The rules governing directors come from a variety of sources. There are rules contained within case law and within specific legislation (such as employment, health and safety and insolvency legislation) but the Companies Act 2006 (“CA 2006”) sets out a director’s duties.
These seven general duties are contained within sections 171-177 CA 2006 and are:
- a duty to act within powers: this includes a duty to act in accordance with the company’s constitution and to only exercise powers for the purposes for which they were conferred;
- a duty to promote the success of the company: a director must act in a 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 (see further below);
- a duty to exercise independent judgement: this includes a duty on the director not to fetter their discretion to act or to take decisions;
- a duty to exercise reasonable care, skill and diligence: this includes both a subjective test and an objective test of what is reasonable;
- a duty to avoid conflicts of interest: this duty applies to situations in which the director has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company unless the conflict has been validly authorised by the directors (for transactional conflicts see further below);
- a duty not to accept benefits from third parties: where the benefit is as a result of his being a director or doing (or not doing) anything as a director; and
- a duty to disclose interests in a proposed transaction or arrangement: this disclosure must occur before the transaction or arrangement is entered into.
The second duty is, in many ways, the most fundamental duty that a director owes (although the CA 2006 does not give it any special status). The CA 2006 goes on to give six (non-exhaustive) matters that a director should have regard to when acting in this way being:
- 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 or business conduct; and
- the need to act fairly as between members of the company.
It should also be noted that the formulation of this duty refers to ‘the members as a whole’ which doesn’t deal with the situation of whether the interests of the company as a separate entity and the interests of its members can diverge.
In the case of a proposed takeover, for example, it is possible that the potential new owners will not benefit the company as a separate entity but the sale price may well be to the benefit of the current (but not future) members. In this case it is unclear how the duty should be applied.
Lord Goldsmith (the government’s spokesman on this part of the CA 2006 when it was being debated) said that ‘success’, for a commercial company, will usually mean the ‘long term increase in value’. However, there will be some difficult situations that the courts will need to clarify in due course.
The Court of Appeal has decided a case on conflicts of interest that highlights the strictness and importance of these directors’ duties.
Mr Towers, a former director of the company, entered into a free, undisclosed and unapproved loan with a customer of the company.
Even though Mr Towers argued that he had not breached his director’s duties because:
- the arrangement was a private, informal, ad hoc arrangement involving small amounts which were negligible and de minimis;
- the customer had received no favours from Mr Towers in relation to the arrangement; and
- Mr Towers had no direct dealings with the customer (the arrangements were made through an employee of the company who normally dealt with the customer and who worked in a division headed by Mr Towers).
However, the Court of Appeal disagreed and found that, even though the company had not suffered as a result of the arrangement, Mr Towers had breached his duties as a director and he should pay the company an amount based on what it would have cost him in the open market.
This case acts as a timely reminder to directors that these seven duties are fundamental to their role as a director and, specifically in relation to conflicts of interest they should always look to disclose a conflict to the board even if they feel it is inconsequential or common practice.
Elemental has an in-house team of chartered secretaries, governance professionals and lawyers who have helped put in place governance frameworks for FTSE companies, AIM companies and organisations in the not-for-profit sector, including reviewing the current directors’ duties and providing board training. To discuss your individual requirements for governance best practice please get in touch with a member of the team. To find out more about our other corporate governance services visit our services page.