So, you’ve just started your own company, or been appointed a director of a business. Congratulations!
This article is for those who’re new to being a director and need to understand their responsibilities. Even if your company is a start-up, you’re the only one running it and hold all the shares, you still have legal duties to your business.
This is because a company is a legal ‘person’ in its own right, separate from you and with certain rights. Read on to find out what this means for you, and your company.
Here we explain:
- What is the role of a company director?
- What are my duties as a director under the Companies Act?
- To act within the powers given to you
- To promote the company’s success
- To use independent judgment
- To exercise reasonable care, skill and judgment
- To avoid conflicts of interest
- Not to accept benefits from third parties
- To declare an interest in proposed or existing transactions or arrangements with the company
- What other director’s duties do I have?
- Who do I owe these duties to?
- What happens if I breach director’s duties?
- How can I avoid breaching my duties as a director?
- What happens if the company is insolvent?
- Can I be protected against any liability I may incur?
- What are the duties of non-executive directors?
- What about my personal dealings with the company?
What is the role of a company director?
Running a business as a limited company has several significant advantages. For one thing, being a legal person in its own right means that the company’s debts and liabilities belong to it. You usually can’t be held responsible for losses if it becomes insolvent. That’s the nature of limited liability, and one of the reasons this type of company was originally created. Entrepreneurs should be encouraged to take risks in business without the danger of losing all their assets.
Despite this, some directors feel that they can do whatever they like when they’re running their business, particularly if they’re a sole operator. Sadly, this isn’t the case. If you’re serious about your business (and we know that you are), getting a handle on your legal responsibilities as a company director is essential.
A company is run by two groups of people, shareholders and directors. As owners, the shareholders ‘run’ the company in the sense that they decide the company’s commercial objectives, choose the directors to take care of business and meet from time to time to oversee its operation.
The directors, on the other hand, are charged with managing the company day-to-day, with the principal objective of taking care of business (in a proper and responsible manner), protecting the shareholders’ capital and providing them with a return on their investment.
The directors fulfil these duties by holding meetings in which they take decisions as a board. While some directors may take decisions solo if that’s within the remit delegated to them by the board (finance directors, for example, may be able to sign off significant expenditure and will prepare the accounts), generally the rule is that all directors should participate in decision-making.
Directors are often company employees as well as being directors, but not always. Non-executive directors are those directors brought onto the board solely to provide independent oversight of the company’s affairs, or because they have a particular skill that the shareholders or directors feel will contribute to the business.
What are my duties as a director under the Companies Act?
Directors’ duties are laid down in law, most importantly in the Companies Act 2006 (the Act). Under the Act, you have certain specific responsibilities:
To act within the powers given to you
When the company is set up there are key documents that describe the limits of its operation and the rights of those involved in it. The most important is the Articles of Association, and there may also be shareholders’ agreements that expand on the Articles and regulate the relationship between the owners.
These constitutional documents describe and limit your powers as a director, and you must not overstep them. Here are some of the ways you could act beyond your duties as described in these documents:
- By allotting more shares than you are allowed to under the terms of the Articles.
- Entering into a contract that’s larger in financial terms than the Articles permit, or of a type that isn’t permitted under the company’s constitution.
- Entering into a transaction over which the shareholders have a right of veto, without getting their consent.
To promote the company’s success
In this context, success doesn’t just mean financial success, it also means making sure that the company acts in a proper manner and in the interests of society as a whole. Directors must act in good faith, and in a way that they think is best to promote the company’s success for the benefit of the shareholders. For this reason, it’s very important to keep written records of directors’ meetings, so that you have evidence of the decisions you have taken as a board, and the reasons behind these decisions. This is the case, even if you are the only director.
The Act describes the factors that directors must consider when making decisions. These include:
- Thinking about the consequences of their decision over the long term, considering the needs of employees, and also the needs of the community and the environment.
- Making decisions that you feel will promote the success of the company and the interests of its members.
- Considering the impact of your decision on your stakeholders such as suppliers and customers.
- Thinking about what the impact of a decision might be on the company’s reputation.
- Not taking decisions that might favour one shareholder over another, or one particular class of shareholders over another.
- Taking decisions that promote an increase in the company’s value.
- Keeping company business confidential.
To use independent judgment
When making decisions, even as part of the board, you need to exercise your independent judgment. You can take other’s advice (your lawyers or accountants for example), but you need to avoid being influenced by other people. This can sometimes be tricky to understand, particularly if you have a seat on the board because you’ve been appointed by a particular shareholder to represent their interests.
And even if you’ve been asked to be on the board of a company because you’re a member of the family of the founder, you’ve still got a responsibility to do what you think is best for the company, even if that conflicts with their opinion.
To exercise reasonable care, skill and judgment
Bearing in mind your particular knowledge and experience, you have to exercise the care, skill and judgment that would normally be expected of someone who’s reasonably diligent.
What this means in practice is that there’s an objective and a subjective test. If you’ve particular skills – you’re a scientist for example – you’ll be held to a higher standard than someone who isn’t (the subjective test). In other cases, you’ll be expected to act in the way that any sensible and commercial director would behave, in other words, with the level of basic competence that might be expected of a director, and not just a member of the public (the objective test).
To avoid conflicts of interest
This duty can be quite hard to avoid in practice, because as a director you may be privy to certain information that you wouldn’t otherwise have had. Let’s say the company is interested in a piece of property that it decides not to buy, but that you’d also like to buy. Or the company wants to do business with another company in which you own shares, or with which your family is connected. Or you’ve received some confidential information that you’d like to exploit in your own personal capacity. These are all areas where you might find yourself tempted to decide against the best interests of the company and in favour of your own.
There won’t be a problem if, in fact, no conflict arises. You need to consider whether in fact there is a conflict, bearing in mind all the relevant facts. It could be that there is a potential conflict, but it’s actually quite remote in reality. For example, if the company wants to build a factory adjacent to where you live and in theory at least, you might find this objectionable.
In addition, if the Articles, the shareholders or sometimes even the directors have OK’d the situation (assuming they’re not conflicted also), you won’t breach the duty.
If you find yourself in this situation:
- Check the Articles to see what they say about conflict.
- Declare your conflict to the board and ask them to approve it.
- Make sure you act in the best interests of the company, even if you feel there is not conflict, and even if your situation has been authorised.
Not to accept benefits from third parties
As a director, you’re not allowed to accept a gift or some other favour because of your position as a director. You can accept corporate hospitality, provided that this isn’t so generous that it would put your independence in jeopardy.
To declare an interest in proposed or existing transactions or arrangements with the company
The reason for this rule is so that your fellow directors know what your interest is before they go ahead with a decision. An example of this would be if the company is intending to sign a contract with a company owned by your sister. Your obligation is to declare your interest before the decision is made.
If you’re the only director, it’s obviously not possible to declare your interest to yourself, but in that case, it would be a good idea to notify the shareholders before going ahead.
On a vote regarding the matter in which you have an interest, a majority of directors attending the meeting will have to approve, excluding your own vote.
What other director’s duties do I have?
Apart from your duties under the act, there are other duties imposed on you in law. For example:
- You owe a duty of confidentiality to the company, and not disclose any information you receive in your role as a director.
- To make sure the laws relating to health and safety and the welfare of workers are complied with.
- To observe environmental, anti-corruption and other such legislation.
- To maintain proper accounting records that are full and accurate and provide copies to members.
- To avoid losses to the company.
- To keep books and records as required by law, such as the register of members.
- To pay the company’s taxes.
- To tell HMRC and Companies House about any changes in the company’s status, such as a change of registered office.
- To issue and transfer shares.
Who do I owe these duties to?
You owe your director’s duties to the company of which you’re a director. It’s the company that will take action against you if you breach them. Sometimes, a shareholder or a group of shareholders can also bring a claim. If the company is insolvent, the liquidator may bring a claim against you.
What happens if I breach director’s duties?
The penalty for breaches of directors’ duties depends on the nature and seriousness of the breach. Sometimes it’s a fine, sometimes disqualification from being a director, and sometimes it’s even a criminal offence.
The company’s remedies include an injunction, damages or compensation. It could be that you have to return any profits made, or property you’ve received, or pay compensation to the company.
If you’re running a small or family business, it may seem to you that conflicts of interest aren’t important, since the directors and shareholders are the same people. However, if the company were to become insolvent, or if at some stage you want to sell, these conflicts may be revealed with serious consequences. Either a liquidator could investigate the breach and require repayment, or your conflict will be revealed in due diligence, making the company impossible to sell or resulting in claims for compensation by the buyers after the sale when they discover the situation.
Here’s a full list of the options open to a court for a breach of statutory duties by a director:
- Order the director to pay a fine.
- Make an injunction against the director to prevent further breach (for example, if a contract has been entered into on the company’s behalf, by a director, without proper authority from the company).
- Set aside a transaction (for example, if a director concludes a contract on behalf of the company but exceeds his authority when doing so).
- Order damages to be paid (for example, if the director makes a fraudulent or negligent misrepresentation in the course of negotiating a contract between the company and a third party).
- Require an account for profit made.
- Require the director to indemnify the company for loss resulted (for example, if a director was negligent).
- Hold the director personally liable for any company debts resulting from continuing to trade, when it was likely the company would become insolvent.
- Hold the directors personally liable for breach of duty of exercising reasonable care and skill (although the directors can also be jointly and severally liable).
A breach of the duty to disclose an interest in an existing transaction, amongst other offences, can lead to the director acquiring criminal liability, whereby a court may:
- Order a fine (for example, for breaking the conditions of a disqualification from being a company director).
- Sentence the director with imprisonment (such as for fraudulent trading).
- Disqualify the director from being a company director (for up to 15 years for failure to meet certain legal responsibilities such as failing to keep proper company accounting records or other ‘unfit’ conduct).
How can I avoid breaching my duties as a director?
The best way to avoid breaching your duties is to educate yourself about them. Companies House provides a leaflet explaining the legal role and responsibilities of a company director. Our team of expert corporate lawyers can also answer questions you may have, or help you decide whether a particular issue will put you in breach of your responsibilities.
If you are concerned that the company may be insolvent, you should seek legal advice so that you avoid becoming personally liable for any losses the company suffers.
What happens if the company is insolvent?
As we’ve seen, if the company of which you’re a director is in financial trouble, you have a duty to act correctly. The law in this area is complicated, and if you breach your duties you risk disqualification, may have to pay money to the company, or risk a criminal conviction.
Here are some of the key issues:
- Your general duty towards the company is modified, so that you need to act in the best interests of your company’s creditors at this time.
- If you know the company is insolvent but you continue to trade, you may have to contribute towards the company’s assets if you knew at that time there was no prospect of avoiding liquidation and you don’t take steps to protect creditors (wrongful trading).
- If you dishonestly take some action to defraud creditors, such as paying one creditor rather than another in order to keep money from creditors generally, you may be guilty of fraudulent trading.
- If you misapply company money or property, or breach your duties, you may be guilty of misfeasance if the company is insolvent at the time.
Can I be protected against any liability I may incur?
If a company chooses to, it can indemnify you against certain liabilities you may incur to third parties and cover the cost of the litigation and any other cost. A company can’t indemnify you against any fines you may incur for breach of regulations or the cost of defending yourself in criminal proceedings and related fines if you’re unsuccessful in your defence. In addition, the Act prevents companies from making any provision which exempts a director from any liability arising from negligence, default, breach of duty or breach of trust to the company.
Companies usually take out insurance that cover their directors and any liabilities they may incur. These are called ‘directors and officers policies’. Again, these won’t cover dishonesty or criminal acts.
Where a director has breached their legal duty, it is possible for the shareholders to ‘ratify’ that breach where they feel that the director acted in the best interests of the company. In addition, a court can also grant relief where proceedings for negligence, default, breach of duty or trust are brought against a director, if the court considers the director has acted honestly and reasonably and they ought fairly to be excused. A director can apply directly to the court for this relief if they anticipate such a claim being brought against them.
What are the duties of non-executive directors?
While both executive and non-executive directors owe the same duties to the company, given that the non-executive directors are far less involved in the running of company’s operations, in practice the standards expected of them are slightly different.
For example, non-executive directors won’t have the day-to-day knowledge of the company’s business and won’t see all the information available to management. For this reason, a non-executive director is slightly less likely to be found in breach of their duty to exercise reasonable care and skill if the company has entered into a risky business opportunity whilst the company faces trading difficulty (which the non-executive director reasonably had no knowledge of).
This doesn’t mean a non-executive director owes fewer duties to the company. Instead, their duty is to use their broader experience to challenge the executive directors and offer independent judgment to the board. For example, non-executive directors are useful to monitor:
- Performance of executive management (and where necessary removing ineffectual executive directors).
- The structure of executive management (and succession planning).
- Remuneration of executive directors (in larger companies this may be done by a remuneration committee).
- Communication with external contacts.
- Risk management.
- Audit (whether formally by setting up an audit committee or by other means to account to shareholders in respect of actions and financial performance).
Directors must take an active interest in the company’s affairs. Ignorance is not an adequate defence that will save a director from liability. If you’ve got concerns about the way the company is being run, you should call a board meeting to discuss this and consider any areas of disagreement.
What about my personal dealings with the company?
An important question for directors is whether it’s possible to transact with the company considering their duty to avoid conflict of interest. Provided a director is transparent about the transaction and his/her interest, directors can enter into arrangements with the company.
Substantial property transactions
If the director, or someone connected with them acquires a substantial non-cash asset (any property other than cash) from a company, or vice versa, whether directly or indirectly through a third party, the arrangement must be approved by an ordinary resolution (unless a higher majority is required by the company’s constitution).
The shareholders must have sufficient information about the central details of the transaction in order for the approval of the transaction to be valid.
The following table can help you determine whether a non-cash asset is substantial.
|£5,000 or less||No|
|Between £5,000 and £100,000||Substantial if the asset is worth more than 10% of the company’s net asset value calculated using the company’s most recent statutory accounts or, if there are no statutory accounts, the asset value is calculated by looking at the amount of the company’s called up share capital|
If there are a series of non-cash transactions or an arrangement involving more than one non-cash asset, it is the aggregate value of all the non-cash assets involved in the arrangement or series, which is relevant to whether the transaction is substantial.
If the transaction is substantial (which should be determined as at the time the arrangement is entered into) and an ordinary resolution (or requisite majority according to the company’s articles) isn’t obtained, the transaction between the company and director is voidable by the company.
Regardless of whether the transaction is voided, the director will still be liable to account to the company for any gain made directly or indirectly from the transaction and may need to indemnify the company for any loss/damage resulting from the transaction.
You should bear in mind that a director may be exempt from liability if they can show they took all reasonable steps to ensure the correct majority was obtained, or if they can show they had no knowledge of the circumstances which constituted the contravention.
Loans to directors
As a director or a connected person of a director, it’s also possible to borrow money from the company. However, when doing so, the Companies Act 2006 requires the arrangement to be approved by an ordinary resolution of the shareholders (or higher majority if required by the company’s constitution.
To obtain the ordinary resolution, it’s important to send the shareholders information about the transaction (the subject of the transaction, the amount and purpose of the loan and extent of any liability the company would have with any transaction in connection with the loan).
This needs to be made available to the members for inspection at the company’s registered office for at least 15 days ending with the date of the general meeting in which the resolution will be voted on and at the meeting itself. The memorandum may alternatively be sent with the written resolution if the written resolution procedure is used (by a memorandum being sent or submitted to every eligible member at or before the time at which the proposed resolution is sent or submitted to him).
There are some exceptions when a loan transaction doesn’t need to be approved by the shareholders. For more information on whether you fall within these exceptions, get in touch with our specialist corporate solicitors.
Directors’ long-term service contracts
If a director’s service agreement will last more than two years, this must be approved by an ordinary resolution of a company.