Director decision-making: obligations & personal liabilities

A. INTRODUCTION

This is the first in a series of joint Corporate & Commercial and Disputes articles on director decision-making.  In this article we (a) summarise the general duties of a director under the CA06 (CA06 Duties), (b) set out practical actions for directors to carry out in order to comply with CA06 Duties, and (c) consider other sources of obligations towards a company.  Looking to recent case law decisions, the Disputes contributions to this series will take a deeper dive into director’s duties in action and provide examples of where things have gone wrong.

In the next Corporate & Commercial article, we will (a) use a fictional scenario to illustrate how directors apply their CA06 Duties in practice, (b) outline potential liabilities for a breach of the CA06 Duties and (c) set out possible protection for a breach of CA06 Duties.

B. SUMMARY OF A DIRECTORS’ GENERAL DUTIES UNDER THE COMPANIES ACT 2006

The CA 2006 sets out seven “general duties” of directors. These are owed to the company (rather than to its shareholders), and only the company has the right to enforce them. However, in specific situations, shareholders may bring a derivative action on behalf of the company. The duties are as follows, which are set out in further detail below:

1. To act within powers (s171 CA06).
2. To promote the success of the company (s172 CA06).
3. To exercise independent judgment (s173 CA06).
4. To exercise reasonable care, skill and diligence (s174 CA06).
5. To avoid conflicts of interest (s175 CA06).
6. Not to accept benefits from third parties (s176 CA06).
7. To declare interest in proposed transaction or arrangement with the company (s177 CA06).

C. THE CA06 DUTIES IN DETAIL

1. To act within powers (s171 CA06)

OBLIGATION: To act in accordance with the company’s constitution and exercise powers for the purposes for which they were conferred (which should be self-explanatory).

2. To promote the success of the company (s172 CA06)

OBLIGATION: Directors must act in the way they consider, in good faith, would be most likely to promote the success of for the benefit of its members as a whole. This also means giving due and careful consideration to each of the following non-exhaustive factors set out in s172 CA06:

• the likely consequences of any decision in the long term;
• the interests of the company’s employees;
• the need to foster the company’s business relationships with suppliers, customers and others;
• the impact of the company’s operations on the community and the environment;
• the desirability of the company maintaining a reputation for high standards of business conduct; and
• the need to act fairly as between members of the company.

COMPLIANCE TIP: Seek professional advice where required/appropriate in order to satisfy consideration of the relevant factor.

3. To exercise independent judgment (s173 CA06)

OBLIGATION: Exercise independent judgment without subordinating their powers to the will of others, whether by delegation or otherwise.

COMPLIANCE TIP: Directors appointed by shareholders should consider decisions on their own merits. Ensure personal interests do not impact their independent judgment.

4. To exercise the reasonable care, skill and diligence (s174 CA06)

OBLIGATION: To exercise the reasonable care, skill and diligence that would be exercised by a reasonably diligent person with both:

• the general knowledge, skill and experience that may be reasonably expected of a person carrying out the functions carried out by the director in relation to the company (an objective test), and
• the general knowledge, skill and experience that the director actually has (a subjective test).Note that this has implications for directors with specialist knowledge and/or a particular function.

COMPLIANCE TIP: Regardless of the directors’ function/areas of expertise, they should (i) attend board meetings; (ii) ensure they have sufficient information to make decisions and (iii) keep themselves informed about the company’s affairs.

5. To avoid conflicts of interest (s175 CA06)

OBLIGATION: Directors must avoid situations in which they have or can have direct or indirect interests that conflict, or possibly may conflict, with the interests of the company. This duty:

• Applies in particular to the use of property/information/opportunities.
• Continues to apply after a person ceases to be a director with regard to property, information or an opportunity they became aware of while a director.
• Does not apply to a conflict of interest arising in relation to a transaction/arrangement with the company (addressed at bullet 6 below).

COMPLIANCE TIP: Maintaining a register of director’s interests, which is periodically reviewed. Ensure activities of directors are disclosed and approved by the board. Ensure conflicts via ‘connected persons’ are considered.

6. Not to accept benefits from third parties (s176 CA06)

OBLIGATION: A director is prohibited from accepting benefits (such as gifts or inducements) from third parties based on their position as a director or with the intention of influencing their actions. This duty is distinct from conflicts of interest.

COMPLIANCE TIP: Consider (a) what corporate hospitality is excessive/out of the ordinary, (b) keeping a register of benefits offered/received, (c) a threshold above which board approval is required.

7. To declare interests in proposed or existing transactions or arrangements with the company (s177/s182 CA06)

OBLIGATION: Directors must declare to the board ‘nature and extent’ of any interest they may have in any transaction or arrangement to which the company is or may be a party. A declaration is not required if:

• The interest cannot reasonably be regarded as likely to give rise to a conflict.
• It concerns the terms of a director’s service contract which have been/are to be considered by the board/board committee.
• The other directors are already aware (or ought reasonably to be aware) of the interest.

Note that, a company’s articles may permit a director to participate in decision-taking in relation to transactions which are the subject of a declaration of interest.

D. OTHER SOURCES OF OBLIGATIONS TOWARDS A COMPANY

• Shareholder involvement: Shareholders may have reserved rights, such as veto powers or reserved voting rights for decisions like issuing new shares, creating different classes of shares, or paying dividends. Shareholder agreements or bespoke articles of association generally outline these rights.
• Specific transactions requiring member approval: The CA06 contains provisions addressing specific transactions between companies and their directors (and their connected persons) which require members approval. While these are outside the scope of this guide, in general terms, they include substantial property transactions; loans and quasi-loans; long-term service contracts and payments for loss of office.

E. COMMENT

In summary, directors should be mindful of their duties, maintain independence, and put significant decisions to board meetings. Directors must consider the impact of decisions on (amongst other things): shareholders, stakeholders (such as, employees, suppliers, customers, and communities), the environment, company reputation, and long-term success. Whilst directors can commit the company to most transactions unilaterally, collective decision-making is crucial. Regular board meetings help ensure all directors act collectively and detailed records of decisions and reasoning should be maintained (see also our article named Company Registers & Statutory Books : A Guide).

Contact our Corporate & Commercial team if you would like advice on the obligations and personal liabilities of directors.