A guide to company directors’ duties when setting up a business in the UK
When setting up a company in the UK it is imperative that you are aware of the main duties and obligations of directors of UK companies.
The following guide highlights the important things you must think about. Although a company is a separate legal person, it cannot act on its own. It relies on its directors to act on its behalf and in its best interests.
The decisions made by the directors affect the company’s assets and interests and involve a high level of trust and confidence. This gives rise to a ‘fiduciary relationship’ between the company and its directors.
Who is a director?
A director is somebody who manages a company on a day to day basis. They are the human agents of an artificial person (the company). Despite there being various types of director, they are all generally subject to the same legal controls on their actions.
A ‘director’ is defined as any person occupying the position of a director by whatever name called. There are several forms of directorship:
An executive director is usually a full-time employee who carries out executive functions in the day to day running of the company’s business. The director will usually have specific tasks and authority delegated to them.
The term ‘executive’ is often interpreted to mean that the director is an employee of the company under a service contract.
The rights and obligations of a director under a service contract are distinct from the legal rights and obligations as a director. Should the director resign or be dismissed from the office of director, the service contract remains in place until it expires or is terminated.
A non-executive director is not an employee of the company or holder of an executive office. They are normally expected to participate at board meetings and on board committees. Although a non-executive director does not have day to day responsibilities, they are still responsible in law for the decisions and actions of the board.
De jure director
A de jure director is a director who is formally appointed and registered as a director with the Registrar of Companies.
De facto director
A de facto director is someone who, whilst not formally appointed as a director, still carries out all the duties of a director and makes decisions as a director. A de facto director may sign company documents and will usually be treated as a director by the other directors.
A shadow director is a person in accordance with whose directions or instructions the directors of a company are accustomed to act. It is not necessary for the entire board of directors to act at the direction of the shadow director, and an individual will be a shadow director where a majority of the board is accustomed to following their directions. Simply giving instructions is not sufficient to make someone a shadow director; nor will a person be regarded as a shadow director if the directors only act on their advice given in a professional capacity.
If you are acting as a director in one of these capacities, the general duties will apply to you.
A director has seven general duties:
- Duty to act within powers
- Duty to exercise independent judgment
- Duty to promote the success of the company
- Duty to exercise reasonable care, skill and diligence
- Duty to avoid conflicts of interest
- Duty not to accept benefits from third parties
- Duty to declare an interest in a proposed transaction or arrangement
1. Duty to act within powers
A director of a company must act in accordance with the company’s constitution and only exercise powers for the purposes for which they are conferred.
A company’s constitution includes its articles of association, decisions taken in accordance with the articles, and any resolutions and agreements that affect the constitution. All of these items place limits on a director’s authority. If this authority is exceeded, the director will have breached the duty.
A company may opt to limit its objects (the purposes for which it is formed) in its articles. If this is the case, a director must not act in any way contrary to these specific objects.
A director must only exercise his/her powers for the purposes for which they were granted and not for any other purpose.
2. Duty to exercise independent judgment
A director must exercise independent judgment. A director may seek professional advice as long as he/she exercises their own judgment in deciding how to proceed based on that advice.
A director can delegate powers to somebody else to act on their behalf as long as the company’s articles permit such delegation and the director has used their own judgment when deciding to delegate.
A director will not be deemed to have breached this duty if he/she acts in accordance with an agreement entered into by the company that restricts the future exercise of discretion by its directors, or if the way of acting is authorised by the company’s constitution.
There is some degree of cross over here with the duty to promote the success of the company (see below). A director may be required to obtain independent advice when considering the six factors relevant to promoting the company’s success, such as the potential environmental or social implications of a decision. Whilst a director must then exercise independent judgment when deciding whether to follow the advice there may also be situations in which a director could be in breach of duty if he/she fails to follow professional advice.
3. Duty to promote the success of the company
A director is required to act in the way he/she considers most likely to promote the success of the company for the benefit of its members. ‘Success’ has been described as ‘long term increase in value’. This duty replaced the fiduciary duty for directors to act in the best interests of the company.
Within its articles, a company may choose to adopt another purpose, which may not be for the benefit of its members, such as a charitable purpose. If this is the case, a director must act in a way which is likely to achieve those other purposes.
In order to satisfy this duty, a director must consider, among other matters, six key factors:
- the long term consequences of the action taken;
- the interests of the company’s employees;
- the company’s business relationships;
- the impact of the action on the environment and the community;
- the advantages to the company of having a reputation for high standards of business conduct; and
- the need to act fairly as between the company’s shareholders.
These six factors are said to represent ‘responsible business behaviour’.
Considering these six factors is mandatory. If a director fails to consider the mandatory factors, he/she will be in breach of the duty even if he/she has taken a range of other factors into account in reaching a decision. However, the list is not exhaustive and a director should also consider any other relevant factors.
The director is only required to take these factors into account in reaching a decision: the director can still take the action even if it has a negative consequence on one of the six factors, so long as the director believes, in good faith, that overall the action is most likely to promote the success of the company.
It is important that directors can show consideration of the six factors through accurate reporting of compliance. To ensure this, management should include a discussion of the required factors in the board papers prior to a meeting. This discussion should focus on the relevant factors from the prescribed list, as well as any other possible factors. It is only necessary to provide specific reference to each of the mandatory factors in the board minutes if a serious implication is likely to arise in reference to one or more of them. In most circumstances it only needs to be noted that the directors concluded the action would promote the success of the company.
In times of threatened insolvency, this duty switches to a need to act in the best interests of creditors, rather than members.
4. Duty to exercise reasonable care, skill and diligence
A director of a company must exercise reasonable care, skill and diligence.
In determining the required standard, it is necessary to consider the care, skill and diligence that would be exercised by 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 (an objective standard); and
- the actual general knowledge, skill and experience that the director has (a subjective standard).
The required level of care, skill and diligence is whichever is the higher of these two standards.
A director’s actual understanding and adeptness (the subjective standard) may not be sufficient to comply with this duty, if more could reasonably be expected of someone in his/her position (the objective standard).
The minimum standard is therefore that a director must act in a way expected of a reasonably diligent person with his/her general knowledge, skill and experience. But if a director has more specialist knowledge, then the higher standard will be applied.
It is important that on appointment of a new director, he/she can actually fulfil the role required to avoid any breach of this duty. For example, an individual who is appointed as a finance director, but who has no experience in such matters will be in breach of this duty – he/she does not have the level of skill and experience required of a hypothetical person carrying out that role.
5. Duty to avoid conflicts of interest
A director must avoid a situation in which he/she has, or could have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company.
This could be a conflict between his/her duties as a director and his/her own personal interests or duties owed to a third party.
A director can be caught by this duty in a number of ways and so it is important that a director carefully considers his/her position, and that of those connected with him/her, in order to find out whether they may be breaching the duty. A breach of this duty does not depend on whether the director is aware that his/her actions are a breach.
This duty applies particularly to the exploitation of property, information or opportunity – for example, a director exploiting for his/ her own personal gain a business opportunity which could have been taken up by the company – and applies regardless of whether the director can take advantage of the particular matter.
There are some exceptions to the duty, such as a conflict that has been authorised by the other directors, or a situation that cannot reasonably be regarded as likely to give rise to a conflict.
A conflict situation can be ‘pre-authorised’ in the articles of association or by a shareholder resolution. It could also be authorised by a decision of the independent directors – that is, those who do not share the same conflict.
This duty continues to apply even after the individual has ceased to be a director of the company. This prevents a director from exploiting an opportunity of which he/she became aware while managing the company’s business simply by resigning as a director.
Conflict situations could arise where a director sits on multiple boards. A director will need to act carefully here as board authorisation of another directorship may not be wide enough to cover the conflict in question.
6. Duty not to accept benefits from third parties
A director must not accept a benefit from a third party given by reason of his/her being a director or by his/her doing anything as a director.
A simple example of this is accepting a sum of money from a third party that is hoping to obtain a lucrative contract with the company. ‘Benefit’ has been defined as a ‘favourable or helpful factor, circumstance, advantage or profit’.
A third party refers to a person other than the company or an associated company.
This duty also continues to apply after a person ceases to be a director in relation to things done before they ceased to be a director.
This duty is designed to prevent bribes or other payments or gifts which could compromise a director’s independence. Accordingly, small gifts or routine hospitality are not deemed to be a conflict of interest for these purposes.
7. Duty to declare interest in proposed transaction or arrangement
If a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company then he/she must declare both the nature and extent of this interest to the other directors before the company enters into the transaction or arrangement.
Although the statutory duty is only to declare an interest in such an arrangement, the company’s articles may impose further restrictions on how the director can act in such circumstances. For example, the director may not be allowed to take part in any board meeting held to consider the relevant transaction.
A director must not just consider his/her own situation, but also that of those connected with him/her. For example, if the spouse of a director was a shareholder in a company with which the director’s company was planning to enter into a contract, the interest would need to be declared.
The exceptions to this rule are similar to the ones in the ‘no conflict duty’ outlined above, in that if the interest cannot reasonably be regarded as likely to give rise to a conflict there will be no breach. Also, where the director is not aware of his/her interest or where the director is not aware of the transaction or arrangement, there will be no breach (directors will be treated as being aware of matters of which they ought reasonably to be aware). If the other directors are already aware of the interest, there will also be no breach.
Relationship between the duties
The seven general duties should not be considered in isolation.
A director’s actions may be a breach of more than one duty. In addition, compliance with one duty does not ensure compliance with the others and compliance with one duty cannot justify the breach of another. A director owes the duties to the company from appointment. The duty to avoid conflicts of interest and the duty not to accept benefits from third parties continue after resignation of a director in respect of opportunities, acts or omissions occurring whilst he or she was a director. The other duties cease to be owed by a director on resignation.
Consequences of breach
The seven duties are owed to the company, so it is only the company, acting via its board of directors, that can enforce them.
An action for a breach of duty brought by the company would fall within the general management of the company. It is the board’s decision whether or not to take action against a particular director.
In some circumstances, the shareholders can step in and bring an action in the name of the company to recover loss on behalf of the company. Such claims are usually considered if the directors as a whole choose not to proceed against the director in breach. However these claims can be difficult to bring as there is a two stage process of court approval that must be satisfied.
A claim for breach of duty can also be initiated by a liquidator or administrator of the company on insolvency. In these situations the insolvency practitioner takes control of the company and so may bring a claim for any historic breach of duty by a director.
Breach of duty may also give a company grounds to dismiss a director as an employee and the director could face disqualification proceedings, preventing him/her from acting as a director, or being involved in the management, of another company.
The general remedies available for a breach of the statutory general duties include:
- damages - to compensate the company for any loss suffered as a result of the breach;
- setting aside the transaction - this would mean rescinding any contract entered into by the company as a result of the director’s breach and placing the parties back in the position they were in before it was entered into;
- accounting for profits - here the director would have to pay back any profit made as a result of the breach of duty; and
- restoration of company property - the director may be required to return any property held by him/her which rightfully belongs to the company.
Protections for directors
There are some ways that a director can be protected against liabilities arising from a breach of duty.
If proceedings are brought against a director for a breach of duty, the court may relieve the director, fully or partially, of any liability if he/she acted honestly and reasonably and, considering all the circumstances of the case, he/she ought fairly to be excused. However, the courts are generally reluctant to grant relief in this way and it should be seen as a last resort by a director.
In certain circumstances, a company can choose to ‘forgive’ a director’s breach of duty by passing a resolution to ratify the act or omission giving rise to the breach. However, a company cannot ratify all acts of a director, particularly where the director was dishonest or where the relevant act was unlawful.
The ratifying resolution must be passed by a simple majority of the shareholders unless otherwise specified in the articles. Any shareholder who is connected to the director would not be eligible to vote on the ratifying resolution. ‘Connected’ for this purpose includes that director’s family members, any trusts of which the director is a beneficiary/trustee, any company in which the director holds at least 20% of the shares and any person who is a partner at a firm where the director is also a partner.
Although the general rule is that a company cannot indemnify a director against liabilities arising out of his/her directorship, an indemnity can be given in certain circumstances. To be lawful, the indemnity must qualify as a ‘third party indemnity provision’, indemnifying a director against liability incurred to a person other than the company or an associated company.
The indemnity cannot indemnify the director against a fine imposed in criminal proceedings, a penalty payable to a regulatory authority or any liability incurred where judgment is given against the director.
Permission to grant such an indemnity is usually found in the company’s articles of association, although a director may prefer this to be included in the service agreement or in a separate deed in order to be certain that the indemnity can be directly enforced by the director.
Companies will often obtain directors’ and officers’ (D&O) insurance to insure their directors against any liability arising out of the discharge of their duties as directors, including claims for negligence, breach of duty or other default. The policies offer protection for a variety of claims such as official investigations, claims by shareholders and claims arising on the company’s insolvency. However, they usually exclude any action that is considered fraudulent, dishonest or criminal in nature.
Other duties and responsibilities
Every company is required to keep certain statutory registers and to provide access to them. These must be kept at the company’s registered office or at some other place notified to Companies House. There are various registers that must be maintained, in particular:
- register of members; register of directors;
- register of directors’ residential addresses (not open to public inspection); register of secretaries;
- register of persons with significant control (PSC register); copies of all charges and mortgages; and
- copies of directors’ service contracts.
Directors must keep adequate and accurate company accounting records. The records must show and explain transactions and disclose the company’s financial position with reasonable accuracy. As a minimum, accounting records must contain day to day entries of all sums of money received and expended by the company as well as a record of the assets and liabilities of the company.
Under data protection legislation in the UK, a company will be classed as a ‘data controller’ and must ensure personal data is processed lawfully, fairly and in a transparent manner. The legislation sets out how personal data must be handled and relates to the collection, recording, use, storage, disclosure and destruction of personal data held by the company. Companies must be able to provide evidence that the legislation has been complied with.
All UK-registered companies are required to comply with the legislation and company directors will be responsible for ensuring compliance. Key requirements under the legislation include having appropriate data protection policies and procedures in place and, if the company meets certain criteria, a designated data protection officer must be appointed. Failing to comply with the stringent requirements can lead to significant fines and any data protection breach is likely to impact on the company’s reputation.
In addition to company specific sanctions and fines, directors could potentially face personal liability of a criminal nature should anybody within the company commit a breach of the legislation.
Directors should ensure that adequate training is provided to all employees so that the rights of data subjects are preserved. The company should also have procedures in place to allow it to respond to any requests from data subjects relating to their personal data.
Health and safety
Directors owe duties to their employees and to persons not in their employment but who may be affected by their undertaking (such as contractors, visitors to their site, etc). These duties stem from the Health and Safety at Work Act and related legislation.
Where an offence under any health and safety legislation is committed by a company and it is considered by the Health and Safety Executive to have been committed with the consent or involvement of, or to have been attributable to the neglect of any director or other officer of the company, that person, as well as the company, will face proceedings for breach of the relevant health and safety legislation.
In these circumstances, ignorance of the law is not a defence. Directors are expected to understand and act in accordance with their obligations.
If convicted, penalties range from a fine to imprisonment for up to two years and disqualification from acting in the capacity of a director for up to 15 years.
In the event of a fatal work-related incident, companies may also face corporate manslaughter charges and a director could face a charge of gross negligence manslaughter which carries a maximum term of life imprisonment.
Having appropriate systems to manage, monitor, audit and review health and safety within an organisation is imperative in order for a director to comply with the legal obligations and to avoid the risk of prosecution.
All directors should familiarise themselves with the joint guidance available from the Health and Safety Executive and the Institute of Directors.
Modern slavery statement
The Modern Slavery Act is aimed at increasing transparency in supply chains. Large organisations with a turnover of over £36 million a year are required to disclose the steps taken to ensure their business and supply chains are free from modern slavery and human trafficking.
Organisations caught by the Act must publish a modern slavery statement every financial year on the company’s website which must be approved by the board and signed by a director.
The statement should include information relating to company policies and any due diligence undertaken as well as highlighting areas of the business which are most at risk from human trafficking along with the steps taken to manage that risk. There is no direct penalty for failing to publish a modern slavery statement. However, failure to comply is likely to lead to criticism and negative publicity and could result in a court order forcing compliance.
Prevention of facilitation of tax evasion
All directors need to be aware of two corporate offences relating to the facilitation of tax evasion both in the UK and overseas. A company will be liable under these offences if it fails to prevent any of its associated persons from facilitating tax evasion. There are three stages to the offences:
- firstly, there must be criminal evasion of a UK or foreign tax by an individual or an entity;
- secondly, there must be facilitation of that criminal tax evasion by a person associated with the company; and
- thirdly, the company must have failed to have reasonable procedures in place to prevent that facilitation of tax evasion.
A director must ensure that the company has reasonable prevention procedures in place in order to prevent the facilitation of tax evasion.
In very limited circumstances, a company may be able to argue that it was not reasonable to expect it to have any prevention procedures in place at all.
To rely on the ‘reasonable procedures’ defence, a company would be expected to carry out a risk assessment to establish which procedures are proportionate to the risk of tax evasion within its organisation and businesses (or whether any procedures are required at all).
HMRC has issued guidance about the procedures that companies can put in place and this lists the same six guiding principles as set out below for the bribery offences. As with the bribery offences, the principles are not strictly mandatory and failing to satisfy all of the suggested methods of prevention will not necessarily mean that the statutory defence is unavailable.
Perhaps most importantly for directors, although companies are required to have appropriate procedures in place to prevent both bribery and the facilitation of tax evasion, they should avoid the temptation to simply apply the same procedures to both offences. The risks of tax evasion are much wider than those for bribery and different factors will need to be considered.
It’s worth noting that the legislation and guidance do not require a company to prevent every act of facilitating tax evasion from being committed, but merely require it to adopt an approach that is proportionate to the areas of identified risk.
Prevention of bribery
The Bribery Act imposes various obligations on a company and its directors. The Act covers the conduct of a business both in the UK and abroad.
There are four main offences in the Bribery Act:
- offering, promising or giving a bribe;
- requesting, agreeing to receive or accepting a bribe; bribing a foreign public official; and
- for commercial organisations, failing to prevent bribery by those acting on their behalf.
- A company will commit an offence if a person associated with it bribes another person for the benefit of that company or its group. This means that actions of the company’s agents, employees, subsidiaries and suppliers could make the company liable for this offence. There is no need for the involvement of the company to be established.
A company will commit an offence if a person associated with it bribes another person for the benefit of that company or its group. This means that actions of the company’s agents, employees, subsidiaries and suppliers could make the company liable for this offence. There is no need for the involvement of the company to be established.
The directors’ role here is in ensuring that ‘adequate procedures’ are in place to prevent the bribery offences: this is a defence to those offences.
Adequate procedures include:
- proportionate procedures; top level commitment;
- risk assessment; due diligence;
- communication; and monitoring and review.
- Companies could face an unlimited fine and individuals could face an unlimited fine as well as a maximum prison sentence of 10 years. Directors should conduct regular risk assessments and ensure that adequate procedures are in place to prevent bribery.
Companies could face an unlimited fine and individuals could face an unlimited fine as well as a maximum prison sentence of 10 years. Directors should conduct regular risk assessments and ensure that adequate procedures are in place to prevent bribery.
And that’s not all…
Directors of publicly listed companies face additional duties depending on the market on which the company is listed. The Main Market of the London Stock Exchange imposes rules through the Listing Rules and the AIM Market imposes additional obligations through the AIM Rules for Companies. Both markets are also subject to the market abuse regime which is designed to provide a level playing field for those seeking to invest in listed companies.
Directors will also owe specific contractual duties and obligations under their service agreement and their position as an employee could give rise to a number of implied duties, such as a duty of confidentiality.
Duties when facing insolvency
When a company is facing financial difficulties, there is a shift in the focus of a director’s duties.
The main change stems from the duty to promote the success of the company. In times of threatened insolvency, the duty to act for the benefit of the company’s members switches to a requirement to act in the best interests of the company’s creditors. If a director breaches this duty, he/she may be required to contribute to the company’s assets on insolvency.
There are also some specific insolvency-related offences of which a director should be aware:
- Wrongful trading – a director may be ordered to contribute to the general pool of assets available to the creditors where he/she knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation and he/she continues to allow the company to trade and he/she does not take every step to minimise the potential cost to creditors.
- Fraudulent trading – this is another way in which a director can be ordered to contribute towards the company’s pool of assets. If the business of the company was carried on with the intent to defraud creditors then a criminal offence is committed. An example of such trading would be where a director continues to incur credit on the company’s behalf without any reasonable expectation of funds being available to repay the debt when it becomes due.
Both of these claims can only be brought by a liquidator. In order to succeed in a claim for fraudulent trading, actual dishonesty must be proved on the part of the director. It follows that a claim for wrongful trading is easier to satisfy.
To avoid any liability under these offences, it is advisable for directors to obtain independent advice as soon as they become aware that the company is in financial difficulties.
A director must take positive action to mitigate the potential loss to creditors – a claim that he/she had done nothing to cause loss themselves is not sufficient. This action must be taken at the right time, so the director must neither act too late nor put the company into liquidation too early.
A director cannot avoid liability by resigning when he/she realises that the company is facing financial difficulty. Such a resignation is unlikely to minimise the loss to creditors.
The director should remain on the board of the company to ensure that his/her warnings are recorded, for his/her own protection and so that at least one voice will be heard representing the interests of creditors, if other directors should refuse to act.
Obligations to file information at Companies House
All companies have an obligation to file documents and updates with Companies House at certain intervals.
These are usually annual filings or a filing that is required as a result of a particular event or change to the company. It is the responsibility of the company’s directors to know when these filings are required and to ensure that these filings occur on time.
Other individuals can be hired to manage these tasks, such as an accountant, but a director is still legally responsible for accounts, records and performance. A director can be fined, prosecuted or disqualified if he/she does not meet his/her responsibilities.
Company records that may not be relevant in a financial sense, but are still important to the running of the company include:
- details of shareholders, directors and company secretaries;
- the results of any shareholder votes and resolutions; details of any promises to pay back loans at a specific date; details of any indemnities;
- information regarding share transfers; and
- details of loans or mortgages secured against the company’s property.
It is also important that Companies House are made aware if records are being kept at a location other than the company’s registered office.
Changes to report to Companies House
If any significant changes occur within a company, the directors must ensure that these are notified to Companies House.
Changes that may occur during the life cycle of a company can be divided into two categories: event driven filings, which usually relate to a change in the company; and annual filings, which are annual requirements outlined by Companies House.
Event driven filings:
- a change of registered office address;
- the appointment of a company director or secretary;
- a change of personal details of a company director or secretary;
- the termination of the appointment of a company director or secretary;
- a change of the address where the company records are made available for inspection; an allotment of new shares;
- a change to the company’s total share capital;
- a change to the company’s accounting reference date; a change to the company’s name;
- the creation of a charge over any of the company’s assets;
- a special resolution or certain other types of resolution being passed by the company’s members; re-registration of the company, from a public to private company, or vice versa;
- any change to the people who have significant control over the company (the company’s ‘PSCs’).
- a confirmation statement providing a snapshot of the company on a specified date and confirming that all the company’s filings are up to date;
- annual accounts filed within nine months of year end (for a private company).
There are substantially more event driven filing requirements when compared with annual requirements. Note also that a significant change to a company may not be effective unless the relevant form is filed with Companies House. With many of these event driven filings, the change will only take effect once the form is submitted. It is therefore essential that the company directors complete the right form and submit it in the specified time period. Detailed guidance on filings can be found on the Companies House website.
If annual filings are not made then Companies House may assume that the company is no longer carrying on business or is no longer in operation. This may result in steps being taken to strike the company off the register. The effect of this is that the company is deemed to no longer exist and all assets become property of the Crown.
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