There are seven codified directors' duties.
The principles behind these were firmly established by common law and in statutes. These are:
to act in good faith to the best interest of the company
to avoid conflicts of interest
not to profit from their offices, and
of care and skill are enshrined in the common law rules and equitable principles and also in statutes such as the Companies Act 1985 (the 1985 Act) as amended by Companies Act 1989
However, the law was short on detail and interpretation. The Companies Act 2006 gives more precise and consistent requirements and the principles remain.
A director must act within his powers
This was a common law rule referring to the fact that powers should be exercised only for their proper purpose. What the proper purpose is depends on the company's constitution, its articles of association.
Promote the success of the company
A director must act in good faith in the company's best interest in order to promote the financial success of the company.
This can be widely interpreted - a director must be aware of the non-exhaustive list of factors listed in s.172 (1). These include:
the long term consequence of decisions
interests of employees
relationships with suppliers and customers
the impact of decisions on the community and environment
the desirability of maintaining a reputation for high standards of business conduct
the need to act fairly as between members of the company (that means shareholders)
As a director, you may have already wondered about what to do if these interests conflict. For example, it goes without saying that environmental decisions, such as deciding to off-set company C02 emissions, may not be the number one priority of the shareholders.
We advise directors to take detailed minutes of all meetings and decisions. This can help to prove that the factors listed in section 172 have been noted.
Exercise independent judgment
Section 173 of the Act imposes a positive duty on a director of a company to exercise independent judgment. This is simply put and continues by saying that the duty is not infringed by his acting in accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or in a way authorised by the company's constitution.
It would appear however, that a director is entitled to follow his own judgement. Outside of any contract, he has no obligation to follow a previous course of action or to accept advice from an expert.
Exercise reasonable care, skill and diligence
This duty is set out in s. 174(1) and codifies the common law rule of duty of care and skill. S. 174 (2) prescribes the degree of 'care, skill and diligence' expected from a director; that is: care, skill, diligence that would be exercised by a reasonably diligence 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; and
The general knowledge, skill and experience that, the director has.
There are two parts to the test.
The first element sets out a minimum objective standard (what a reasonable person might think) expected of any director.
The second, subjective test requires a director to carry out his duty with the general knowledge, skill and diligence that he in fact possess. Therefore, a director who has more experience, knowledge and skill will have a higher threshold in discharging this duty.
Avoid conflicts of interest
This is the most complex of the seven duties. Previously contained in Part 10 of the Companies Act 1985, the 2006 Act simplifies these duties.
This duty applies to dealings between the director and third parties, not between the director and the company. Dealings which fall into the latter category are dealt with differently and require you to declare your interest to the other directors (see rule 7 below).
There is now no need to gain shareholders' approval prior to entering into transactions with third parties where the director's interests conflict with company's interests. Now, directors can gain authorisation from the directors who don't have conflicting opinions provided that certain requirements as listed in s175 (5) (6) including who can participate and vote on such authorisation are complied with.
To make this section quite clear, here is the full text:
A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.
This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the company could take advantage of the property, information or opportunity).
This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.
This duty is not infringed—
if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or
if the matter has been authorised by the directors.
Authorisation may be given by the directors—
where the company is a private company and nothing in the company's constitution invalidates such authorisation, by the matter being proposed to and authorised by the directors; or
where the company is a public company and its constitution includes provision enabling the directors to authorise the matter, by the matter being proposed to and authorised by them in accordance with the constitution.
The authorisation is effective only if—
any requirement as to the quorum at the meeting at which the matter is considered is met without counting the director in question or any other interested director, and
the matter was agreed to without their voting or would have been agreed to if their votes had not been counted.
Any reference in this section to a conflict of interest includes a conflict of interest and duty and a conflict of duties.
Don't accept benefits from third parties
This is a long established, and now codified provision known as 'non profit'. Of course it is obvious that a director is not permitted to accept a benefit from a third party due to either his being a director or his doing or not doing anything as a director.
Declare interest in proposed transaction or arrangement with the company
Those who are familiar with s.317 of the 1985 Act, will know that a director is required to disclose his interest to the board of the company when a transaction is proposed between a director and his company. This is contained in s.177 of the 2006 Act.
S.177 goes beyond s.317 of the 1985 Act by requiring a director to declare the nature and the extent of the interest to the other directors. Further, disclosure must be made where a director “ought reasonably to be aware” of (s.177 (5)) the conflicting interest. Disclosure also extends to a person connected with the director, for example, his wife and children.
Note however, the requirement is extinguished where the director believes that the interest cannot reasonably be regarded as likely to give rise to a conflict of interest or if other directors are already aware or “ought reasonably to be aware” of the director's interest.
Next you may be interested to read about the duties of the company secretary, roles of different types of directors, or duties of directors when the company is in trouble.