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#10127 - Directors' Duties - Business Law and Practice

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Step 1:

Are they a Director?

  • This will usually be obvious, but it is also defined by s.250(1) of the CA 2006 as:

  • s.250(1): it covers any person occupying that role, howsoever called (this includes executive and Non-Executive Directors and de facto directors(NEDs) Commonwealth Oil and Gas v Baxter. Shadow D’s only to the extent that these duties apply to them s.170(5))

  • s.170(2): Former Ds can remain liable under s.175 and s.176 if the breaches were committed (or he knew about them) at the time that he was a D

T&F NOTE A director is likely to be an employee of the company and is also an agent and a fiduciary. A director will not necessarily be a shareholder of the Co.

Step 2:

To Whom is the Duty Owed?

  • T&F NOTE The DUTY is always owed to the company (s.170(1)) and

  • Very exceptionally to:

  1. members/S’holders, (where D’s agree to act as agents for the S’hold or if D assumed responsibility)

  2. other Ds or creditors (if the Co. is insolvent or approaching insolvency s.172(3))

  3. members/S’holders see: Derivative Action, Unfair Prejudice Petitions, and Wind up (see separate notes Below)

Step 3:

Who can Take Action?

  • A majority of Ds or the Board (on behalf of the Company) can decide to bring an action

  • The Company is the proper claimant (Foss v Harbottle) “the proper claimant rule”

  • Members/S’holders can bring action against D’s via a:

    • Derivative Action (see separate notes Below)

    • Unfair Prejudice Petitions (see separate notes Below)

    • Wind up (see separate notes Below)

Step 4:

Which Duty has been Breached?

Note that more than one duty may be breached and applied to a D at any given time (s.179(1))

Under s.171

a D must act within Powers

s17 CA defines Constitution to include the Art of Association

  • s.171 A director must act :

(a) under the constitution and

(b) only exercise powers conferred on him.

  • Apply the test:

    • Objectively, what was the purpose of the power for?

    • Was this D’s primary purpose in acting as he did?

Under s.172

a D must Promote the Success of Company

(Re Smith and Fawcett Ltd)

  • s.172 A director must act in a way he considers, in good faith, to promote the “success” of the company for the benefit of the members as a whole.

  • Must have regard to s.172(1):

    1. Likely long-term consequences

    2. Interests of Co.’s employees

    3. Need to foster Co.’s good business relationships

    4. Co.’s Impact on the environment and the community

    5. Maintenance of the company’s reputation

    6. Act fairly between the Co.’s members

    7. Any other relevant circumstances

Court applies a Subjective test, i.e. what the D honestly believed was likely to promote the success of the Co. and benefit of the Shareholders. (Re Southern Counties Fresh Food Ltd)

WS5 NOTE In order for the Ds to show that they have complied with s.172 they should draft minutes of the decisions made and state that they have acted honestly and to promote the success of the Co.

Under s.173

a D must exercise Independent Judgment

  • D’s must not do anything that fetters their independent judgement (e.g. accepting a financial “thank you” in exchange for not voting/disclosing info to Co. etc.)

  • Can take legal / financial advice, but must not fetter his own discretion i.e. restrict his own independent judgement.

  • This duty is not infringed by the D of a Co.:

    • Acting in accordance with an arrangement entered into by the company (s.173(2)(a))

    • Authorised by the constitution (s.173(2)(b))

Under s.174

a D must exercise

Due care, skill and diligence

*Common Law*

  • Apply both parts of the test:

    1. Objective: did D act with the general knowledge, skill & experience expected of such a person in his position (s.174(2)(b))

    2. Subjective: did D act diligently by a person with D’s general knowledge, skill & experience (s.174(2)(b)) [e.g. if he’s worked for 20 years as a D, he’ll be judged by a higher standard; NEDs by a lower one]

  • Delegation: this does not allow a D to escape liability (Re Barings No 5)

  • Inactive Director: may be liable for other Ds’ wrongdoing (e.g. in family Co.s when spouses, children & relatives are appointed as inactive D’s)

  • It D’ has a Service Contract: did D breach a term of this contract?

Under s.175

a D must Avoid a Conflict of Interests

  • s.175(1): direct/indirect/possible conflict will trigger this duty

  • s.175(2): must not make a profit unless authorised

  • A D may wish to rely on one of these exceptions:

    • s.175(3): interest arises by a contract between the Co. and the D (see s.177/s.182 below)(this simply means that s.175 and s177 are mutually exclusive)

    • s.175(4): the board authorised the matter (¿is it a valid Board decision?)

    • s.175(4): if the situation cannot reasonable be regarded as giving rise to a conflict

    • s. 175(5)(a) Co’s Arts may prevent Authorisation and 175(6) Quorum

Examples:

  1. As a result of his position as D a D obtains info about a new business opportunity for the Co. but uses that info for his own benefit instead of that of the Co. (Cook v Deeks)

    1. This breaches s175(2), unauthorised profit

  2. D invests after a company decides not to

    1. Must account to company for the profits made because they obtained the opportunity to invest only because they were Ds (Regal Hastings)

  3. D resigns and then takes up the opportunity

    1. Liable for breach of this duty and must account to any profits made (Cooley)

    2. Time is a factor; if the resignation was long before, then there’s likely no breach (Island Expert)

  4. D sets up a competing company

    1. If a D poaches a company’s clients, they have exploited opportunities that rightly belonged to the company

    2. Must account for profits made (CMS Dolphin)

  5. D borrows equipment/money from Co.’s customer for his own use

    1. Even if there is no bad faith, no loss to the Co, and no Conflict the D is abusing his position as D (Towers v PWM)
Under s.176 a D must Not to Accept 3rd P Benefits

  • If receive a benefit because you are a D and you did/did not do something for a 3rd P, you mustn’t accept benefit (s.176(1))

  • Exception:

    • s.176(4): if acceptance of the benefit cannot reasonable be regarded as giving rise to a conflict of interest (and Articles can permit benefits)

  • Corporate Hospitality is generally OK but, Alex, you should question this in an exam question under the Bribery Act 2010 – just say that it may potentially be a problem (Towers v PWM)

T&F NOTE s170(2) expressly states that the duty under s176 survives a director ceasing to hold office in respect of circumstances which occurred whilst a director.

Unders.177/s.182

a D must make a Declaration of Interests

 [See Procedure Model Articles or Procedure TA Articles notes]

Step 5:

Remedies for Breach of D

  • The aim of these remedies is to confiscate any profit made, NOT to compensate thus,

the breach of: ss.171, 172, 173, 175, 176 and 177 carries the following remedies:

  • The D is accountable for profits made (Regal Hastings)

  • The D must return company property (JJ Harrison)

  • The D must pay equitable compensation to the company at judge’s discretion

  • Rescission of a contract entered into as a result of the breach

  • Injunction against the D who threatens the breach

Breach of: s.174:

  • Common law damages for professional negligence (Lexi Holdings plc)

Breach of: s.182(Declaration of interest in existing transaction or arrangement):

  • Criminal offence (see the Procedure Model Articles notes)

Step 6:

Can the Director Avoid Liability?

Ratification

(Decision of shareholders through OR)

  • Under s.239(1) members/Shareholders may ratify post-breach,

  • by an OR at a GM/WR (s.239(2))

  • If D is a shareholder, his and ‘connected persons’ votes don’t count, but they do form part of the quorum (s.239(4))

  • Not possible if ratification would be unfair/illegal towards a minority of the members (North-West Transp. Co Ltd v Beatty)

T&F NOTE e.g. Sid is a director and shareholder of ("CFL"). He owns 300 ordinary shares. Other directors are Sylvia, Sid's wife, who owns 300 ordinary shares and Mike, who owns 200 ordinary shares. Arnold, who is not a director, owns 200 ordinary shares. Sid has had legal advice that he may be in breach of his duties to CFL, but that it may be possible to ratify the breach. Sid calls an "emergency" shareholders' meeting for the purpose of ratifying his breach of duty. At the meeting, Sid, Sylvia and Mike all vote in favour of the relevant resolution, but Arnold votes against. s239(4), prevents both Sid and Sylvia's votes from counting. This means there will be 1 vote in favour and 1 against. The resolution will not pass. It would not be passed on a poll vote either.
Court Relief

  • s.1157(1): a court may relieve D of liability for negligence, default, breach of duty or breach of trust, if they believe he acted reasonable and honestly considering all the circumstances

  • s.1157(2) D can apply for this relief before a claim has been brought
Insurance

  • s.233(1): insurance can be purchased to cover risk of negligence (because exclusion clauses in service contracts are void)

Authorisation

For s.175

(Decision of the Board of Directors)

  1. Available for s.175 (duty to avoid conflicts of interest) only if transaction is authorised by the Board of Directors at Board Meeting.

  2. Where the D acts in accordance with the provisions of the articles he will not be in breach of s. 175 (s.180(4)(b) CA 2006)

  3. Where authorisation has been validly given the transaction cannot be set aside (s.180(1)(a) CA 2006)

  4. T&F NOTE In a Private Co. authorisation may be given if the Co.’s articles do not prevent it (s175(5)(a)) but the D in question can’t vote...
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