The Duties And Liabilities Of Directors Of Limited Companies Incorporated In The UK

The general duties owed by directors to their companies evolved through the interpretation of those duties by decisions of the English courts, that is, they were "common law" duties rather than being set out in statute. The Companies Act 2006 ("CA 06") has now introduced for the first time a statutory statement of directors' duties which will, when fully implemented, replace entirely those existing "common law" duties. Most of the provisions of CA 06 relative to duties and liabilities of directors came into force on 1 October 2007, but those dealing with conflicts of interest will not come into force until 1 October 2008.

The Companies Act 1985 ("CA 85") also contained numerous provisions which imposed duties and obligations on directors of companies, and restrictions in respect of the manner in which they could behave in relation to their companies (often referred to as "fair dealing" provisions). CA 06 simply re-enacts many of these provisions without alteration, although some have been subject to significant changes. The most notable of these provisions are considered below.

All references to sections of an Act in this note are to sections of CA 06 unless specifically stated otherwise.

1. Definition Of "Director"

CA 06 does not contain a specific definition of the term "director". There is a general provision in section 250 which states that the expression "director" includes "any person occupying the position of director, by whatever name called", which includes a person who is treated by the board as such despite not having been validly appointed.

The law also recognises the concept of "shadow directors" and many of the statutory provisions which apply to directors also apply to "shadow directors". A shadow director is defined by section 251 as "a person (which may be an individual or a company) in accordance with whose directions or instructions the directors of the company are accustomed to act". A shadow director exerts control and may be held liable for his acts, particularly in cases of insolvency or where wrongful trading is alleged. A shadow director who exerts control but seeks to evade liability by not being appointed as a director will not be protected just because he has not been formally appointed.

2. General Duties Of Directors

Section 170 provides that the codified general duties of directors set out in sections 171-177 should be interpreted and applied in the same way as the common law rules and equitable principles which they replace, and regard should be had to the corresponding common law rules and equitable principles when interpreting and applying the statutory duties. Accordingly, courts will need to interpret and apply the general duties in a way that reflects the rules that they replace and it is thought that insofar as the newly codified duties do not encapsulate pre-existing duties, those duties will survive. It therefore remains to be seen quite how different the new directors' duties regime will be from what went before.

The codified duties apply to all the directors of a company, including shadow directors and, in the case of the duties in sections 175 (duty to avoid conflicts of interests) and 176 (duty not to accept benefits from third parties), even former directors of the company. It should be noted that the law in this area is new and has not yet been the subject of interpretation by the courts.

From 1 October 2007, four of the seven new codified provisions on directors' duties in CA 06 are in force:

2.1. Duty To Act Within Powers (Section 171)

Section 171 codifies the equitable rule that a director must act in accordance with the company's constitution and must only exercise his powers for their proper purpose.

The section does not clarify aspects of the duty to exercise powers for proper purposes, such as how those purposes are to be ascertained, or the extent to which an improper purpose may taint a decision. Such matters will fall to be determined in accordance with previous case law, under which courts have approached the duty by first ascertaining the purpose for which the power was conferred, and then determining whether that was the director's substantial purpose when exercising the power. The liability is strict: if the director's substantial purpose was not the purpose for which the power was conferred, it will not matter if he exercised the power in good faith or in the belief that it would promote the success of the company for the benefit of the members as a whole.

2.2. Duty To Promote The Success Of The Company (Section 172)

Section 172 replaces both a fiduciary duty which was usually summarised as being "to act in good faith in the best interests of the company", and also the statutory duty to consider the interests of the company's employees under section 309 of CA 85.

Section 172 provides that a director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. In so doing, the director must have regard (among other matters) to:

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 the members of the company.

Where the company's purposes consist of or include purposes other than the benefit of its members, the director must act in the way he considers, in good faith, would be most likely to achieve those purposes.

The duty is subject to any enactment or rule of law requiring directors in certain circumstances to consider or act in the interests of the creditors of the company. Accordingly, the duty is displaced when the company is insolvent, and may be modified by an obligation to have regard to the interests of creditors as the company nears insolvency.

It should be noted that:

the duty will apply to all decisions made by a director, not merely formal decisions made by the whole board;

"success" is not defined. It is thought that "success" in this context will usually mean "long-term increase in value" for commercial companies, and that what will promote the success of the company, and what constitutes such success, will be for the director's good faith judgment;

the obligation to have regard to the listed factors is clearly subordinate to the overarching duty to promote the success of the company for the benefit of its members as a whole. However, the obligation to have regard to at least the listed factors, in carrying out the overarching duty, is mandatory;

the list of factors is not exhaustive - directors should have regard to other matters relevant to the duty to promote the success of the company; and

in having regard to the listed factors, the duty to exercise reasonable care, skill and diligence (section 174) will apply. In some cases, to satisfy the duty, it may be necessary to seek expert advice, for example in relation to impact on the community or environment.

Concerns have been raised about this section, including:

whether directors should now give precedence to the interests of current members over future members. Historically, the fiduciary duty to act in the best interests of the company has been interpreted by identifying the company with its shareholders, both present and future and requiring directors to balance short-term and long-term interests. It is not clear that this will continue to be the case, but until the meaning of the section is more settled, directors may wish to seek professional advice in circumstances where...