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13/02/14

Shareholder Director – A Tough Act to Master

In a timely reminder, the Institute of Chartered Secretaries’ (ICSA) has updated its guidance on the induction of directors and the duties owed to his or her company as directors. And it has never been clearer that directors of SMEs continue to face a perpetual juggling act between their roles as director and shareholder.

Directors have always owed duties to their companies but the Companies Act 2006, introduced in a fanfare of legal commentary, made directors’ duties hit the headlines.  Five years since the Act came into force, the excitement has faded and it’s business as usual.  However, with no specific qualifications required to be a director and with ever increasing legal obligations (breach of which can give rise to personal liabilities) understanding these duties is vital.

Director and shareholder: A split personality?

Your interests as an owner and manager of a company are often aligned because the end goal for both is the commercial success of the business: as a result the line between the two roles can become blurred and difficult to separate.  Whereas shareholders are allowed to act in their own self-interest, directors always have to consider their duties (set out below) and act in the best interest of the business as a whole.

What are my directors’ duties?

Historically directors have owed fiduciary duties of good faith and loyalty and common law duties of skill and care to the company.  The 2006 Act simply put those duties in writing.  Importantly, these will apply to all decisions made by you, not merely formal decisions made by the whole board.

The seven duties under the 2006 Act are:

  • Duty to act within your powers – you must act in accordance with the company’s constitution and document(s) and must only exercise your powers for their proper purpose.
  • Duty to promote the success of the company – you must act in the way you consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole, bearing in mind (among other things) the likely consequences of any decision in the long term;
  • Duty to exercise independent judgment – this does not prevent you from relying on professional advice, as long as you exercise your own judgment in deciding whether or not to follow the advice.
  • Duty to exercise reasonable care, skill and diligence – this is an objective test save that where you have specialist knowledge, your actual knowledge will be considered.
  • Duty to avoid conflicts of interest – you must not, without the company’s consent, place yourself in a position where there is a conflict, or possible conflict, between the duties you owe to the company and either your personal interests or other duties you owe to a third party.
  • Duty not to accept benefits from third parties – you must not accept any benefit from a third party which is conferred because of your being a director or your doing or not doing something.
  • Duty to declare interest in proposed transaction or arrangement with the Company – you must declare to the other directors the nature and extent of any interest you may have, direct or indirect, in a proposed transaction or arrangement with the company.

What if my duties conflict?

Compliance with one duty should not cause you to breach another duty and does not require or authorise you to breach any other law.  If you think your duties are conflicting you should seek legal advice.

When problems are likely to arise?

Conflicts between your interests as a director and shareholder can arise at any time, but some classic examples of circumstances when problems can arise include:-

  • Where assets are to be transferred to directors or where assets are to be purchased from directors;
  • Where domestic and personal expenditure is wrongly put through the company;
  • When you take up directorship with a competing company; or
  • When you want to personally exploit an opportunity that the company has previously turned down.

What if I cease to be a director?

Certain aspects of the duties to avoid conflicts of interest and not to accept benefits from third parties will continue to apply, even if you cease to be a director.  You cannot simply terminate your directorship in order to exploit an opportunity which you encountered as a result of being a director.

What are the consequences of breach of duty?

You may face personal liabilities for both civil and criminal offences and you will also be required to reimburse the company for any loss it has experienced or to repay an amount equivalent to any profit made.  In a worst case scenario, you may even face disqualification from holding office as a director.

Relief may be available to a director who has acted honestly and reasonably despite being in breach of his statutory duty.  Nonetheless it is important to note that the relief is at the discretion of the court and will only be given if it thinks you ought fairly to be excused.  It is not automatic, even if you have acted honestly and reasonably.   You will generally be held to have acted reasonably if you act in the way in which a person in your position would have been expected to act; a director, who acts as a mere puppet, even if an innocent one, will not be relieved of his duty.

How do I protect myself?

The duties are complex but you should consider these every time you make a decision.  Always ask yourself:

1) Why am I doing this? and

2) Does this benefit the company?

Some practical steps to take:

  • Record professional advice received and steps taken in response;
  • Take minutes of board meetings;
  • Record all commercial decisions by directors;
  • Record accurate financial information;
  • Take steps to protect creditors;
  • Keep investors and banks up to date with decisions;
  • Draw up contingency plans, with notes of significant deadlines or targets; and
  • Take out a professional indemnity insurance policy.

This article is an overview of your duties.  If you would like to find out more about directors’ duties or have any specific concerns, please get in touch.