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Gavin Kramer, senior associate at Collyer Bristow, explains the key responsibilities of directors from exercising independent judgment to avoiding conflicts of interest as set out in Companies Act 2006
Gavin Kramer, Senior associate, Collyer Bristow
Many directors, busy running their companies in difficult economic times, may regard the question of their duties as a director to be a largely abstract concern to which little attention needs to be paid.
However, the breach of those duties can have serious real life consequences, from claims against the director by the company or, more usually, a liquidator if the company fails and goes into insolvent liquidation, to the risk of being disqualified from acting as director on the application of the secretary of state for a period ranging from two years to, in the most extreme cases, 15 years.
All directors of companies registered in England and Wales need to be mindful of their duties, owed to the company but also, in certain circumstances, to the company’s creditors as well.
These duties fall into two categories – the statutory duties set out in Companies Act 2006 (CA 2006) at sections 171 to 177, also known as the general duties, and what are called fiduciary or common law duties, developed over time by the courts, which continue to apply alongside the statutory duties.
There are six separate duties under CA 2006 with which all directors should be familiar. These are:
a duty to act in accordance with the company’s constitution and only to exercise their powers for the purpose for which they were conferred (s171);
a duty to promote the success of the company for the benefit of its members (shareholders) as a whole (s172);
a duty to exercise independent judgment (s173);
a duty to exercise reasonable care, skill and diligence (s174);
a duty to avoid conflicts of interest (s175);
a duty not to accept benefits from third parties if this is likely to give rise to a conflict of interest (s176); and
a duty to declare any interest the director may have in a proposed transaction or arrangement with the company (s177).
A director’s fiduciary or common law duties include:
the duty to act with loyalty and in good faith;
to not promote the interests of another company or individual to the detriment of the company;
to use the company’s assets and resources for its benefit, to account to the company for any loss, disposal, or transfer of those assets, and to restore to the company any assets which have been misapplied or dissipated in breach of that duty;
to join their co-directors in supervising and controlling the company’s affairs and to keep themselves informed of the company’s affairs; and
to have enough knowledge and understanding of the company’s business to be able to perform their duties properly.
It is important to note that these duties apply equally to non-executive directors (a term not recognised by CA 2006) and to de facto directors – persons who have not been formally appointed to the board but who nevertheless act as or hold themselves out to be directors of the company.
They also apply, to the extent they are capable of applying, to what are termed shadow directors – a shadow director is any persons in accordance with whose directions or instructions the appointed directors are accustomed to act.
Bordering on insolvency
Directors also need to be aware that their duty under s172 CA 2006 to promote the success of the company for the benefit of its members (shareholders) is modified to include the interests of the company’s creditors in certain circumstances. The question of when this duty to creditors arises was recently considered by the Supreme Court in the landmark case of BTI 2014 LLC v Sequana SA [2022] UKSC 25, a decision which has implications for all company directors. [See Sequana judgment: keep calm and carry on]
The Supreme Court held that the creditor duty is engaged when the directors know, or ought to know, that their company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable.
Where the company is insolvent, or bordering on insolvency, but insolvent liquidation or administration are not inevitable, the directors must consider the interests of creditors in their decision-making, balancing those interests against the interests of shareholders where they may conflict.
Creditor’s duty
The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors (as a general body – there is no requirement to consider the interests of particular creditors). Where an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount, and directors must act accordingly.
Directors who breach the creditor’s duty prior to their company going into insolvent liquidation therefore run the risk of the liquidator taking legal action against them to recover a compensatory payment equal to the loss caused by their breach.
Directors who pay themselves excessive salaries or bonuses or who confer excessive rewards on employees whom they wish to favour, for example family members, when they know, or ought to know, that their company is insolvent or bordering on insolvency are likely to be breaching their duty to the company’s creditors, as well as their duties to the company, and putting themselves at risk of a claim for equitable compensation or damages by a future liquidator.
Even when a company is solvent, directors who award themselves excessive remuneration relative to the company’s profits may be in breach of their duties to the company – directors must set their salaries at a level appropriate to the company’s finances, not one which accords with their own interests (see the Court of Appeal’s decision in Maidment v Attwood and Others [2012] EWCA Civ 998).
Directors may also breach their duties to the company and its creditors if they choose to pay certain creditors, for example suppliers with whom they hope to do business in the future through a new company, in preference to the company’s other creditors when their company is insolvent.
It is therefore important for anyone who is, or who intends to be, a director of a company registered in England and Wales to be aware of the duties described above. If in doubt about the correct steps to take, directors should seek legal advice at an early stage to avoid the risk of claims against them in the future.
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