Directors' responsibilities & fiduciary duties

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Directors' responsibilities & fiduciary duties

In many cases a director’s responsibilities and fiduciary duties are far from clear, yet the liabilities potentially devastating. We interpret the risk and tell you how to minimise exposure.  We act for both directors and companies.

Shareholders’ powers

Ultimately, the shareholders own the company. Thus shareholders have the right to actively control how the directors manage the business. It is always advisable that shareholders, even in small businesses:

  1. Set clear boundaries as to what they expect of directors; and
  2. Communicate the extent and limits of the directors’ authority to bind the company.

Without communicated authority, a third party is entitled to assume that the directors have actual or ostensible authority to bind the company. This is a common pitfall directors fall into and carry risk they may not even realise. This pitfall can be avoided with the correct documentation.

Directors’ duties

Directors will owe a fiduciary duty and a duty of care and skill, whether or not this is set out in a contract. These duties apply to both executive and non-executive directors. The statutory duties replace many existing common law and equitable principles. The statutory duties are owed to the company and only the company will be able to enforce them.

Company law protection for shareholders

Shareholders can take action against any director who has breached their duties. Shareholder action must be taken in the name of the company, and on the company’s behalf for the benefit of the company’s members as a whole.

Fiduciary relationship

A fiduciary relationship is a relationship of trust. This places a duty on company directors to act within the best interests of the company, in good faith, and honestly. A director must comply with his responsibilities and fiduciary duties set out in the Companies Act 2006.

Duties under the Companies Act 2006

There are seven general directors’ duties set out in the Companies Act, which are:

  • A duty to act in accordance with the powers set out in the company’s articles;
  • A duty to promote the success of the company for the benefit of its members;
  • A duty to exercise independent judgment;
  • A duty to exercise reasonable care, skill and diligence;
  • A duty to avoid conflicts of interest;
  • A duty not to accept benefits from third parties; and
  • A duty to declare to the company’s other directors any interest a director has in a proposed transaction or arrangement with the company.

The duties are separate and distinct. However, a director acting in breach of one duty may breach others and may also have breached the terms of his director’s service agreement, the articles of the company, and any shareholders’ agreement.

Statutory duties under the Companies Act

The statutory duties include the duty to:

  • Act within the powers of the company;
  • Promote the success of the company;
  • Exercise independent judgment;
  • Avoid conflicts of interest;
  • Not accept benefits from third parties; and
  • Declare any interest in proposed transactions or arrangements with the company.

Code of conduct on directors’ responsibilities and fiduciary duties

Alongside the statutory duties there is what is known as the ‘code of conduct’ for directors. These include but are not limited to:

  • The likely consequence of any decision in the long term;
  • The interests of the company’s employees;
  • The need to act fairly as between members of the company; and
  • The impact of the company’s operations on the community and the environment.

Personal responsibility

Directors will be personally liable for any failure to comply with their director’s duties. The Companies Act 2006 requires directors to take more responsibility for their actions. This means directors will have to take more care to understand what is going on in the management of the business.

Breach of a director’s duties

There are a variety of routes to consider where there is a breach of a director’s duties.  The best one will depend upon the circumstances and can include:

  • An injunction to force or stop an act; or
  • Removal from office

Injunctions to force a director to act appropriately

If a director is found to have breached their responsibilities or fiduciary duties, or is in the process of doing so, the court has the power to order the director to do an act, or omit from doing an act, to prevent the director from damaging the company by acting in breach. The court remedy is an interim injunction.

How an interim injunction can work where there is a breach of a director’s duties

The injunction is interim as it is in force until trial, or until set aside. The director can apply to set aside the injunction. This could be on the grounds that the injunction addresses no serious question, or the injunction is unfairly detrimental to the director.

Undertakings

As an alternative to seeking an interim injunction, the company may request for the director to give an undertaking to the company that he/she will not take action, or will take action, for the benefit of the company. If correctly drafted, an undertaking can be as enforceable as a court order.

Obtaining an interim injunction

The application is made by the company on behalf of the shareholders. To succeed on an application for an interim injunction, the company must show:

  1. That there is a serious question to be tried, that being the director acting in breach, or intending to act in breach of their responsibilities or fiduciary duties;
  2. That damages would not be an adequate remedy, this is often proved as the director’s breach may irreparably damage the company;
  3. That the injunction would not unfairly detriment the director; and
  4. That there are special factors in favour of granting the injunction, often that the director is intent on damaging the value of the company or that the company is made up of several directors and the actions of one are affecting the management of the business as a whole.

Interim injunction costs

If the interim injunction is granted, the company can usually claim its costs from the director suspected of acting in breach of duty. However, it is not uncommon for the court to reserve costs to a later date, i.e. the date of the full trial. With this in mind, it is always worthwhile offering an undertaking to the director as an alternative. This can help protect the company’s position on costs come trial.

Removing a director from office

If appropriately drafted, a director’s service agreement will contain detailed provisions outlining the situations in which a director may be dismissed from their employment, and subsequently their position as a director of the company.

No director’s service agreement

However, it is all too common for a director to not have a service agreement. Therefore, whilst the director may be dismissed as an employee, there will not be a contractual power to remove the director from their position as officer of the company. Although not ideal, statute does provide the shareholders of a company with an appropriate remedy.

Ordinary resolution required to remove a director under the Companies Act 2006

The shareholders can remove a director from office by a majority vote, i.e. over 50% of the shareholders agree, providing:

  • The vote is given at a general meeting and not through writing.
  • At least 28 days’ notice of the general meeting is given to the shareholders of the company and the director subject.
  • The director is given the opportunity to make representations at the meeting.

If these procedures are strictly followed, then the removal is valid. However, a company’s articles or shareholders’ agreement may exclude or limit the extent of the statutory procedure – we can draft or interpret accordingly.

Risk of bankruptcy for directors

Directors often act as guarantors. What this means is that if a company defaults on a loan, the lender can enforce the loan against the director and recover the sums due to it from the director in his/her personal capacity.

Bankruptcy and directors’ duties

A director has a duty to act in the best interests of the company. The company may be in financial hardship and a loan may be necessary. The best interest of the company would be to take the loan, but the director will be asked to act as a personal guarantor. This is may not in the director’s best interests.

Reducing risk of bankruptcy

The worst case scenario for the director is bankruptcy if the lender seeks to enforce the personal guarantee as a debt against the director. We  give legal advice on the terms of any guarantee agreement and review the terms with an eye to minimise exposure.

Disqualification following bankruptcy

If a director is made bankrupt, then the court may choose to disqualify the director from acting as a director for a set period of time. We represent directors faced with litigation relating to their actions aiming to limit the damage in the best way possible.

Conflict situations

It is all too common, particularly in owner managed business, for the directors to also be employees and/or shareholders. Where the roles overlap, it is important to maintain a distinction between roles.

The shareholder director

A director, who is also a shareholder, will have an interest in the financial success of the company through receipt of dividends. With this in mind, such a director must ensure that their interests in the company as a shareholder do not overlap with the duties owed under the Companies Act 2006.

To ensure that the directors are not subject to shareholder scrutiny, it is important for the board of directors to keep a paper trail for company decision making.

All board decisions will have an impact on the company’s shareholders, from the hiring of a director to securing debt finance. These decisions should be made by the directors for the benefit of the company as a whole. Where a director is also a shareholder, the director must declare their interests.

Dealing with deadlock

Deadlock occurs where a majority vote cannot be passed at either board or shareholder level, leaving decision making impossible. Deadlock usually arises through what is known as a “quasi-partnership” which is a legal term for a limited company being run as if it were a partnership between two people. Usually, both individuals have an equal say in the management and running of the limited company. A shareholder dispute is of no benefit to the company.

Possible solutions to a deadlock situation

Subject to the provisions of the company’s articles and any shareholders’ agreement, there are remedies in deadlock situations, such as:

  1. Appointing a non-executive director to assist in decisions reserved for the board.
  2. Issuing further shares, with only voting rights, to an independent third party.
  3. Initiating a company buyback.
  4. Offering to sell shares/purchase the other shareholder’s shares.
  5. Applying to the court for the company’s winding up and cessation of trade.
  6. Alternative dispute resolution methods, such as mediation.

Finding the right solution to a deadlock

As can be seen, some remedies are more drastic than others – we tell you which is most likely to resolve the situation and use our experience to your advantage.

Shadow directors

A doctor has to be registered with the British Medical Association. A solicitor has to be registered with the Law Society. You would be forgiven for thinking that someone can only be a director of a company if they are officially registered as a director at Companies House. Yet legally “any person occupying the position of director, by whatever name called” is a director, regardless of their name or title.

Who is a shadow director?

In the Companies Act 2006 “shadow director”, in relation to a company, means a person in accordance with whose directions or instructions the directors of the company are accustomed to act. Example being the board acting on instructions from another individual not registered as a director at Companies House, but who directs decisions.

What does being a shadow director mean in practical terms?

If somebody in a company is given the title of “manager”, but that person regularly gives advice to the directors of the company, who then customarily act in accordance with that advice, the “manager” becomes a shadow director in the eyes of the law.

“De Facto” Director

A “de facto” director is someone who performs the functions of a director and who owes the same duties to the company as a director, but who has not been validly appointed. However, determining whether someone is acting as a de facto or shadow director is not easy and there are no hard and fast rules. Legal advice should be sought to protect any external advisors.

Implications arising from acting as a shadow director

If a company runs into financial difficulties, then in certain circumstances the directors can be held responsible and sometimes have personal financial liability. Insolvency legislation allows the creditor of a company that has been wound up to request a court to compel an “officer” of the company to pay sums. This can be in respect of a misuse of power or breach of fiduciary duty. The courts have held that the term “officer” includes a shadow or de facto director.

The legal test

In considering whether someone is in fact (rather than title) a director, the primary question is whether the person has a direct influence and control over the direction of the business and the people within it. The focus of the court will be on what the individual does, not what they are called, and a critical question will be whether the individual is discharging functions that can only be properly discharged by a director.

Acting as a shadow or de facto director is not an offence in itself (unless the person is an undischarged bankrupt or disqualified from being a director), but risks to a shadow or de facto director may be just as great as for those directors registered at Companies House.

Non-executive directors

Increasing numbers of non-executive directors (NEDs) are being appointed by companies. They are recommended for large companies for corporate oversight and an independent view; they assist smaller, growing companies by providing board-level strategic advice without the cost of a full time director.

Duties of non-executive directors

However, there is often confusion over the role of NEDs and in particular the duties they owe to the company.

How do these differ from the duties owed by the executive directors? The simple answer is: not at all. The duties owed by a director to the company are the same for all directors and the law does not distinguish between NEDS and other directors.

The role of NEDs

Even though not working full-time in the business, the NED is under the same duty to avoid conflicts of interest, and disclose interests in any transactions, as the other directors. A NED taking up an appointment needs to consider carefully his or her other interests and whether there is any likely scope for conflict.  Board meeting minutes should be carefully drafted to address these issues.

The liability of non-executive directors

The NED must also consider the possible risks of being a director without full involvement in the company. The NED will be potentially liable for issues such as wrongful trading if the company is insolvent and must keep himself sufficiently informed to manage any potential risks.

Letter of appointment for NEDs

The company would always be well-advised to issue a letter of appointment for NEDs, clarifying such matters as the term of the appointment, the statutory and other requirements on the NED and the obligation to comply with all laws, rules, the articles of the company etc, the fees to be paid, confidentiality, intellectual property rights, any restrictive covenants and other matters. It pays to have a letter of appointment in the event of a conflict or dispute.

Track record in dealing with directors’ responsibilities and fiduciary duties

Our recent instructions include:

  • Assisting a liquidator to successfully claim for an electronics company’s restoration to Companies House to permit a full investigation into the directors’ management of the company’s affairs prior to insolvency.
  • Obtaining an interim injunction on behalf of a pharmaceuticals company where a director intended to market a new product through another company in which he had a direct conflict.
  • Revising NED agreements for a hedge fund to align with new confidential information introduced to the NEDs appointed to the board.
  • Applying to the court for the disqualification of a director found to have breached his fiduciary duties to a firm of accountants by misleading investors and overstating the firm’s financial position.

Directors are in the spotlight and are expected to be aware of their duties. The corporate landscape is ever changing and in light of calls for reform in the fall out of the economic crisis, directors’ duties are of paramount importance. There needs to be a proactive attitude to having the right contracts and policies specific to your company, and in the event of a dispute, the correct legal support – this is where we can advise.