Directors’ powers and financial liabilities

Being a director has its rewards and its responsibilities.

Whether you are appointed to the board of the company you work for or from establishing a new business yourself, taking on the role of director gives you a sense of achievement.

However the role of director should not be accepted lightly. The introduction of the Companies Act 2006 has brought about a number of changes and pitfalls for directors which you must be aware of.

1. You have a duty to act within the company’s powers – A director must always act in a way allowed by the company’s articles of association and its decisions.

2. You have a duty to promote the success of the company – A director must act in the way that will promote the success of the company for the benefit of the shareholders. When doing this, a director must consider the following:

  • the long term consequences of any decision
  • 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
  • the need to act fairly between the members (shareholders) of the company

This means that making the most money for shareholders (profits) should not be the only concern of a director; he must also consider the wider effects of how the money is generated. The advice of Cousins Business Law solicitors is that the above checklist should be gone through whenever making board decisions. This ensures all the directors can leave an audit trail to show they have considered the impact of every decision upon the business.

3. The duty to exercise independent judgment – This may arise, for example, if a bank or major funder wants you to act in a particular way. This duty can, however, be modified by agreement or by changing the company’s articles of association.

4. The duty to exercise reasonable care, skill and diligence – A director will be judged according to what would be reasonable in his role, as well as any particular skills or knowledge he has. For example, a financial director would be held more culpable for financial errors than a general director. But all directors must perform to a minimum reasonable standard. For example, a sales director will not be excused with saying that he left the finances to the financial director to deal with and he had no idea about the company’s finances. It is his duty to find out.

5. The duty to avoid conflicts of interest – A director must avoid any situation where he has or could possibly have a conflict of his own interests with those of the company. He cannot exploit any property, information or opportunity that comes his way because of company activity. For example, if in the course of running a company a director discovered a business opportunity he cannot exploit it himself or by setting up another company, even if the first company did not take advantage of it. There are a few exceptions to this, the most important being that the board of directors can authorise a director to exploit a particular opportunity even if there is a conflict.

6. The duty not to accept benefits from third parties – This prevents taking bribes but may also include benefits from being a director, shareholder, employee or advisor to a competing company.

7. The duty to declare interests in a proposed transaction or arrangement with the company – A director, or shadow director, must declare the nature and extent of any interest he has in a proposed transaction or arrangement to the board of directors, whether he is directly or indirectly interested in it. A director is deemed to always be aware of matters which he ought, reasonably, to be aware of.

This will arise particularly when a director is a shareholder, director, employee or advisor to another organisation or person with whom the company is about to enter into a transaction or arrangement.

The director must make the declaration in writing before the company enters into the transaction. He is to give what is called a “general notice”, which is where he says he has an interest in another organisation or person and is therefore to be taken as being interested in any transaction or arrangement that that organisation or person might make.

8. The duty to declare interests in existing transactions or arrangements – A director should declare an interest before the company enters into a transaction. This duty is primarily aimed at new directors, who should declare their interests when they are appointed. Clearly, if you have not already declared an interest when appointed, you should do so now.

Common law fiduciary duties remain unaffected by the new Act and there is some overlap between them and the duties in the Act, e.g. to act in the company’s best interests, to use company property for legitimate company interests only, to act in accordance with the company’s constitution, to avoid conflicts of interest and to avoid making a secret profit.

Insolvency duties remain unaffected too, such as the duties to the company’s creditors when a company becomes technically insolvent and the duty to put a company into liquidation if an insolvent liquidation cannot reasonably be avoided.

The Sanctions

If you breach these duties, a court can hold you personally liable to pay back to the company any losses that it suffered or any profits that you made.

When Breaches May Come to Light

Generally, breaches of a director’s duties come to light in the following circumstances:

  • when directors fall out with each other or the shareholders
  • when a director leaves
  • when the company is wound up or put into liquidation or administration
  • when the company is sold

Certainly, if you have any concerns and one of these circumstances is about to happen, you should take legal advice to minimise the risk of you having to pay lots of money back to the company.

However, often it’s difficult to predict when something might happen. So the time to consider these duties and to ensure you are compliant is now!

Summary

The role of the company director has, until recently, been defined by case law. The Companies Act 2006 confirms previous case law and requires company directors to act in a way most likely to promote the success of the business.

You must exercise a degree of skill and care. You must:

  • show the skill expected of a person with your knowledge and experience
  • act as a reasonable person would do looking after their own business

You must act in good faith in the interests of the company as a whole. This includes:

  • treating all shareholders equally
  • avoiding conflicts of interest
  • declaring any conflicts of interest
  • not making personal profits at the company’s expense
  • not accepting benefits from third parties

You must obey the law:

  • company law requires you to produce proper accounts and send various documents to Companies House
  • other laws include areas such as health and safety, employment law and tax
  • you may be responsible for the actions of company employees

If in doubt, take professional advice. Acting improperly can lead to fines, disqualification from being a director, personal liability for the company’s debts or a criminal conviction.

However you may be not be aware of how easy it is to fall foul of the law:-

An engineer at Rhone Poulenc Rorer Ltd stepped onto a roof “guarded” by a sign which stated that crawling boards had to be used since the roof was fragile. He ignored the sign and stepped on the roof and fell to his death.

You would have thought that a warning sign was sufficient, apparently not. His widow sued and succeeded in her action against the company.

The court stated that the onus was on the company to protect all workers on its premises and that both practical and physical preventative measures were needed.

There were additional steps that the company could have taken to provide themselves with a valuable defence*.

In another legal case of Pharmed Medicare Private Ltd v Univar, two employees described as “managers” of the firm placed a small number of orders on behalf of the company. Later they placed a much larger order. When there was a dispute over payment for the larger order the other party successfully claimed that the employees had authority since all previous transactions had been ratified by payment by the purchasing company.

I must admit that the ramifications of this particular case shocked me, so I have now taken preventative measures to put in place controls so that our own companies have both expenditure control and bribery prevention strategies in place*.

What about Director’s Liability Insurance?

We understand that insurance companies find selling Director’s Liability Insurance very profitable as they hardly ever pay out, largely due to the small print on their policies. Therefore investing your hard earned cash in such a policy is no guarantee of protection.

How can you best prevent a problem occurring?

To bring yourself up to date, you might consider attending a one day seminar, such as the one offered by Benchmark Training, I recently attended this course myself and found it extremely practical and helpful in bringing me up-to-date with current and anticipated requirements and remedies.* The course was full of practical solutions, along with legal theory and helpful handouts. I must say that the comprehensive and user-friendly handouts containing ‘ready to use’ checklists, procedures and policies (including safety and vehicle folders) were worth their weight in gold. Attendees gained these valuable resources for free.

Final Comment

We recommend ALL directors take steps to update themselves on the recent legislation and their liabilities. The Benchmark Training seminar is a great way of finding out about the latest requirements for directors and to ensure you are compliant with the Companies Act 2006.

If interested in further details please e-mail us for course details and enrollment form.

Ray Best can help you protect your financial future. To find out more, simply click here!

About Ray L Best

Ray Best has had over 30 years experience of advising on complex financial matters. A published author of a number of books including “Partnership and Shareholder Protection”, Inheritance Tax Simplified”. We provide an initial meeting at no cost and only engage with clients when we can add significant value.

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