Directors’ duties: the risks and possible protections

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. In this insight we give an overview of what happens when a duty is breached by a director and what protections are available to that director.

Who do directors owe the duties to?

A director owes the statutory duties to the company and so only the company has a right to enforce them, with a few minor exceptions. In certain circumstances, the shareholders may be able to step in and bring a claim for breach of duty on the company’s behalf. Where a director has engaged in a special relationship with a shareholder, for example where a shareholder has a right to appoint a director to represent their interests at the board, then that director would owe that particular shareholder additional duties.

How long do directors owe the duties for?

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 while they were a director. The other duties cease to be owed by a director on resignation.

What if there’s a breach?

If a director has breached a duty, the company could bring a claim against a director, as an individual:

• for damages;
• for an injunction to prevent the breach from continuing;
• to set aside any transaction constituting a breach and restore to the company any profits made by the director from that transaction; or
• to restore any company property affected by the breach.

A company may also have grounds to dismiss a director (under the terms of their service contract) and the director could face disqualification proceedings, preventing them from acting as a director, or being involved in the management, of another company.

Is there any relief?

A duty cannot be used as a get out of jail free card. So, for example, a director cannot use the fact that they were acting in accordance with their duty to promote the success of the company to justify non-compliance with the other duties or the law in general. Neither can a company exempt a director from any liability arising out of a breach of statutory duties.

But there are some protections available:

Court relief

A court can grant relief, or partial relief, from liability if it considers that the director has acted honestly and reasonably and they ought fairly to be excused considering all the circumstances. A director can apply for relief in anticipation of an action being brought against them. However, the courts are generally reluctant to grant relief in this way and it should be seen as a last resort by a director.

Ratification

In certain circumstances, a company can choose to forgive a director’s breach of duty by the members of the company passing a resolution to ratify the act or omission giving rise to the breach. However, a company cannot ratify certain acts of a director including where the director was dishonest or where the relevant act was in itself unlawful or unauthorised.

The ratifying resolution must be passed by a simple majority unless otherwise specified in the articles. Any members who are connected to the director would not be eligible to vote. ‘Connected’ for this purpose includes that director’s family members, any trusts of which they are a beneficiary/ trustee, any company in which the director holds a certain number of shares and any person who is a partner at a firm where the director is a partner.

Indemnity

Although the general rule is that a company cannot indemnify a director against liabilities arising out of their 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 associated company. The indemnity cannot indemnify the director against a fine imposed in criminal proceedings or a sum 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 their service agreement or in a separate deed in order to be certain that the indemnity can be directly enforced by the director.

Insurance

A company may also take out insurance to insure its directors against any liability arising out of the discharge of their duties as directors. This is known as Directors and Officers insurance (or D&O insurance) and could protect the directors against a variety of claims, including official investigations, claims by shareholders or claims arising on the company’s insolvency.

A directorship is not an honorary title to be accepted without thought and all directors should be aware that the office comes with associated responsibilities and duties which can carry significant liabilities. Directors should ensure that they are fully aware of these duties and take all steps necessary to ensure that they always comply with them. But it will be of some comfort to know that there are some protections available where inadvertent breaches occur.