Code, which has been developed and helped to standardise the role.
Shadow directors The definition is regulated by the Companies Act and states it is ‘a person in accordance with whose directions or instructions the directors of a company are accustomed to act.’ This can refer to an individual or corporate body. The shadow director’s influence over the board must be real but need not extend over the whole of the company’s activities. There are exceptions, advisors such as accountant and lawyers, in their advisory capacity, and parent companies. Where they may be seen to have too much influence or control there may be a risk of falling within the definition. Further detail and information is separately available.
Managing directors The person to assume senior powers of responsibility within the executive director team, and their powers will be outlined in articles of association and employment contract.
Alternate directors Only articles of association may entitle directors to appoint an ‘alternate’ to represent them when they are unable to attend meetings or otherwise to perform their duties as directors.
Appointment and removal of directors
Companies are able to determine the means of appointment, via their articles of association. Articles may also impose requirements as to the number of directors that there should be on the board and as to whether directors should be subject to some sort of specific eligibility condition, such as a requirement to hold shares in the company.
By resolution of the company’s members
The conventional way for a director to be appointed is via a resolution passed by the company’s members. Company articles will invariably provide for this to happen, however it is best to check to verify the process outlined, as point (ii) below may apply.
By resolution of the directors
A company’s articles of association will usually empower the directors to appoint a new director, either to fill a vacancy or to act as an additional director. A power of this kind is especially useful when a director leaves office unexpectedly and the remaining director or directors feel that the company needs to recruit a new person in the short term, ie before the next scheduled general meeting, either to fill a skills gap or to ensure that the company has any required minimum number of members set down by the articles. A statutory power for directors to make an appointment to fill a ‘casual vacancy’ is contained in the Companies Act.
A director may leave office in one of the following ways.
Removal by the members of the company
By passing an ordinary resolution, however procedures are to be followed as there are rights afforded to the director.
Resignation – a director may voluntarily terminate their own appointments for any number of reasons, via a formal resignation from office
Powers of Directors
Directors' general authority
Subject to the articles, the directors are responsible for the management of the company's business, for which purpose they may exercise all the powers of the company. The Companies Act 2006 provides that, unless a company’s articles specifically restrict the objects of the company, the company’s objects are unrestricted.
Most companies do not have special articles and most have not passed special resolutions to restrict the directors' powers, so the reality is that in most companies the directors can take any decision unless the Act says it needs a resolution in general meeting is required.
In addition there are some Director’s decisions which require members’ consent, such as some loans to directors (further detail available).
Validity of directors’ acts
The acts of individual directors will be valid and binding on the company even if it subsequently transpires that there is a defect in their appointment, that they were disqualified from acting as a director, that they had ceased to hold office or were not entitled to vote on a particular matter. While this ensures that company transactions are not invalidated, it will not absolve the director concerned from any personal repercussions that may ensure.
Directors General Duties
The introduction of the statement of general duties outlines the way that directors are expected to act and for how they account for their actions to their company.
i. The status of the general duties
The director’s duty to his or her company as a collective body: no duty is owed under the statement to individual shareholders or to persons outside the company. While the established rules and principles that are superseded by the statement of general duties no longer have direct effect, the accumulated experience of the courts in defining directors’ duties over many years is likely to influence the way that the courts decide to interpret the new statutory provisions.
ii. Duty for directors to act within their powers
A director must (a) act in accordance with the company’s constitution and (b) only exercise powers for the purposes for which they are conferred.
iii. Duty to promote the success of the company
A director must act in the way that he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. Provided they meet this standard, honest business misjudgements or failures will not give grounds for claims of negligence against them.
iv. Duty to exercise independent judgement
The duty to exercise independent judgement is not infringed if the director acts in accordance with an agreement duly entered into by the company which restricts the future exercise of discretion by the directors; in addition, it is not infringed if the directors act in a way that is authorised by the company’s constitution. These enable a company’s shareholders to exert some measure of control over the directors’ powers of discretion.
v. Duty to exercise reasonable care, skill and diligence
Exercised by a reasonably diligent person with, the general knowledge, skill and experience which may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and the general knowledge, skill and experience that the director has.
It is impractical to expect directors to do everything themselves and that it is permissible for directors to delegate responsibility for at least some of their functions, whether that delegation is to fellow directors or to employees of the company.
vi. Duty to avoid conflicts of interest
They have a duty to avoid a situation in which either: there is, or may be, a conflict between the interests of the company and the direct or indirect interests of the director; or between the director’s duties to the company and those to another person.
vii. Duty not to accept benefits from third parties
A director must not accept any benefit (including a bribe) from a third party which is conferred because of his being a director or his doing or not doing anything as a director. Benefits conferred by the company, its holding company or subsidiaries, and benefits received from a person who provides the director’s services to the company, are excluded. Benefits will also be excluded from the prohibition if their acceptance cannot reasonably be regarded as likely to give rise to any conflict of interest.
The duty will continue to apply after a person ceases to be a director in relation to things done or omitted by him before he ceased to be a director – so that, as before, a director cannot simply resign and then accept an opportunity that he has diverted from the company itself.
viii. Duty to declare interest in proposed transactions or arrangements
A director must declare to the other directors the nature and extent of any interest, direct or indirect, which he has or will have in a proposed transaction or arrangement with the company. The director need not be a party to the transaction for the duty to apply. An interest of another person in a contract with the company may require the director to make a disclosure under this duty, if the other person’s interest amounts to a direct or indirect interest on the part of the director. The declaration must be made before the company enters into the transaction or arrangement.
Other matters to consider
Directors are not automatically entitled to remuneration, and it would usually be outlined in the company’s articles. In addition, a service agreement, for those directors who are also employees, will provide the usual employment provisions.
Directors must maintain accurate statutory records, keep minutes of all director and shareholder meetings, and must also file annual accounts and maintain accurate tax and national insurance records. It is usual to delegate these duties to the Company Secretary. There are also general provisions relating to where and how the company details are to be displayed and failure to do so makes the directors liable to a fine.
Directors are permitted to conduct board meetings how and when they choose although, the articles may set out specific details. All directors are entitled to attend and vote unless the contrary is contained in the articles.They have a general duty to attend meetings (by telephone is usually permitted), however are not required to attend every one. Minutes should be taken and maintained as outlined in point 2 above. Unless the articles specify otherwise, board meetings can be called on 'reasonable notice'.
Directors loans, restrictions apply on size of loan, are permitted subject to shareholder approval for all companies.
Directors have restricted authority when it relates to substantial property transactions if the disposal or acquisition is to or from a person connected with a director. It applies to non-cash assets with a value of more than £100,000 or 10% of the company’s net assets to or from a director.
Every company must keep accounting records, and directors are obliged, for each accounting period, to prepare a profit and loss account and a balance sheet.
Consequences of breaches of directors’ responsibilities
Both criminal and civil actions can be contemplated against individual directors in respect of their responsibility for the alleged wrong-doing. It is therefore advisable that, wherever a director believes that a particular board decision would expose the company or the directors personally to litigation, and opposes the taking of that decision, that director should insist that this opposition.
A director who fails in his duties to the company may have unlimited liability for any loss suffered by the company even if he himself has not made any personal gain. It has long been established that the courts will not accept ignorance of duties as a defence. In particular, case law has determined that foreign individuals who accept directorships in The Companies Act and other statutes identify a large number of circumstances where failure to comply with statutory requirements may result in criminal sanctions being imposed on companies and their individual directors.
(i) Enforcement of directors’ obligations by the company
The company has the following options; recover any of the company’s property which has been misapplied by the director; make the director account to the company for the profit made in breach of the fiduciary duty. The company can also seek to issue an injunction to prevent the act complained of from being committed in the first place or alternatively seek to rescind the contract. Where the director has breached the duty of skill, care and diligence, the company can claim damages from the director.
(ii) Enforcement of directors’ obligations by the members
Where the director/s who have been at fault control the board, however, there is an obvious practical problem in getting the company to commence legal proceedings and in obtaining due compensation for the members. The courts have addressed this problem by allowing members of a company to bring legal proceedings in the name of their company via the so-called ‘derivative action’ procedure. These may arise from an act or omission involving negligence, default, breach of duty or breach of trust by a director. A derivative claim may arise from an actual or proposed act or omission.
(iii) Other grounds for personal liability under companies legislation
• Pre-incorporation contracts
• Contravention of the rules on substantial property transactions
• Illegal loans
• Ad hoc payments to directors
• Failure to call a company meeting
• Breach of rules on political donations
• Costs regarding the revision of defective annual accounts
• False or misleading statements in company reports
• Contravention of members’ pre-exemption rights
• Illegal dividends
• Liability following disqualification
(iv) Directors’ liabilities to creditors following the insolvency of their company
It is the company’s shareholders and creditors who will have to bear the financial loss in the event of an insolvency situation, and the directors who controlled the company and led it into insolvency will have no automatic responsibility to share the losses.
However, where it is just and equitable to do so, the ‘corporate veil’ can be temporarily pierced and companies and their officers can be dealt with as if they were not subject to the standard protections of company law in relation to the circumstances of the case. Thus, the reckless or unethical conduct of company directors can, in some circumstances, lead to their being made personally liable for the debts of their company.
Where a company is in a state of insolvency, however, the law holds that the primary stakeholders in the directors’ actions are the company’s creditors, rather then the members, and it is to the creditors that directors owe their duties. Creditors, through the mechanism of liquidation, displace the power of the shareholders and directors to deal with the company’s assets. The following are the ways in which the creditors primacy is applied:
• Wrongful trading
• Involvement in phoenix companies
(v) Liability to third parties
Directors may be held to owe a duty of care to third parties where by their conduct they assume personal responsibility for the information or undertakings they give. Directors may be at risk of doing this in the course of take-over negotiations. Where a duty of care is held to exist, directors will be liable to the other party in respect of any negligent conduct on their part.
A director may be disqualified from holding office as director, or from being otherwise involved in the management of limited companies, under the provisions of the Company Directors Disqualification Act. Where a person has been disqualified they may not, without special leave of the court, act as a director of any limited company or be concerned or take part in the management of a company. The Act lays down a number of grounds on which a director may be disqualified and provides for penalties to be levied in all cases.
Court orders will specify the period of disqualification and in non-criminal cases, orders made against an unfit director of an insolvent company will be for a minimum period of two years and a maximum period of 15 years.
Directors’ liability - indemnity and insurance cover
Companies may not provide an indemnity or include provisions in their articles or in separate contracts, for the purpose of exempting directors from liability for their negligence, default, breach of duty or breach of trust. They may, however, insure their directors against any such liability to the company and, in the circumstances to third parties. Companies may pay directors’ costs of defending civil or criminal cases, subject to the director being required to repay the costs if the defence fails. It is not necessary for shareholders to vote in favour of such a decision, which can be taken by the company’s board.
No responsibility for loss occasioned to any person acting or refraining from acting as a result of any material in this publication can be accepted by Entreprenor Limited.