Directors’ duties: liabilities and responsibilities of a company directorship

Last updated: 16 May 2018

Estimated reading time: 31 minutes

What are directors’ duties? Many of our clients have been requesting a guide to the liabilities and responsibilities connected to directorship of a company.

Here we explain:

  1. Glossary and definitions
  2. The Companies Act and statutory duties
  3. Common law and equitable duties
  4. In practice: discharging directors’ duties
  5. Duties of executive and non-executive directors
  6. Transactions with the company
  7. Liabilities of directors
  8. Protection from liability
  9. Options for shareholders unhappy with how a director discharges their duties

Glossary and definitions

Direct interest: when a director has an interest arising from contracting directly with the company.

Indirect interest: when a director has interest through a spouse, relative, or through a company in which the director is a shareholder or member.

Executive director: a director that is also an employee (i.e. director has a service agreement with the company).

Non-executive director: a director that’s not an employee.

Shadow director: any person that a governing majority of directors of a company are accustomed to following the instructions of. Giving instructions alone is not sufficient, there must be a positive action by the board in line with the person’s instructions to be considered a shadow director and the action must not be something that the board are required to do by law anyway. Also, a body corporate is not a shadow director of any subsidiaries just because the directors of the subsidiary tend to act in line with its directions or instructions.

The Companies Act and statutory duties

All directors have duties which they must discharge. The general statutory duties which directors must comply with are contained within the Companies Act 2006 (CA 2006). These duties consist of the following:

Duty to act within powers (section 171 CA 2006)
It’s important that directors only act within the company’s constitution and powers. This means directors shouldn’t do anything which the company hasn’t/doesn’t authorise. Most of the directors’ powers and restrictions on their powers are set out in the memorandum and articles of association of the company – but note that some powers and restrictions may derive from decisions of the company or resolutions and agreements affecting the constitution of the company.

Duty to promote the success of the company (s172 CA 2006)
The duty to promote the success of the company imposes a duty to act in good faith in the best interest of the company as a whole. This means directors need to prioritise the interests of the company, its shareholders, and other stakeholders. A company is able to adopt alternative purposes, not just those in the best interests of members. Directors must then act in good faith, in the ways most likely to achieve those alternative purposes.

Guidance has been provided to assist directors with complying with this duty. Although not an exhaustive list of factors to consider, when making a decision for and on behalf of the company and in its best interests, it’s good practice to follow the guidance and think about:

  • The likely long-term consequence of any decision
  • The interests of employees
  • The need to foster a business relationship with suppliers, customers, creditors, and others
  • The impact of the company’s operation on the community and environment
  • The desirability of maintaining a reputation for high standards of business conduct
  • The need to act fairly between members.

This duty requires directors to aim to run the business in a manner which leads to a long-term increase in value. In addition to compliance with applicable rules and regulations, directors should ensure the business is competitive and returning value to all stakeholders.

Part of this duty encompasses the directors’ obligation to protect the company’s confidential information. Although executive directors will be contractually obliged to protect and not exploit confidential information through their service agreements, non-executivedirectors must also uphold confidentiality as a matter of statutory duty. Using confidential information or leaking confidential information to the public or competitors would be seen as failing to act in the best interest of the company, therefore would amount to a breach of the duty to promote the success of the company.

Duty to exercise independent judgment (s173 CA2006)
Exercising independent judgment means not allowing director powers to be fettered (by being limited or delegated) unless allowed by the company’s constitution. This duty supports the duty to promote the success of the company because it requires the directors to act in the best interest of the company as a whole (and not just in the interest of one or a group of shareholders).

Most importantly, exercising independent judgment means that the director should not be acting in the narrow interest of any individual or group. For example, if a director is appointed by a shareholder with significant control, the director shouldn’t act in the narrow interest of that shareholder. The duty is to act for the company and shareholders as a whole.

This duty does not prevent a director from relying upon advice, provided that they have exercised their own judgment when following such advice. 

Duty to exercise reasonable care, skill, and diligence (s174 CA 2006)
Legislation requires all directors to exercise reasonable care, skill, and diligence. When considering whether this duty has been breached, the law has introduced a two-stage test which provides a standard of care expected of directors.

Firstly, a director must have the knowledge, skill, and experience that would reasonably be expected of anyone doing that job. This part of the test is objective and requires directors to have the basic competence expected from a person performing the functions carried out by a director.

Secondly, a director has to perform according to the knowledge, skill, and experience they actually have. This part of the test is subjective and varies according to each individual director.

A director will also be required to exercise their duties diligently, keep themselves well informed and join together with their co-directors. A director can rely on the expertise of colleagues or, reasonably delegate tasks, provided that the director does not attempt to abrogate all responsibility.

Duty to avoid conflict of interest (s175 CA 2006)
It is extremely important that the directors’ obligations to the company do not clash with the director’s own personal interests or duties they owe to a third party (direct or indirect). Directors have a duty not to place themselves in such a position without the prior consent of the company.

Examples of conflict of interest:

  • Having an interest in a commercial opportunity that could be exploited by the company for example, you may be a shareholder of a separate company which is proposing to supply material to the company for which you are a director.
  • Using information belonging to the company for personal use.
  • Being a director who sits on two boards, where duties to each company conflict. This can even occur where an individual acts as a director for both a parent and subsidiary company because the two companies may still have conflicting interests.

Where these situations arise, there will be a breach of the duty to avoid conflict unless*:

  • the situation can’t reasonably be regarded as likely to give conflict. For example, the director’s (potential) interest may be so indirect or remote that no reasonable person would see it as a problem and it can be ignored; or
  • the situation which gives rise to the conflict has been authorised by the other independent directors. Where authorisation is sought, you need a majority of the directors to vote in favour. Don’t forget that as the interested director, you can’t count in the quorum (the vote).

*The exceptions are subject to the articles of the company. Some companies may require special articles to be included to permit these exceptions. It is advisable to provide in the company’s articles, that directors may hold additional directorships and that they do not need to disclose confidential information obtained through those other offices.

Duty not to accept benefits from third parties (s176 CA 2006)
Directors are also under a duty to not accept benefits from third parties. When complying with this duty, a director will need to identify whether the benefit was offered because of the position they hold as director, or because he or she is doing or not doing something as a director, if either of these is the case, then to accept a benefit would be in breach of this duty. If a conflict of interest is not likely due to the acceptance by the director of the benefit, they will not be in breach of this duty. If members of a company have previously authorised the acceptance of benefits which would now be in breach of this duty, this will be able to continue, but unless this is the case or there is a provision in the company’s constitution dealing with these benefits (for example a limited value of benefits which can be received by directors from third parties) board authorisation is not allowed. This duty continues to apply after a director resigns, in relation to things done or not done by them, whilst they acted as a director.

Duty to declare interest in proposed transactions or arrangements (s177 CA 2006)
Where the company is proposing a transaction or arrangement in which a director has an interest (direct or indirect), a director needs to disclose that interest. Disclosure of interest needs to be ‘full and frank’ in order to ensure the other directors are fully aware of the nature and extent of the director’s interest before they approve the transaction. The director does not need to be a party to a transaction to breach this duty, as the interest can be indirect, and so directors should ensure that so far as possible they are aware of the interests of those people connected to them, as well as their own.

The disclosure must be made before the company enters into the transaction or arrangement in question and may be oral at a meeting, or in writing before the meeting. If the director has a continuing interest, they may give a general notice that they have an interest in any arrangement entered with a specified company. Where such a disclosure is made, the director must ensure he/she updates the disclosure when it becomes inaccurate.

Under legislation, there’s no declaration of interest required where:

  • the director wasn’t aware of their interest and it’s reasonable to be unaware;
  • the director wasn’t aware of the arrangement with the company and it’s reasonable to be unaware;
  • there is a sole director (so they would not be required to meet alone to declare an interest to themselves and formally record this). It would be prudent as a sole director to gain approval of the members before entering into a transaction in which the sole director has an interest. It is worth remembering that any contract entered into by a limited company with its only member must be recorded in writing, if the sole member is also a director or shadow director of the company.
  • the interest cannot reasonably be regarded as giving rise to a conflict;
  • the rest of the board is already aware of the director’s interest (or ought to be aware of it); and/or
  • the interest arises from the director’s service contract – a contract that has either already been considered by the board or a board committee or is due to go before them.

As with the duty to avoid conflicting interests, approval requires support from the majority of the directors present and voting (and which excludes the interested director).

Again, this exception to whether there is a breach of the duty to disclose interests, is subject to the company’s articles, as special provisions may be required to permit these exceptions.

A failure to comply with this duty could lead to civil liability. In addition, if the company suffers a loss due to the failure to disclose, the company can bring a legal action against the director for the direct loss suffered. Alternatively, the shareholders may bring a claim against the director on behalf of the company.

Disclosing interests in existing transaction or arrangements (s182 CA 2006).
This duty requires directors to disclose their interests and the extent of those interests in existing arrangements or transactions with the company, as soon as is practicable, so far as it has not already been disclosed under s177, above and to update any declarations, if required, where a director:

  • holds an interest in a transaction entered into by the company before he was appointed;
  • has not complied in part or at all with section 177above, before the company entered into a transaction; or
  • has acquired an interest after the company entered into the transaction.

Extending this duty to include existing arrangements ensures directors are transparent about their interests.

It’s extremely important to comply with the duty to disclose interests in existing arrangements, as it is a criminal offence to breach this duty punishable on conviction on indictment, by an unlimited fine or on summary conviction by a fine not exceeding the statutory maximum. There are no other civil consequences for non-compliance with this section, as would be the case with other duties and the transaction does remain valid despite a breach by a director of this duty.

Common law and equitable duties

Whilst most director duties have been codified, the statutory duties must be interpreted and applied in the same way as the common law rules and equitable principles (on the fiduciary duties and duty of care and skill which were imposed by common law before many of the duties were codified under the CA 2006) and the statutory duties do not cover all director duties. For example, the duty to consider or act in the interests of creditors, and the equitable duty of confidence owed by a director to the company (although the general duties take precedence over the duty of confidentiality). Therefore, common law and equitable duties are still relevant and should be considered carefully, especially when interpreting the above duties.

In practice: discharging directors’ duties

Since directors are responsible for the day to day management of the company, the legal duties of the company fall upon the directors.

A few examples of duties which a director must complete for a company include:

  • Maintaining full and accurate accounting records, providing copies of annual accounts to members and being aware of the financial position of the company;
  • Minimising financial losses of the company where reasonably possible;
  • Maintaining statutory company records and making them available for inspection;
  • Filing annual accounts, a confirmation statement (previously called an annual return) and company tax returns, every year;
  • Paying any tax liabilities of the company in full and by the deadlines;
  • Updating HMRC and Companies House about any changes in the information it holds (including information regarding the directors/secretary/shareholders, the company’s registered office, the company’s accounting reference date, the number of issued shares, and any mortgage or charge granted over the company’s assets);
  • Arranging general meetings and board meetings and distributing minutes of meetings;
  • Issuing and/or transferring shares;
  • Appointing a company secretary, if required, and any external company advisers, such as solicitors;
  • Filing changes to a company’s articles of association and special resolutions; and
  • To comply with applicable laws and regulations (e.g. employment, health and safety and tax).

A failure to comply with some of these duties would lead to the directors being liable. Although these tasks can be delegated to the company secretary, the liability for failing to comply with these duties will remain with the director. It’s therefore important for the director to supervise these tasks carefully, to ensure they are completed properly.

Duties of executive and non-executive directors

Both executive and non-executive directors owe the same statutory duties to the company and have the same potential liabilities. However, considering executive directors have different knowledge and experience to a non-executive director, the standard expected from the directors may vary slightly.

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 does not mean a non-executive director owes fewer duties to the company. Instead, the non-executive directors have a slightly different role in running the business by utilising their broader experience to challenge the executive directors and offer independent judgment to the board. Non-executive directors might be usefully deployed in monitoring:

  • 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; and
  • 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. A director with concerns about the way the company is being run, should call a board meeting to discuss this and consider any areas of disagreement.

Transactions 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 arrangements with the company.

Substantial property transaction
If the director, or a connected person acquires a substantial non-cash asset (any property or interest in property, which is not cash) from the company or its holding company, or if the company or holding company acquires a substantial non-cash asset from the director (or connected person), either directly or indirectly (catching any use of an intermediary) 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.

Asset value Substantial?
£5,000 or less Not substantial
Between £5,000 to £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.
Over £100,000 Substantial

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.

The only circumstances in which the company can’t void the unapproved arrangement would be where:

  • restitution is no longer possible (i.e. the transaction can’t be reversed);
  • the company has been indemnified by another person for the loss/damage suffered;
  • bona fide rights have been acquired by a third party who wasn’t party to the transaction; or
  • the arrangement has been affirmed by an ordinary resolution within a reasonable period.

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 the director can show he/she 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.

A final point to note is that you don’t need shareholder approval for a substantial property transaction where the transaction involves:

  • shareholders of a wholly owned subsidiary of another company or two wholly owned subsidiaries of the same holding company;
  • a non UK registered company;
  • a company and a person in his character as a member of that company (for example dividends paid in their current form, not in cash);
  • a company being wound up (unless this a members’ voluntary winding up) or a company that is in administration (as the company’s affairs are then run by a liquidator or administrator and it is no longer appropriate to receive members’ approval), or
  • a recognised investment exchange and a director, or connected person using an independent broker to make the arrangements.

Loans to directors
As a director or a connected person of a director, it’s also possible to enter loan arrangements, quasi-loan arrangements (where the company would arrange without any agreement, to pay a sum or reimburse a third party for the director), credit transactions, and guarantee arrangements with the company or its holding company. However, when doing so, the Companies Act 2006 requires the arrangement to be approved by an ordinary resolution or higher majority if required by the company’s constitution (and an ordinary resolution of the holding company as well, if the director is a director of the holding company).

In order to obtain the ordinary resolution, it’s important to send a memorandum which contains the details of 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
An ordinary resolution of a company (and if a director of a holding company, also an ordinary resolution of that company) must be passed before a company can agree to a director’s employment contract lasting longer than two years. This does also extend to the terms of appointment of non-executive directors, even though ‘employment’ is referred to in s188 of the CA 2006.

If more than six months before the end of the guaranteed term the company enters into a further service contract (other than in pursuance of a right conferred, by or under the original contract, on the other party to it), the unexpired period of the guaranteed term of the original contract must be added to the guaranteed term of the new contract.

Rolling contracts do not appear to be covered by this prohibition, as an old contract is terminated and replaced by a new fixed term contract, so there would be no unexpired period of the old contract and the new contract would fall outside the section.

Any attempt by a company to contravene s188 CA 2006, is void to the extent of the contravention, and the contract is deemed to contain a term entitling the company to terminate it at any time by giving reasonable notice.

Liabilities of directors

There are a number of ways in which a director can incur personal liability, which can be civil or criminal.

For example, a breach of the statutory duties (excluding a duty to disclose interest in existing transaction) leads to civil liability. In the case of civil liability, a court may:

  • Order the director to pay a fine (for example, if the company does not comply with any of the requirements in The Companies (Trading Disclosures) Regulations 2008);
  • 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; and/or
  • 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 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); and/or
  • 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).

Under some statutes, if a company commits a criminal offence, a director is also guilty of the offence if the director consented (was aware of the offence), connived (was aware and did nothing to stop the offence from being committed), or if there was any neglect (failure to act when duty bound to, even where there is no knowledge of the offence) on the part of, the director. Certain offences under the Bribery Act 2010 (offering, or receiving a bribe, or bribing a foreign public official) are examples of this. A company being convicted of one or more of these offences could lead to a director facing a maximum penalty of an unlimited fine and/or 10 years imprisonment and possible disqualification as a director for up to 15 years.

An important thing to note is that if a director’s act or omission gives rise to liability, he/she can still be liable after they’ve resigned from the board. For example, if a director has been involved in fraudulent trading and the company becomes insolvent after the director has left, a legal action can still be brought against them.

Liability of directors on insolvency
When a company enters insolvency, directors need to be aware of the potential personal liabilities which may arise for the company’s past transactions. There are 3 main actions which may be brought against directors: wrongful trading, fraudulent trading and misfeasance:

  • Wrongful trading
    A liquidator or administrator may bring an action against a director if they knew, or ought to have concluded, that there was no reasonable prospect the company could avoid insolvent liquidation/administration but continued to trade after they knew or ought to have known that fact and did not take every step he/she ought to have to minimise creditor loss. There is no requirement for dishonesty by the director, for him/her to be found guilty of wrongful trading.Where a claim for wrongful trading is brought, the director may rely on the defence that he/she took every step to minimise the potenial loss to creditors. It’s therefore important that directors take particularly great care to discharge their duty towards creditors when the company is in financial difficulty.When considering whether the director took every step, an objective test of ‘general knowledge, skill, and experience that may reasonably be expected of a director carrying out the same function’ is applied. If the director fails to show he/she took steps that can be reasonably expected from a director with the same general knowledge, skill, and experience due to carrying out of the same function, then a subjective test is applied. The director is then required to show that he took every step that a director would take who has the actual knowledge, skill, and experience, as the director has.

     

    If the claim is successful, the director would have a civil liability to contribute towards the company’s assets. In addition to this, the director may be disqualified as a director.

    If the directors continued trading, it must be shown that it was in the best interest of the creditors. For example, the directors may be able to show the continued trading was intended to keep the business going so it could be sold as a going concern.

  • Fraudulent trading
    A liquidator or administrator may bring an action against a director (or anyone) that is knowingly party to conducting business with intent to defraud creditors, or for any fraudulent purpose. To succeed with this claim, the claimant would need to show the director acted dishonestly.If successful, the directors acquire civil liability, meaning they may be required to make such contributions towards the company’s assets as the court thinks proper, taking into account the control of the director and benefit they derived. The aim of this is to increase the assets available to distribute between creditors, on insolvency.The director may also acquire criminal liability. If convicted on indictment, the director could be imprisoned for up to 10 years and/or ordered to pay a fine.  If summarily convicted, the director may be imprisoned for up to 12 months and/or ordered to pay a fine.  In addition to this, the director may be disqualified as a director.
  • Misfeasance
    A liquidator, official receiver, creditor, or contributory may bring a claim against the director (or anyone) if he/he has misapplied, retained, or become accountable for money or other company property or is guilty of any misfeasance or breach of fiduciary or other duty. The main aim of this cause of action is therefore to allow liquidators and administrators to sue directors for breach of duties.A director may rely on the defence that he/she acted reasonably and honestly, and ought fairly to be excused.Where a claim of misfeasance is successful, the director will need to repay, restore, account for the monies/property, and/or contribute towards the company’s assets with interest or some other form of compensation, as the court sees fit. 

Limiting liability
Where a director breaches their statutory duty, it’s possible to relieve that director from liability by ratifying the director’s conduct. This means that the company (and shareholders) can’t later make a legal claim against the director for that particular conduct.

For example, if a director breaches their duty to act within their powers by entering a contract which, without the required ordinary resolution, the company can ratify the action to relieve the director from liability for this breach. This may be desirable where the contract is a highly valuable business opportunity for the company, and the shareholders consider it inappropriate for the director to be liable for making such a lucrative opportunity possible. To ratify the conduct of a director, the shareholders just need to pass an ordinary resolution (unless the company’s constitution requires a higher majority for approval).

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.

Protection from liability

The CA 2006 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.

However, companies can make provisions to indemnify directors for other liability incurred. If a company has model articles of association, there is permission for the company to indemnify a director for liability incurred to third parties, and indemnify for costs incurred in defence proceedings (civil and regulatory proceedings).

A company can indemnify a director in two ways. It may:

  • Purchase and maintain insurance for a director against such liability (often referred to as director and officer insurance or D & O insurance; and/or
  • Provide Qualifying Third-Party Indemnity Provisions (QTPIPs) and Qualifying Pension Scheme Indemnity Provisions (QPSIPs). QTPIPs allow a company to indemnify a director for costs incurred in defence proceedings with third parties (not the company itself or any associated company). The director however, must pay back any sum paid out on their behalf, if judgment is given against them. QPSIPs allow a trustee company (or an associated company) to indemnify its trustee directors against liability incurred in connection with the company’s activities as trustee of the scheme. With regards to QPSIPs, the indemnity can’t extend to reimburse for criminal proceedings, criminal fines, or regulatory penalties or any cost incurred as a result of defending a claim he/she is convicted of.

Options for shareholders unhappy with how a director discharges their duties

Shareholders have a range of actions they can take against directors if they’re unhappy with the manner in which directors discharge their duties.

The three main options available which you should be aware of include:

  • Removal of directors
  • Derivative claims
  • Unfair prejudice claims

Removal of director
Shareholders can remove a director by passing an ordinary resolution. However, unlike other ordinary resolutions (OR) which can be passed at a general meeting with 14 clear days’ notice, or by way of written resolution, an OR to remove a director involves a special procedure.

Procedure to remove directors If the shareholders wish to pass an OR to remove a director, the special notice procedure of giving 28 days’ notice for the general meeting must be used. It’s not possible to use the written resolution procedure to pass an OR to remove a director and reduce the notice.

 

Upon receiving the notice, the directors will usually call a general meeting within 14 clear days. However, the directors may alternatively refuse to put the resolution on the agenda for the general meeting.

In circumstances where the directors refuse to put the OR on the agenda, the shareholders can serve a section 303 (CA 2006) request for a general meeting. A section 303 request can only be made if supported by shareholders which together, hold 5% of the paid-up share capital (or 5% of the voting rights if there is no share capital). The directors must subsequently call a meeting within 21 days from the request, and the date of that meeting must be within 28 days of the request.

If the directors fail to comply with the shareholders request within 21 days, the shareholders can call a general meeting themselves on the 22nd day after their section 303 request.

Since the director concerned must have an opportunity to prepare his/her representations, and have a chance to be heard at the meeting, the director should be sent a copy of the notice which requests an OR to remove that director and if practicable these representations should be circulated to the shareholders prior to the meeting. Once the director has made his/her representations, the shareholders must vote on the OR.

Whilst the articles of association cannot exclude the statutory procedure relating to director removal per se and any attempt to is unlawful and unenforceable, if a Bushell v Faith clause is included in the company’s articles, when the director concerned is also a shareholder of the company, the concerned director has weighted voting. This makes it harder to remove the director as it’s more difficult to achieve the threshold of above 50% of those shareholders entitled to vote, voting in favour.

Where the director is an employee, the circumstances should be reviewed carefully and legal advice taken, as a court may find that removing a director amounted to constructive dismissal in the specific case. Our specialist employment lawyers can advise on this.

Remedies for the director being removed Under the CA 2006, the company may be required to pay the director for loss of office. To do this, the shareholders of the company must pass an OR.

 

Similarly, if the director is an employee, they may be entitled to damages for breach of their employment contract or wrongful dismissal. (e.g. for loss suffered as a result of the director being denied the contractual notice period, or loss resulting from the company’s failure to make payment in lieu of notice). The director may also be entitled to bring a claim for unfair dismissal if he/she was an employee for more than 2 years and the dismissal is considered unfair.

Derivative claim
This is where the court has discretion to permit shareholders to bring a claim in their own name but on behalf of the company where there is an actual/proposed act or omission involving the negligence, default, breach of duty, and/or breach of trust by a director of the company and these wrongs have not been authorised or ratified (see ‘limiting liability’, above). A derivative claim must also not be contrary to the duty to promote the success of the company, after board consideration (where factors such as long term impact on the company, its employees, its relationship with business contacts and reputation are considered).

It’s not very common for shareholders to make a derivative claim because the company is usually the ‘proper’ claimant (the wrong has been done against the company). There must be a legal action vested in the company for a shareholder to bring a derivative claim and obtain relief on behalf of the company, so such a claim can be brought for any breach of a statutory obligation which causes harm to the company, whether this be against a director, third party or both, whether or not the wrongdoer benefited. An alleged breach of the directors’ duties discussed above, could give rise to a derivative claim.

Procedure for bringing a derivative claim A claimant needs to issue a claim form for a derivative claim and then will need to follow a two-stage procedure to be given permission by the court to continue with the claim. If the shareholder is successful with these two stages a full trial of the issues of the derivative claim can be granted.

 

Stage 1: file an application notice with the court in order to attend a permission hearing where the court will decide whether to give permission for the application to continue. The application notice requires the claimant to make a prima facie case which is supported by evidence. If a prima facie case is made, the court will allow the claim to proceed to Stage 2, below. If a prima facie case is not made, the court will dismiss the application, and a consequential order such as a civil restraint order or costs order may be made against the claimant if the court considers it appropriate.

It’s important to note that where an application is refused, the claimant may ask for an oral hearing to reconsider the decision.

Stage 2: The court will consider the evidence (including evidence directed by the court to be provided by the company) and after hearing the application, the court will decide whether to give permission for the claim to be brought.

The court will either give permission to the claimant to continue the claim, refuse permission and dismiss the claim (in light of the statutory grounds outlining when dismissal of a claim is mandatory), or adjourn the proceedings.

Where permission is granted, the case will proceed to a full trial. If the claimant is successful, it’s likely that the company will be given damages to compensate it for any losses suffered. If the director benefited from his/her act or omission which was subject to legal action, the court may also order the director to account for this profit.

Unfair prejudice
Distinct to bringing a derivative claim, a shareholder can bring a legal action where the company’s affairs are being, have been, or are proposed to be conducted in a manner that is unfairly prejudicial to that shareholder’s interests or to the interests of shareholders generally.

Procedure to bring unfair prejudice claim To initiate an unfair prejudice claim, the shareholder must file a petition with the court. The petition must specify the grounds of the claim and the relief/remedy sought.

 

Upon receiving the petition, the court will either give directions with regards to the petition or will set a hearing date.

If the shareholder wishes to obtain relief against the director pending the petition hearing, it’s also possible to obtain interlocutory relief (temporary relief).

Requirement A company’s affairs will be considered to be ‘unfairly prejudicial’ to the shareholders interest where there is:

 

  • Conduct which is prejudicial (for example, causes prejudice or harm to the relevant interest of shareholders or some part of the shareholders of the company); and
  • The prejudicial conduct is unfair from the view of a reasonable bystander.

Examples of prejudicial conduct commonly include:

  • excessive remuneration for a director
  • conduct by the directors which prevents the legitimate expectation of the shareholders (such as continuing to be involved with decision making in small private companies)
  • diversion of business to another company in which the majority shareholder holds an interest
  • the majority shareholder awarding himself excessive financial benefits
  • abuse of power and breaches of a company’s articles of association
Remedies Where a shareholder successfully makes an unfair prejudice claim, the court can:

 

  • Regulate the conduct of the company’s affairs in the future
  • Require the company to refrain from doing or continuing an act complained of, or to do an act which the petitioner has complained the director omitted to do
  • Authorise civil proceedings to be brought in the name and on behalf of the company by such persons and on such terms as the court may direct
  • Require the company not to make any, or any specified, alterations in its articles without the leave of the court; and/or
  • Provide for the purchase of shares of any members of the Company by other members or by the company itself and, in the case of the purchase by the company itself, the reduction of the Company’s capital accordingly.

What next?

If you need to draft, manage or amend your articles of association, if you are involved in a directorship dispute or would like assistance with any of the matters discussed above, our corporate solicitors can help. Call us on
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