Directors beware! New duties under the Companies Act 2006 - In Business Summer 2008

19 June 2008

Directors have always been required to conduct themselves in accordance with case law and equitable principles, but in October 2007 new legislation defining directors’ duties came into force with the purpose of clarifying these principles and putting them into statute.

If a director is in breach of statutory duty, he could find himself criminally liable and facing fines or imprisonment. It is therefore important that directors are made aware of the changes so that they can reassess their practice if needs be.

There are seven general duties which apply to executive and non-executive directors, and in certain circumstances to former and shadow directors.  

A director must:

1. Act within his/her powers.
2. Promote the success of the company.
3. Exercise independent judgement.
4. Exercise reasonable care, skill, and diligence.
5. Avoid conflicts of interest.
6. Not accept benefits from third parties.
7. Declare an interest in proposed transactions.

On first reading, these are established duties and most directors would be confident that they comply with them. However taking the duty “to promote the success of the company’’ (which is perhaps the most significant change) as an example, the Companies Act 2006 lists the factors that a director needs to consider in order to comply, and these include the likely consequence of any long terms decision, the interests of the company’s employees, taking account of the company’s business relationships with suppliers and customers, 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 between members of the company. If the board is considering a transaction where the company could make a quick profit, and the directors disregard the long term interests of the company or the fact that it will have an adverse effect on the environment, the directors could be found to be in breach of this duty.

Directors need to show that they have given consideration to the relevant factors and whilst it may be impractical to document in detail the reasoning behind every decision, the company may want to review the format of board minutes and reports to ensure that the information covering relevant areas is provided, and fully considered, prior to a decision being made. Certainly for substantial decisions, it would be wise to increase the level of detail recorded in the board minutes, reporting how the decision was made and the factors that were considered.

The duties are owed to the company, and it is largely the company who will enforce the duties. However another change that the statute brings is that a shareholder can bring proceedings against directors for breach of statutory duties with the Court’s permission.

This does theoretically increase directors’ liability and could increase litigation against them. Directors should therefore ensure that their insurance policies cover the defence of derivative claims and they should be aware, if they are required to hand over board papers to a shareholder, that the shareholder may be gathering evidence to initiate a derivative claim.

Summary of steps to consider:

1. Ensure that the board are properly briefed so that they understand their duties.
2. Review board procedures to ensure that they aid compliance with directors’ duties under the act.
3. Review insurance policy.
4. Review and update directors’ service contracts to cover the new duties in the section on directors’ obligations.
5. In light of the statutory duty for directors to act within their powers, it is paramount that  directors know the constitution of the company and it would be prudent to refresh themselves with the Memorandum and Articles.

For further information contact Charlotte Reid on 01227 763939.

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