Directors' duties and powers

Re Barings plc and others

Andrew Tuckey, the former deputy chairman of Barings bank, was responsible for the supervision of Nick Leeson, the derivatives trader whose unauthorised trading brought the bank close to collapse in 1995. In a case concerning the disqualification of Tuckey as a director, it was alleged that he had failed to exercise his duty of skill and care to the company by failing to exercise adequate supervision over Leeson's activities. It was held that Tuckey had failed in his duties because he did not have sufficient knowledge and understanding of the nature of the derivatives markets and the risks involved in derivatives dealing (which led to the collapse of Barings). He was therefore unable to consider properly matters referred to the committee he chaired, which was responsible for supervising Nick Leeson's activities

Power to delegate

Articles of association invariably allow the directors to delegate their powers and, in practice, this is what they do, recognising that a board which meets, say, once a month cannot possibly manage the business on a day-to-day basis. For example, article 5 of the Model Articles for public limited companies states: 5. Directors may delegate • Subject to the articles, the directors may delegate any of the powers which are conferred on them under the articles— - (a) to such person or committee; - (b) by such means (including by power of attorney); - (c) to such an extent; - (d) in relation to such matters or territories; and - (e) on such terms and conditions; as they see fit. • If the directors so specify, any such delegation may authorise further delegation of the directors' powers by any person to whom they are delegated. • The directors may revoke any delegation in whole or part, or alter its terms and conditions. Boards usually delegate extensive management powers to the executive directors. These powers typically flow through the chief executive officer as the leader of the executive team. Executives are usually allowed to sub-delegate their powers to other people in the organisation. This does not necessarily happen by a literal chain of delegation down to the most junior employee. Most boards use a combination of formal delegation (e.g. to executive directors) and the adoption of company-wide policies and procedures, which set authority limits for the various tiers of management.

General management powers

Articles of association routinely make the directors collectively responsible for 'managing the company's business' and confer upon them (acting as a board) all the powers of the company necessary to do so. For example, article 3 of the CA2006 model articles for public limited companies states: 'subject to the articles, the directors are responsible for the management of the company's business, for which purpose they may exercise all the powers of the company.' The wording in article 3 does not mean that each individual director can exercise these powers. The directors must exercise their powers collectively by a majority decision of the board, unless they are allowed under the articles to delegate those powers to someone else. Provisions such as article 3 above are known as the 'general management clause'. They confer on the directors the powers necessary to manage the business and can only be used for those purposes. For example, the general management clause does not give the directors power to reject a share transfer. They need a 'special power' to do that.

How could a breach of the s.171 duty to act within powers occur?

A breach of the duty to act within their powers may arise where: • an individual director or the board does something that is beyond the company's powers; or • an individual director or the board does something that is within the company's powers but not within their own powers. As mentioned previously, the directors' general management powers under the articles may be subject to certain limitations in its constitution. For example, an objects clause may restrict the type of business activities the company may undertake or the articles could contain a borrowing limit. If the directors act beyond the company's powers or their own powers and the company suffers a loss as a result of this breach of duty, the company can sue the relevant directors in order to recover that loss. Most cases in this area concern examples where the directors have acted outside the company's powers. Such a case could arise where, for example, a company has an objects clause which limits its business activities to, say, operating supermarkets in the UK. If the directors of this company sought to expand the business overseas and in the process the company suffered considerable losses, it could sue the directors to recover those losses. If the unlawful business venture had been successful, it would be pointless for the company to sue as there would be no losses capable of being recovered. There have been surprisingly few cases of this nature against directors, probably because companies have always tended to adopt objects clauses that impose very few restrictions on what the company can do. Companies (other than charities) are no longer required to have an objects clause, and if they do not have one their objects are deemed to be unrestricted. If a company still has an objects clause, it still operates as a limitation on the company's powers. Given the choice, directors would probably prefer to operate without an objects clause. However, shareholders may prefer to have one in order to prevent the directors from expanding into areas in which both they and the company have no experience.

When would s.176 be breached? How is the threshold determined?

A clear and obvious example of a breach of the duty not to accept benefits would be for a director to accept a bribe in return for awarding a contract to a supplier (Boston Deep Sea Fishing and Ice Co Ltd v Ansell [1888]). Another example would be for a director to accept a secret benefit from a third party in connection with a takeover bid or reconstruction (General Exchange Bank v Horner [1870]) It is almost inconceivable that a director could be found to be in breach of this duty for accepting an occasional invitation to lunch or dinner from a customer or supplier. These could not reasonably be regarded as giving rise to a conflict of interest. However, the acceptance of an all-expenses-paid trip to a high value corporate hospitality event (such as the Monaco Grand Prix) might conceivably be pushing the boundaries as to what might be acceptable. In practice, the threshold as to what is or is not considered acceptable in this area will be influenced far more by the policies which the company adopts for the purposes of compliance with the Bribery Act 2010 (see Chapter 13). Directors are responsible for a company's arrangements concerning compliance with the Bribery Act. The Act made the giving or accepting of bribes illegal and introduced a corporate offence of failing to prevent bribery. Under that offence, a company risks prosecution for the illegal acts of employees or agents unless it can show that it had 'adequate procedures' in place to combat bribery. Ministry of Justice guidance on the procedures that businesses need to put in place to provide a defence against prosecution under the Bribery Act suggests that companies need to adopt strict internal anti-bribery policies, including policies on matters such as the acceptance of gifts and corporate hospitality. Such a policy might preclude directors from accepting any gifts or allow them to accept small gifts but not to keep them. The policy may require directors to obtain clearance before accepting any benefits from third parties and/or require all instances of gifts or hospitality to be recorded in a register. By their nature, anti-bribery policies should help to ensure that directors do not fall foul of their duty not to accept benefits from third parties. However, it is helpful to keep Companies Act compliance in mind as a subsidiary objective when designing such policies. For example, it might be a good idea to hold directors to higher standards than other employees.

Funding of legal expenses

A company is not required to obtain members' approval (as would otherwise be required, in connection with loans to directors under ss. 197, 198, 200 or 201) for doing anything to provide a director with funds to meet expenditure incurred in defending any criminal or civil proceedings or an application for relief under s. 1157 (general power to grant relief in case of honest and reasonable conduct) or doing anything to enable a director to avoid incurring such expenditure (for example, insurance) (s. 205). Section 206 makes similar provision in connection with regulatory actions or investigations.

Scottish Co-operative Wholesale Society v Meyer [1959]

A holding company deliberately and successfully 'starved out' its partly owned subsidiary by not providing it with business contracts on which its livelihood depended. Although the case was decided on other grounds, the House of Lords indicated that the three directors who were nominees of the holding company on the board of the subsidiary were in breach of their duty to exercise independent judgement through their failure to take any positive steps to protect the subsidiary against the oppressive policy of the holding company.

Shareholders' reserve power to give directions

As a general rule, where a company's articles confer a power on the directors, the shareholders cannot then exercise that power themselves unless the articles provide some sort of mechanism enabling them to do so. This is the case even though the shareholders are, in effect, the people who delegated those powers to the directors. Most articles give shareholders a reserve power to issue directions to the directors but invariably require them to do so by passing a special resolution for these purposes. For example, article 4 of the Model Articles for public limited companies allows shareholders to instruct the directors by special resolution to take, or refrain from taking, specified action. However, it provides that a resolution of this nature has no effect on the validity of anything which the directors have already done before the resolution is passed. For example, there would be no point in the members passing a special resolution to prevent the directors from selling part of the business, if that sale had already taken place. In practice, shareholders rarely use these powers. Shareholder activists sometimes do so as part of a campaign designed to put pressure on the company to change, say, its environmental policies. They typically do so more to gain publicity for their cause than in the expectation of victory. It is easier for shareholders who oppose the actions of management to seek the removal of the existing directors and to appoint new people in their place, both of which can be done by ordinary resolution, albeit one that requires special notice.

Duty to avoid conflicts of interest (section 175)

Director have a duty under s. 175 of the CA2006 to avoid conflicts of interest. Under this duty they must avoid a situation in which they have, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. Section 175(2) clarifies that this duty applies in particular to the exploitation of any property, information or opportunity. Section 175(3) clarifies that it does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company in which a director has an interest. This type of conflict is dealt with separately by ss. 177 and 182 of the CA2006 Directors are liable as trustees if property under their control is misapplied, e.g. applied outside their powers. This means that a director who wrongly makes a profit by exploiting a business opportunity that belongs to the company can be made to repay that profit. The courts may also rule that a third party acquiring company property through a breach of duty by directors holds that property on behalf of the company as a constructive trustee and, as a result, can be forced to return it.

General duties of directors under the Companies Act 2006

Directors also have a number of civil duties under the CA2006. These duties are set out in Part 10, Chapter 2, ss. 171-177 and are referred to as the 'general duties of directors'. Some people still refer to them as the common law or fiduciary duties of directors as they derive from common law and equitable principles developed by the courts over many years. The UK government decided to codify these duties in the CA2006 in order to make them more accessible and easier for directors to understand. ICSA: The Chartered Governance Institute issued in August 2020 a guidance note on Directors' general duties under the Companies Act 2006. The general duties are owed by the directors to the company and concern the manner in which they carry out their functions as agents of the company. They set certain minimum standards of conduct and behaviour on the part of the directors. If they act in breach of these duties, they can be sued by the company in civil proceedings, which may result in them having to pay the company compensation for any losses that it suffered or account to the company for any secret profits they made. There is no limit to the amount of compensation that may be awarded in these civil cases. As the duties are owed to the company, only the company can bring an action against the directors for a breach of the general duties. As an exception to this rule, shareholders can bring what is known as a 'derivative' action in the name of the company. However, if they win, any compensation is still paid to the company, rather than to the shareholders who brought the action

Duty to exercise reasonable skill, care and diligence (s.174)

Directors have a duty under s. 174 to exercise reasonable skill, care and diligence in the performance of their duties. This was one of the common law duties that became a statutory duty under the CA2006. It does not derive from the fiduciary duties of trustees. Directors may be found to be in breach of this duty if they acted negligently For many years, the leading case in this area was Re City Equitable Fire Insurance Co [1925], in which Romer J ruled that directors need not exhibit in the performance of their duties a greater degree of skill than may reasonably be expected from a person of their knowledge and experience. Section 174(2) now sets a more rigorous and objective standard. It follows later cases, such as Re D'Jan of London Ltd [1993], in providing that the standards against which directors should be judged are those of: 'a reasonably diligent person with— • the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and • the general knowledge, skill and experience that the director has.' The original Re City Equitable Fire Insurance test was wholly subjective. It could be summarised as saying that if you had the misfortune to appoint a fool as a director, you could only expect them to behave like one. The modern formulation still includes a subjective test ('the general knowledge, skill and experience that the director has'). However, that test no longer acts as the lowest threshold for determining what is reasonable skill and care. This is set by the more objective test in which the director's conduct is compared against the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions in relation to the company. Under this objective test, a finance director would typically be expected to know more about finance than other directors. However, under the subjective test, a non-executive director with a financial background would be expected to bring that experience to bear and would be held to a higher standard on financial matters than those with no such financial background.

Duty to declare interests in proposed or existing transactions or arrangements (s.177)

Directors have a general duty under s. 175 to avoid conflicts of interest. However, that general duty does not necessarily preclude them from having a direct or indirect interest in a transaction or arrangement that the company has entered into or is proposing to enter into. Section 175 specifically states that it does not apply to such interests. Instead, directors have a duty to declare any interests that they have in: • any proposed transaction or arrangement with the company (s. 177); and • any existing transaction or arrangement with the company (s. 182).

Wrongful trading

Directors may also be liable to contribute to the assets of the company if they are regarded as having authorised wrongful trading by the company under s. 214 of the Insolvency Act 1986. This liability will potentially arise where the directors allowed the company to continue trading even though they knew (or ought to have known) that there was no reasonable prospect that the company could avoid going into insolvent liquidation. It is a defence for a director to show that after becoming aware of the possibility of insolvent liquidation they took every reasonable step with a view to minimising the potential loss to creditors. The wrongful trading provision underlines the need for directors to insist on reviewing management accounts (including cash flow statements) at frequent intervals. Any director having doubts as to the continued solvency of the company should immediately take expert advice on their own and the company's position (immediate resignation is not necessarily the appropriate course).

Dorchester Finance Co. Ltd v Stebbing [1989]

Dorchester Finance, a money-lending business, brought an action against its directors for negligence and misappropriation of the company's property. The company had three directors, S, H and P. S was a qualified accountant and acted as managing director; H and P were nonexecutives. One was an accountant. The other had considerable accountancy and business experience. S secretly arranged for the company to make loans to persons connected with him and persuaded P and H to sign blank cheques for this purpose. The loans turned out to be irrecoverable. It was held that all three directors were liable to pay damages to the company. S, as an executive director, was held to be grossly negligent. P and H, as non-executives, were held to have failed to show the necessary level of skill and care in performing their duties as nonexecutives, even though it was accepted that they had acted in good faith at all times.

Managing conflicts of interest

If an actual or potential conflict might arise it can be authorised in one of two ways: • shareholders can authorise an actual or potential conflict by ordinary resolution. A director who Is a shareholder can participate In the vote, even if he is one of the directors interested in the matter. • directors can also authorise conflicts by a majority vote, so long as they are not themselves Interested in the matter. When making a decision to authorise a conflict, directors need to think about their other duties to the company, particularly their duties to promote the success of the company, to act independently of other interests and to exercise reasonable care, skill, and diligence. Directors in public companies can only authorise conflicts if their articles of association contain specific authority for them to do so Directors in private companies can authorise conflicts unless there are specific provisions in the articles preventing them from doing so. Despite this implied authorisation, some companies set out within their articles a preferred way of managing conflicts. Provided the facts and circumstances surrounding the conflict stay the same, an authorisation will last indefinitely or for so long as the authorisation stipulates. If the facts change a new authorisation will be needed. Conflicts can only be ratified after the event by shareholders who are not interested in the matter. Where a company's articles set out a preferred way of managing conflicts it would usually Include • how, when and where an interest is to be declared by a director • the procedure by which the non-conflicted directors authorise a conflict - who can vote and for a quorum • conflicting interests which are expressly permitted, for example, an indirect economic Interest in possible competitors. All of these permitted conflicts will need specific approval.

Charterbridge Corporation v. Lloyds Bank [1970]

In a case decided under the former common law rules, a subsidiary company mortgaged some land to secure the indebtedness of its parent. The directors of the subsidiary were sued for failing to act in the best interests of the subsidiary. The court ruled that the directors were not liable. The directors of a group company are required to have regard to the interests of the individual company and not to those of the group as a whole but this would not of itself involve a breach of duty if an 'intelligent and honest' person in the position of the directors could have reasonably believed the transaction to be in the interests of the individual company.

Related party transactions

Listed companies may have to obtain shareholder approval for certain transactions in which one or more directors have an interest. These types of transactions are known as related party transaction. There are also disclosure requirements for these types of transactions.

In the UK, from where do directors derive their powers?

In the UK, the directors of a company derive their powers from its articles of association, rather than anything in legislation. Although the Companies Act 2006 (CA2006) requires every company to have at least one director (or at least two for public companies), it does not really confer any management powers on them. It deliberately leaves the division of powers between the shareholders and the directors to be determined in the company's articles of association. Almost without exception, articles of association delegate wide powers to the directors. If they did not do so, nearly all decisions would have to be taken by a majority vote of the shareholders, either by written resolution or at a general meeting. This would be impractical for most purposes even in a small owner-managed company, let alone a listed company with thousands of shareholders.

What happens if the directors caused a company to enter into a transaction that was outside its powers?

In the past, if the directors caused a company to enter into a transaction that was outside its powers, that transaction would be treated as void and could not therefore be enforced by third parties. The CA2006 now provides that: • the validity of an act done by a company shall not be called into question on the ground of any lack of capacity by reason of anything in the company's constitution (s. 39); and • in favour of a person dealing with a company in good faith, the power of the board of directors to bind the company is deemed to be free of any limitation under the company's constitution (s. 40). Section 40 goes on to say that a person dealing with the company: • is not bound to enquire whether there are any such limitations in the company's constitution; • is presumed to have acted in good faith unless proved otherwise; and • is not to be regarded as having acted in bad faith merely because they knew the act was beyond the powers of the directors This means that third parties will generally be able to enforce a contract against the company even though it was illegal for the directors to enter in that contract on its behalf. These rules do not affect the potential liability of the directors to compensate the company for any losses arising from their breach of duty. In addition, a contract or arrangement entered into by the board with an individual director would not be protected because the director concerned would not be viewed as a person dealing with the company in good faith. The duty under s. 171 to act in accordance with the company's constitution also means that the directors must comply with any procedural requirements set out in the articles. On its own, a breach of a procedural requirement will not necessarily give rise to any liability unless the company suffers a loss as a consequence of that breach. Cases of this nature are also surprisingly rare.

Norman v Theodore Goddard [1991]

In this case it was held that a director was not liable for the theft of company money by a senior partner in a firm of solicitors as he had no reason to doubt that other person's honesty.

Directors' and officers' insurance

In view of the heavy potential liabilities that directors (and other officers) face, it has become increasingly common for companies to effect and pay the premiums on an insurance policy (or policies) indemnifying directors and officers against such liabilities. This insurance is known as directors' and officers' insurance, or D&O insurance. The UK Corporate Governance Code used to include a provision requiring listed companies to arrange such cover for directors (2016 Code provision A.1.3). This provision is no longer included in the 2018 Code or the 2018 FRC Guidance on Board Effectiveness, probably because the practice has become so well-established that it was no longer thought necessary. Section 232 of the CA2006 generally renders void any attempt by a company to exempt its directors from any of their liabilities or to indemnify them against those liabilities. However, s. 233 specifically authorises companies to take out and maintain insurance policies on the directors' behalf as an exception to this rule. One of the reasons why the CA2006 allows companies to take out such policies is that it is considerably cheaper to take out a group policy than for each individual director to arrange their own cover. If the directors had to take out their own policies and pay their own premiums, the company would still be paying for them indirectly. It would just cost more.

Special powers

Invariably, articles of association also give the directors various special powers that they would not otherwise have under the general management clause. The power to delegate is one of those special powers. If a decision that the directors are proposing to make does not feel like a management decision and there are no special powers authorising them to make that decision, shareholder approval may be required. Share transfers are a good example of this. Rejecting a share transfer does not feel like a decision concerning the management of the business. It relates to the composition of the company's membership. Accordingly, directors need a special power in order to reject share transfers.

Irreconcilable conflicts of interest (s.175)

Irreconcilable conflicts of interest would arise if a director of a competitor joined the board. In the competing areas, any business opportunity could be viewed as a diversion of an opportunity from the other company. The directors who are conflicted in this regard cannot be counted in determining whether there is a quorum at the meeting on the matter and cannot vote on it. If they do vote, those votes must be ignored. If there are not enough non-conflicted directors to make a decision, only the members will be able to authorise the conflict. Even though two companies may not necessarily compete directly in their main area of business, they may compete in some subsidiary areas of business. This is the reason why lawyers often suggest that all outside appointments should be authorised as a potential conflict of interest. Directors might be protected from liability in these circumstances by s. 175(4), which provides that the duty to avoid conflicts of interest is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest. However, it is very difficult to judge when this exception may apply.

Why does the CA2006 require directors to declare their interests in existing transactions?

It is easy to understand why the CA2006 requires directors to declare their interests in proposed transactions but less easy to understand why they are required to do so for existing transactions. One of the reasons is to ensure that the board is aware of any conflicts which may influence a director's opinion on whether, for example, the company should terminate an existing contract or seek to find a new supplier. In addition, it might not be sensible for the board to put a person who has a material interest in a contract in charge of managing that contract. If the company entered into the contract before the director joined the board, it would not otherwise know about these interests in existing transactions. Another reason for the rule in s. 182 is that it creates a criminal sanction in the most serious cases where a director has failed to disclose an interest in a proposed transaction. There is no criminal penalty for failing to disclose an interest in a proposed transaction if the company never enters into that transaction. However, an offence is technically committed under s. 182 from the moment the company enters into the transaction if the director still has not made the necessary disclosure. It should be noted in this regard that notifications made for the purposes of s. 177 for a proposed transaction also serve as notice for the purposes of s. 182 if the company enters into that transaction.

Does the board or company need to authorise any interest declared under s.177?

It should be noted that, under the CA2006, it is not necessary for the board or the company to authorise any conflict of interest that may arise from a director's interest in a proposed or existing transaction or arrangement as long as the director has declared that interest in accordance with s. 177. By contrast, conflicts of interest arising under s. 175, such as the diversion of business opportunities, must be authorised by the non-conflicted directors in accordance with the procedures in that section or by the shareholders. One could argue that by agreeing to enter into the transaction notwithstanding the fact that a director has declared an interest in it, the board has somehow authorised the interest.

What limitations can directors' general management powers be subject to?

Provisions such as article 3 above are known as the 'general management clause'. They confer on the directors the powers necessary to manage the business and can only be used for those purposes. For example, the general management clause does not give the directors power to reject a share transfer. They need a 'special power' to do that. In addition, the directors' general management powers can be subject to limitations which arise under: • an objects clause, which limits the powers of the company, and therefore the powers of the directors (for example, if a company has an objects clause which limits the types of business the company may operate, the directors would be in breach of their duty to act within the company's powers if they decided to expand the business into an area not covered by the objects clause); • an article imposing some sort of specific limit on the directors' powers, like a borrowing limit; • an article allowing the members to give directions to the directors (see below); • a shareholders' agreement - which could require shareholder approval for certain types of decisions which would normally fall within the directors' powers; • the Companies Acts and other rules or regulations - which often impose a requirement for shareholder approval and may impose procedural conditions. Company secretaries/governance professionals have to be alert to these potential restrictions and are expected to advise the board on whether matters are within the directors' powers.

What are derivative actions? Are they likely to benefit shareholders?

Recognising that directors rarely think it is a good idea to sue themselves, the CA2006 provides a procedure that allows shareholders to bring what is called a 'derivative action' in the name of the company against the directors. As mentioned previously, if the shareholders win such an action any compensation that is awarded is paid to the company, not to the shareholders. If the company is in financial difficulty, it is likely that other stakeholders, such as charge holders, creditors, preference shareholders, employees and pension schemes will be the main beneficiaries of any compensation awarded. Even if there is anything left for shareholders, those who brought the claim have to share the spoils with other shareholders who did not participate in bringing the claim. In view of these and other practical difficulties, it is hardly surprising that derivative actions are relatively uncommon. The procedures for bringing a derivative action are set out in Part 11 of the CA2006. A derivative action can be brought in relation to an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director. There is no need to show that the company has suffered a financial loss. Minority shareholders are therefore able to bring actions against directors who have acted in a way that is preferential to a majority shareholder and has breached their duty to promote the interests of shares as a whole. The procedures for making an application include safeguards designed to prevent shareholders from bringing unreasonable claims. One of the tests that the court must apply in deciding whether to allow a derivative action is whether a hypothetical director would consider it worth pursuing it in view of their duty under s. 172 to promote the success of the company. Where the act or omission has already occurred, the court must refuse permission if it was authorised by the company before it occurred or has been ratified after it occurred. For example, a conflict of interest may have been authorised under s. 175. Section 239 of the CA2006 deals with the procedure for ratification of directors' acts giving rise to liability. The courts must also take into account any available evidence regarding the views of other members on whether the action should be pursued. Those other members must have no personal interest in the subject of the claim. In practice, it is both expensive and time-consuming to pursue a derivative action. If the shareholders lose they will be liable to pay the other party's legal costs. Shareholders may sometimes threaten to initiate one in the hope that the directors or their insurers agree to settle the claim. If they refuse to do so, it may make more sense for shareholders to discuss their grievances with the company and to persuade the board to take measures to deal with the offending director or, where relevant, rely on the liquidator to do so.

Regal (Hastings) v Gulliver [1942]

Regal formed a subsidiary to take up the lease of two cinemas, but the owner of the cinemas insisted that the subsidiary have a paid-up share capital which, in the honest opinion of Regal's directors, was more than the company could afford. The directors accordingly subscribed for part of the balance themselves. The cinemas were eventually sold and the company sued the directors for the profits they had made through their investment in the subsidiary. They were held liable despite the fact that: • the directors were held to have acted honestly throughout; • the company could not have completed the transaction without the additional investment; • it had not suffered any loss as a result of the transaction; • the directors probably could have secured shareholder approval for their involvement in the transaction; and • none of the shareholders at the time of the proceedings was a shareholder at the time the profit was made; • In effect, the court ruled that the only thing that would have saved the directors would have been for them to obtain authority from the company's shareholders for their participation in the transaction.

Common law and fiduciary duties of directors

Section 170 of the CA2006 confirms that the general duties of directors set out in the Part 10, Chapter 2 (ss. 171-177) 'are based on certain common law rules and equitable principles as they apply to directors, and have effect in place of those rules and principles as regards the duties owed to a company by a director'. It goes on to say that the statutory general duties should be interpreted in the same way as the common law rules and equitable principles. Accordingly, most of the historic case law is still relevant today for the purposes of interpreting the relevant statutory provisions. Most of the common law rules developed by the courts for directors were based on the rules that they already applied to trustees. This is why some of the duties are referred to as fiduciary duties. A 'fiduciary' is a person in a position of trust. A fiduciary duty is therefore one owed by a person in a position of trust. A trustee is an obvious example of a person in a position of trust. The courts decided that company directors are also in a position of trust because they act as agents of the company, make contracts on its behalf and control the company's property.

Who can bring an action for breach of the general director duties?

Section 170(1) of the CA2006 clarifies that the general duties of directors set out in ss. 171 to 177 are owed to the company. This means that only the company can bring an action against a director. In practice, boards of directors do not often relish the idea of suing themselves for a potential breach of duty, although they may be more inclined to do so with regard to a former director. Section 170(1) of the CA2006 clarifies that the general duties of directors set out in ss. 171 to 177 are owed to the company. This means that only the company can bring an action against a director. In practice, boards of directors do not often relish the idea of suing themselves for a potential breach of duty, although they may be more inclined to do so with regard to a former director.

Duty to promote the success of the company (s.172)

Section 172 imposes a duty on the directors to exercise their powers in good faith in what they consider - not what a court may consider - would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to: • the likely consequences of any decision in the long term; • the interests of the company's employees; • the need to foster business relationships with suppliers, customers and others; • the impact of the company's operations on the community and the environment; • the desirability for the company to maintain a reputation for high standards of business conduct; • the need to act fairly as between members of the company. It is important to note that this duty can only be enforced by the company and not by any of the stakeholders to whom the directors are meant to have regard. Even though it does not appear first in the CA2006, the duty to promote the success of the company can be considered to be the primary duty of directors. This is reflected in the UK Corporate Governance Code, which uses very similar words to describe the overarching role of the board and makes reference to stakeholder interests.

Duty to exercise independent judgment (s.173)

Section 173 of the CA2006 provides that a director must exercise independent judgement. This means that they must not fetter their discretion. For example, a director will be in breach of this duty if they make an arrangement with an outsider to vote in the outsider's interests on a particular transaction, thereby leaving themselves with no independent discretion to consider the company's interests in the matter (Re Englefield Colliery Co [1878]). The duty applies to both executive and non-executive directors and does not depend on whether they are considered 'independent' for the purpose of the UK Corporate Governance Code. The duty to exercise independent judgement does not prevent a director from acting in accordance with an agreement entered into by the company (which could include a shareholder agreement if the company is a party to that agreement) or from acting in a way authorised by the company's constitution (e.g. acting in accordance with a direction given by shareholders under the articles). The duty can cause difficulties for directors who represent outside interests. The position under the law seems to be that a director, who, without any concealment and with the consent of the company, seeks to protect the interests of an outsider on the board will not be in breach of this duty as long as they preserve a substantial degree of independent discretion and do not allow the interests of the outsider to override the interests of the company It should be noted in this regard that directors are required to take into account the interests of other stakeholders under s. 172, but that their overriding duty is to promote the success of the company.

Sections 232 - 238 (Indemnity)

Section 232 declares that any provision (whether in a company's articles or in any contract) that purports to exempt or indemnify a director from any liability for negligence, default, breach of duty or breach of trust in relation to the company is void. Section 233 clarifies that this rule does not prevent a company arranging D&O insurance cover. Sections 234 and 235 provide two further exceptions to this rule. The exception in s. 234 allows (but does not require) companies to indemnify the directors against certain liabilities to third parties. These are known as qualifying third party indemnity provisions. These are defined (negatively) as excluding any indemnity: • against any liability incurred by the director to the company or to any associated company; • against any liability incurred by the director to pay a criminal or regulatory penalty; or • against any liability incurred by the director: - in defending criminal proceedings in which they are convicted; - in defending any civil proceedings brought by the company, or an associated company, in which judgment is given against them; or - in connection with any application for relief under s. 661(3) or (4) (acquisition of shares by innocent nominee) or s. 1157 (general power to grant relief in case of honest and reasonable conduct), where the court refuses to grant relief. Indemnity provisions in articles or contracts often state that the directors are indemnified to the full extent allowed by law. In order to work out the scope of this type of indemnity you need to refer to the types of indemnities that are prohibited under ss. 232 and 234. Such an indemnity would not be effective against any liability for a breach of the general duties of directors under Part 10, Chapter 2 of the CA2006 because these duties are all owed to the company. However, it would be effective in a negligence case brought against a director by a third party that is not an associated company. The exception in s. 235 permits companies to indemnify a director of a company acting as a trustee of an occupational pension scheme against liability incurred in connection with the company's activities as trustee of the scheme (a qualifying pension scheme indemnity provision). Section 236 imposes disclosure requirements in relation to qualifying third party indemnity and qualifying pension scheme indemnity provisions. The directors' report must disclose whether any such provisions were in force at any time during the financial year covered by the report or at that time the directors' report was approved. In addition, ss. 237 and 238 require the terms of any such provisions to be made available for inspection and copying by members.

s.172 statement in the strategic report

Section 414C of the CA2006 states that the purpose of the strategic report is to inform members of the company and help them assess how the directors have performed their duty under s. 172 to promote the success of the company. Section 414CZA requires all large companies (whether quoted, unquoted, public or private) to include a s. 172 statement in the strategic report for financial years commencing on or after 1 January 2019. Small- and medium-sized companies are exempt from this requirement, unless in the latter case they are part of an ineligible group. The s. 172(1) statement must describe how the directors have had regard to the matters set out in s. 172(1)(a) to (f) when performing their duty under s. 172 to promote the success of the company. These matters can broadly be summarised as the stakeholder interests Guidance on what the s. 172(1) statement should cover can be found in the latest 2018 edition of the FRC's Guidance on the Strategic Report. The GC100 Group also published guidance for directors in 2018 on the stakeholder considerations associated with s. 172 (Guidance on Directors' Duties - Section 172 and Stakeholder Considerations).

What are the consequences of a director breaching their general duties?

The CA2006 states that the consequences of a breach of a director's general duties are the same as if the corresponding common law rule or equitable principle applied, but it does not set out in detail what those consequences are. In practice, the remedies available to the company depend on the nature of the breach. As a general rule, directors can be made to repay any illegal payments they have received or secret profits they have made. Where there is a breach of the duty of skill and care or the directors have acted beyond their powers, the company can be awarded compensation for any losses that it has suffered. Where the directors have acted outside their powers, the courts cannot normally declare the transaction void. However, where the directors have used their powers for improper purposes, the transaction can be declared void (see Section 4.1). Where a director has failed to disclose an interest in a transaction, the company can choose whether or not to treat that transaction as void. It is, of course, part of the company secretary's job to ensure that the directors understand their duties, and it is a good idea to reinforce such training with practical examples from case law of the consequences of a breach.

What does the ICSA guidance note (August 2020) on 'Directors' general duties under the CA2006' say in relation to the s.173 duty?

The ICSA guidance note August 2020 on 'Directors' general duties under the Companies Act 2006' provides practical guidance as follows on this duty: • A director should ensure that they do not allow personal interests, for example in a particular contract, to affect the exercise of their independent judgment in the interest of the company. A director should ideally excuse themselves from any meeting at which a decision is to be taken in respect of their own property or duties under sections 175-177. • Importantly, where someone is an executive director, they must not, without due consideration, promote a collective executive line, but should give the board the benefit of their own independent judgment, including their appreciation of the risks involved in a particular course of action. • This duty does not prevent a director from exercising their power to delegate but they must do so appropriately and still exercise their own judgment in deciding whether to follow the action suggested. They should not abrogate all responsibility. • Similarly, a director would not be prevented by this duty from seeking legal or other professional advice (and, indeed, where needed should do so) but, ultimately, the director's final judgment would need to be independent. The circumstances. • A director associated with a major shareholder should set any 'representative' function aside and make decisions on their own merits. This is of particular importance in joint venture situations where there may be constraints imposed by joint venture agreements. However, as set out under 2.3.2 above, this duty is not infringed by a director acting in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by directors. • Likewise, a director who is a family representative in the business may consult their family but must be clear that they will make the final decision. • A director of a subsidiary would need to take into account the interests of the parent company and other group companies, where relevant, provided the exercise of their power remains in the interests of the company of which they are a director. This might apply for instance in relation to a transfer of assets within a group. This could, and should, lead to tensions between the subsidiary board members and colleagues where actions are proposed that may be in the interests of the parent but not of the subsidiary company.

The Wates Corporate Governance Principles for Large Private Companies

The Wates Principles state that nothing within them is meant to override or be an interpretation of the directors' duties set out In the CA2006, which apply to all companies, regardless of their size or whether they are private or public . The Wates Principles are intended to support directors when making decisions to ensure that they meet the requirements of the CA2006 duties, particularly the s172 duty to promote the success of the company.

Section 180 CA2006

The basic position under the CA2006 now is that directors are allowed to have an interest in a proposed transaction or arrangement as long as they have declared that interest in accordance with the CA2006. Section 180 provides that, subject to any contrary provision in a company's articles, where s. 177 (duty to declare interest in proposed transaction or arrangement) is complied with, the transaction or arrangement is not liable to be set aside by virtue of any common law rule or equitable principle requiring the consent or approval of the members of the company. This was not the default position under the Companies Act 1985 or its predecessors. However, articles of association from that era usually included provisions that achieved the same outcome (see, for example, 1985 Table A, regulations 85 and 86).

What actions may a company wish to take to deal with conflicts of interest?

The board should consider introducing a procedure for dealing with conflicts of interest. The GC100 in 2008 produced a template briefing note for directors on conflicts, a questionnaire for directors and a checklist for company secretaries relating to the duty to avoid conflicts, which can be adapted for a particular company's circumstances. The following are actions which a company may wish to take: • As part of the induction process, the company secretary may want to provide each new director with a briefing explaining the duties in section 175 of the Act and the requirement for the prior authorisation of conflict situations. And request that they complete a questionnaire to assist with the identification of any conflict situation they or their connected persons may have. • Put in place a process for authorising conflicts, including the basis on which authorisation is to be granted and the terms/conditions attached - for example whether a director should be excluded from the board meeting, whether board papers should be withheld, whether the director would be required to step down from his directorship on a temporary basis. Also consider confidentiality issues, including whether, if a company is to release a director from disclosing confidential information relating to a third party, it will want to make sure that the director has an equivalent release from the third party in respect of confidential information relating to the company. • Consider appointing a committee to review conflict authorisations (possibly the Nominations Committee). • Advise directors they may need to take independent legal advice if a direct conflict situation arises. • Prepare board papers setting out details of each director's conflict situation for the board then to consider and authorise, if appropriate. • If the board wish to pass a written resolution to authorise conflicts then the articles of association must be checked to see if a written resolution can be passed without all the directors as interested directors cannot be counted. • Decide how to record authorisations. Company secretaries may decide to maintain a register of authorisations which can set out the terms and conditions rather than simply rely on board minutes. • Decide how to deal with conflict situations affecting directors of subsidiary company.

Delegation and the duty of skill and care (s.174)

The case of Norman v Theodore Goddard above (case study 5.4) is an example of a director being allowed to trust the honesty of other company officials. However, in other cases, it has been ruled that delegation by the directors does not absolve them completely from the duty to exercise skill and care. They can be found to be in breach of that duty if they fail to exercise adequate supervision over those performing those delegated functions (see case study 5.5). The power to delegate does not allow the directors to abdicate their functions in favour of some other person as manager. Nor does it allow them to place unquestioning reliance upon others to do their job. They must retain the power of overall control.

What are the consequences of breaching s.177?

The current duty under s. 177 is based on the typical provisions previously found in articles of association in this regard. As it is a civil duty, it gives rise to potential civil remedies in the event of a breach. These remedies are the same as those under the original common law rule. The company can force the director who failed to disclose the interest to repay any profits they made from the transaction. In addition, the company has the option to rescind the transaction. In these circumstances, the transaction is said to be voidable at the instance of the company. In other words, the company can choose whether or not to be bound by a contract.

What does the section 174 duty require of directors?

The duty of skill, care and diligence does not require directors to give continuous attention to the affairs of the company. Their duties are of an intermittent nature to be performed at periodical board meetings and at meetings of any committee of the board upon which they happen to be placed, although they ought to attend whenever, in the circumstances, they are reasonably able to do so (Re City Equitable Fire Insurance Co). This requirement is probably best understood with regard to non-executive directors, who will typically only attend to the company's business at board or committee meetings and, possibly, the annual general meeting (AGM). The position is different for executive directors because they are also employees of the company with a contract of service. That contract will require them to attend to the company's business on a full- or part-time basis. Unless there are particular grounds for suspecting dishonesty or incompetence, a director is entitled to leave the routine conduct of the company's affairs to the management. If the management appears honest, the directors may rely on the information they provide. It is not part of their duty of skill and care to question whether the information is reliable, or whether important information is being withheld. The courts in the UK are generally reluctant to condemn business decisions made by directors that appear, in hindsight, to show errors of judgement. Directors can exercise reasonable skill and care, but still make bad decisions. For a legal action against a director to succeed, a company would have to prove that serious negligence had occurred. It would not be enough to demonstrate that some loss could have been avoided if the director had been a bit more careful. For this reason, successful legal actions against directors for breach of this duty are relatively uncommon.

The duty to exercise powers for proper purposes has also been used to challenge directors' decisions on...

The duty to exercise powers for proper purposes has also been used to challenge directors' decisions: • on the forfeiture of shares; • on the approval of share transfers; • to enter into a management agreement that effectively deprived shareholders of their constitutional right to appoint new directors; and • to enter into a supplementary partnership agreement that exposed the company to a serious contingent liability. The importance of this duty should not be underestimated. It is not sufficient for the directors of a company to act in what they consider to be the best interests of the company. They must also use their powers for proper purposes. This was demonstrated in a recent Supreme Court case, Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc [2016], in which the court overruled the exercise by the directors of JKX Oil & Gas of a power in the articles enabling them to impose restrictions on the shares held by the plaintiffs for failing to respond adequately to a s.793 notice (s.793 of CA2006 allows public companies to require shareholders to provide information about the beneficial ownership of the company's shares). The court held that the directors' primary motivation for imposing the restrictions was to prevent the plaintiffs from voting against certain resolutions at its 2013 AGM. Even though the directors were acting in what they considered to be the best interests of the company, this was held to be an improper purpose and therefore rendered their decision invalid.

What are the consequences of breaching the duty under s.182?

The duty under s. 182 to declare interests in any existing transactions or arrangements is a statutory duty which gives rise to potential criminal penalties in the event of a breach. The maximum penalty is £5,000. It does not derive from the common law duties but could conceivably also lead to potential civil action for breach of statutory duty

Industrial Development Consultants Ltd v Cooley [1972]

The managing director of a design and construction company, who was an architect himself, failed in an attempt to win a valuable contract for the company. He was subsequently approached by the potential client with an offer to take up the contract in his private capacity. The client confirmed that it was still not prepared to offer the contract to the company. The managing director concealed this offer from the company and took it up himself. In order to do so he falsely represented to the company that he needed to retire on the grounds of ill health. He was held liable to account to the company for the profit he obtained from performing the contract on the basis that he put his own personal interest as a potential contracting party in direct conflict with his pre-existing and continuing duty as managing director of the company.

Duty to exercise powers for proper purposes (s.171)

The second limb of the rule in s.171, that directors must only exercise their powers for the purposes for which they are conferred, means that they must not exercise their powers for any collateral purpose other than the purpose(s) for which the power was, on the true interpretation of the articles, conferred. Cases under this second limb of s. 171 are much more common than under the first. Many of them concern abuses by directors of their power to allot and issue new shares. For example, in Hogg v. Cramphorn Ltd [1967] the directors, fearing a takeover bid, allotted shares to parties likely to support them and thereby enable them to continue in office. The court declared the allotment void. The primary purpose of any power to allot new shares is to raise new capital as and when required. The directors were found to have for an improper collateral purpose.

How should the CoSec support directors in fulfilling their duty to act within powers?

To support directors in fulfilling this duty, the company secretary should ensure that: • all powers and delegation of authority are properly documented, for example in a schedule of matters reserved for the board, terms of reference for committees and a delegation of authority matrix for management. • it is clear when powers are being exercised that they are being exercised by the proper body or Individual, whether that is the board, a board committee, or an individual such as the CEO. • directors are aware of what powers they have under the articles of association, and which are granted by shareholder resolution. Directors should also be aware if/when those granted by shareholder resolution should be renewed.

In what circumstances do directors not need to make a declaration of interest under s.177 or s.182?

Under both s. 177 and s. 182, directors are not required to make a declaration where they are not reasonably aware of the interest or where they are not reasonably aware of the transaction or arrangement in question. In addition, they need not declare an interest: • if it cannot reasonably be regarded as likely to give rise to a conflict of interest; • if, or to the extent that, the other directors are already aware of it; or • if, or to the extent that, it concerns the terms of their service contract However, if a declaration of interest under either s. 177 or s. 182 proves to be, or becomes, inaccurate or incomplete, a further declaration must be made.

S.171 - duty to act within powers and for proper purposes

Under s. 171, directors have a duty to act within their powers in accordance with the company's constitution and should only exercise powers for the purposes for which they are given. A company's constitution is defined in s. 17 of the CA2006 as including: • its articles of association (including any provisions in the memorandum of association of a company incorporated before 1 October 2009 that are treated as article provisions under s. 28); and • any resolution or agreement that must be filed at Companies House in accordance with Part 3, Chapter 3 of the CA2006 (e.g., a shareholders' ordinary resolution authorising the directors to allot shares).

Authorisation of conflicts under s.175

Under s. 175 of the CA2006, the non-conflicted directors may now authorise conflicts such as the exploitation of business opportunities. This is the case for a private company unless the articles provide otherwise. In the case of a public company the articles must specifically allow the board to authorise such conflicts.

Duty not to accept benefits from third parties (s.176)

Under s. 176 of the CA2006, directors must not accept any benefit from a third party, whether conferred by reason of them being a director or them doing (or not doing) anything as director A third party in this context means someone other than the company or any other member of the same group (including a person acting on their behalf). However, directors will not be in breach of this duty if their services (as a director or otherwise) are provided through a third party, such as an outside services company. The duty not to accept benefits from a third party is clearly related to the duty to avoid conflicts of interest. By accepting such benefits, directors clearly put themselves in a position of potential conflict which may compromise their independent judgement and their duty to act in good faith to promote the success of the company. The link between the duty to avoid conflicts and the duty not to accept benefits from a third party is reinforced by s. 176(4), which provides that the duty not to accept benefits will not be infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.

How should declarations of interest be made under s.177?

Under s. 177, the declaration must be made to the other directors before the transaction is entered into. If there are no other directors, no declaration need be made. Declarations of interest can be made in a variety of ways, including at a meeting of directors, by general notice to the company or written notice to the other directors. The procedures for each method are designed to ensure that any declaration of interest is brought to the attention of the other directors before they or the company enters into the proposed transaction or arrangement. It plainly makes sense that the other directors should be made aware of any potential conflicts of interest that their colleagues may have in this regard. It may, for example, help to explain why a particular individual has been promoting the transaction so enthusiastically or why the company does not appear to have put the proposed contract out to tender. Armed with this knowledge, the board might be more cautious about approving the proposal and might wish to review it. Directors also need to declare their interests so that it can be decided whether they should be allowed to participate in the decision. Articles of association usually contain rules as to whether or not this is the case. In listed company articles the default position is usually that the interested directors cannot vote or be counted in the quorum on that matter, although they commonly make certain exceptions to that rule. One could also argue that disclosure is necessary to prevent directors from making secret profits.

How did s.172 change the legal position from the common law?

When it was first introduced, many commentators thought that s. 172 represented a significant change to what was previously understood to be the position under the common law, in that it created a duty on the part of the directors to take into account the interests of other stakeholders. The previous formulation of this duty was usually summarised as being that the directors had a duty to act in good faith in what they consider to be the best interests of the company (as represented by the present and future shareholders). Directors sometimes used this old formulation to argue that they could not, for example, legally spend any money cleaning up pollution caused by the company (unless required by law to do so) as it would not be in the best interests of its shareholders. This was never really the position under the common law, which has always allowed the directors to take stakeholders' interests into account. Under what became s. 307 of the Companies Act 1985, directors already had a duty to take into account the interests of employees. That duty was owed to the company and did not create any enforceable rights on the part of the employees. Similarly, the duties under s. 172 do not create any enforceable rights on the part of stakeholders such as employees, customers or suppliers. Various bodies expressed concern that the new formulation may require boards to change their decision-making procedures so that they can show compliance with the duty to take into account stakeholder interests. This was denied by ministers during the passage of the CA2006. The duty to promote the success of the company can create problems for directors of subsidiaries. The principal duty of the directors of a subsidiary company is to promote the success of that subsidiary company. Under the CA2006, directors are required to take the interests of other stakeholders into account. Those other stakeholders include the shareholders, which in the case of a subsidiary means its parent company. However, the interests of its stakeholders are not meant to override the interests of the company itself.

Fraudulent trading

Where a company becomes insolvent, sanctions may be imposed on its directors under the Insolvency Act 1986. Fraudulent trading arises under s. 213 of the Insolvency Act 1986 where the directors have acted with intent to defraud creditors. In these circumstances, they may be required to contribute to the assets of the company. Fraudulent trading is also a criminal offence, even if the company does not go into liquidation (s. 993, CA 2006)

Duties of directors under s. 171 - 177 of the CA2006

• to act within their powers in accordance with the company's constitution (and to use those powers for proper purposes) (s. 171); • to promote the success of the company (s. 172); • to exercise independent judgement (s. 173); • to exercise reasonable care, skill and diligence (s. 174); • to avoid conflicts of interest (s. 175); • not to accept benefits from third parties (s. 176); and • to declare any interest in proposed transactions or arrangements (s. 177). Section 170 confirms that these duties are owed by a director to the company and apply equally to any shadow director. It is also worth noting that the duties apply to both executive and non-executive directors.