Author: TheLawStudent

Whether or not unhappy shareholders choose to remove a director, there are two key actions which shareholders may be able to bring in respect of a director’s misconduct.

Section 260 CA 2006 has introduced a new statutory derivative claim which allows a shareholder to bring a claim on behalf of the company (i.e. where the cause of action vests in the company) arising from an actual or proposed act or omission involving the negligence, default, breach of duty or breach of trust by a director of the company. This includes a breach of the director’s general duties set out in ss.170-177 CA 2006. Section 260 CA 2006 applies to current, former and shadow directors.

The second action is for protection of shareholders against unfair prejudice. Under s.994 CA 2006, a shareholder can apply to the court for an order that the company’s affairs are being, have been, or are proposed to be conducted in a manner that is unfairly prejudicial to that shareholder’s interests or to the interests of shareholders generally.

Case law (in respect of the equivalent provision in CA 1985) has tested the meaning of unfair prejudice. The courts have been specific and restrictive in their interpretation of what amounts to unfair prejudice. Examples can include excessive remuneration of directors or a failure to pay a dividend. The courts are, however, unwilling to intervene in internal affairs or management decisions of companies. Therefore petitions based on disagreements in company policy (e.g. as to whether to pursue a sale of the business or some
other exit strategy) will be more difficult to bring.

Such an action is often brought at the same time as an action under s.122(1)(g) IA 1986 which gives a shareholder the right to apply for the company to be wound up on the grounds that it is just and equitable to do so.

The ability to remove a director from his office is the ultimate sanction shareholders have against a director. Under s.168(1) CA 2006, a company (i.e. the shareholders) may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in any agreement between the company and that director.

Under s.168(2) CA 2006 special notice is required of a resolution to remove a director.

What is special notice?

For simplicity, I will refer to a resolution to remove a director under s.168(1) CA 2006 as a “removal resolution”.

Shareholders proposing a removal resolution must give notice of that proposed removal resolution to the company (i.e. to the board of directors) at least 28 clear days before the general meeting at which the removal resolution will be voted on by shareholders (ss.312(1) and 360(1) and (2) CA 2006).

The board usually decides what matters will be considered at a general meeting. Therefore, when the board receives notice of the proposed removal resolution, two courses of action are open to it:

Place the removal resolution on the agenda

The board may decide to place the removal resolution on the agenda of a general meeting, in which case, when the general meeting is held, shareholders will vote on that removal resolution.

If the board does decide to place the removal resolution on the agenda of a general meeting, it should give the shareholders notice of that removal resolution at the same time and in the same manner as it gives notice of the general meeting (s.312(2) CA 2006). This means that the board will need to give shareholders at least 14 clear days’ notice of the removal resolution under ss.307(1) and 360(1) and (2) CA 2006 (see Fenning v Fenning Environmental Products Ltd (1981), which was an authority for the equivalent rule under CA 1985).

If that is not practical (e.g. because notice of the general meeting has already been sent out), notice of the removal resolution may be given either by advertisement in a newspaper or any other mode allowed by the company’s articles of association at least 14 clear days before the general meeting (ss.312(3) and 360(1) and (2) CA 2006).

It might seem strange that the board needs to give shareholders notice of the removal resolution when it was the shareholders who sent the removal resolution to the board in the first place.

The reason for this lies in understanding that only some of the shareholders will have sent the proposed removal resolution to the board. We shall call these shareholders the “unhappy shareholders”. The company’s other shareholders may have no knowledge of the fact that the unhappy shareholders have proposed a removal resolution.
Therefore, if the board decides to put the removal resolution on the agenda of a general meeting, it needs to give notice to all shareholders (including the unhappy shareholders) of the fact that a general meeting will be held and that, at that general meeting, all shareholders will have the opportunity to vote on a removal resolution.

Decide not to place the removal resolution on the agenda

Alternatively, the board may decide not to place the removal resolution on the agenda of a general meeting. Directors are not bound to place the removal resolution on the agenda for consideration at a forthcoming general meeting (Pedley v Inland Waterways Association Ltd (1977), a CA 1985 authority). In practice, this creates a problem for shareholders as directors may choose simply to ignore the proposed removal resolution.

If the removal resolution is not placed on the agenda, it will not be considered at the general meeting. In this case, the shareholders may need to force the directors to call a general meeting in accordance with s.303 CA 2006.

Shareholders’ power to require calling of general meeting

As we have seen above, it is sometimes the case that the board of directors will try to frustrate an attempt to remove a director by refusing to call a general meeting. In this situation, the unhappy shareholders may have the ability to require the directors to call a general meeting and, if the directors refuse to do this, the unhappy shareholders may be able to call the general meeting themselves.

How do shareholders require the directors to call a general meeting?

Under s.303(1) CA 2006, shareholders together holding not less than 5% of the paid up voting share capital of the company can serve a request on the company i.e. the board. The request will require the board to call a general meeting (a “s.303 request”). The threshold of 5% is found in s.303(2) CA
2006.

A s.303 request must state the general nature of the business which the shareholders wish to be dealt with at the general meeting, and may include the text of the resolution they want proposed at the meeting (here, to consider a removal resolution pursuant to s.168 CA 2006).

What are directors’ obligations on receipt of a s.303 request?

Under s.304(1) CA 2006, when the directors receive a s.303 request, they must call the general meeting:

1. within 21 days from the date on which they become subject to the s.303 request to call the general meeting; and
2. to be held on a date not more than 28 days after the date of the notice convening the general meeting.

What happens if the directors fail to call the general meeting?

If the directors fail to call a general meeting under s.304(1) CA 2006, all of the shareholders who submitted the s.303 request or any of them representing more than one half of the voting rights of those who submitted that s.303 request, can call a general meeting themselves pursuant to s.305 CA 2006.

If the shareholders call the general meeting themselves then that general meeting must be called on no fewer than 14 clear days notice (s.305(4) CA 2006) and held within 3 months of the date that the directors received the s.303 request (s.305(3)).

Under s.305(6) CA 2006, if the shareholders are forced to call the general meeting themselves, they can recover their reasonable expenses for doing so from the company.

Conclusion

In order for the unhappy shareholders to ensure the resolution to remove a director is heard as soon as possible, they will submit a s.303 request requiring the directors to call a general meeting at the same time as sending their s.312 CA 2006 special notice to the board.

By sending these two notices to the board at the same time, shareholders will comply with s.312 CA 2006 (which is a stand alone requirement that needs to be satisfied) and also ensure that:

1. the directors either call a general meeting with an agenda which includes the resolution to remove the director under s.303 CA 2006; or
2. the shareholders can step in and call the general meeting under s.305 CA 2006 themselves.

Director’s rights to protest removal

If a company receives notice that one or more members intends to propose a removal resolution, the company must immediately send a copy of the notice to the director concerned (s.169(1) CA 2006).

The director then has the right to make representations in writing provided those representations are of a reasonable length (s.169(3) CA 2006). These representations will, for example, set out the reasons why the director feels he should not be removed. These representations should, unless they are received too late for the company to do so, be circulated to the members of the company. If the representations are not circulated, they should be read out at the general meeting (s.169(4) CA 2006).

In any event, the director concerned has a right to be heard i.e. to speak in his defence at the general meeting, whether or not he is a shareholder (s.169(2) CA 2006).

Will the director be entitled to any compensation?

Section 168(5) CA 2006 provides that removal under s.168 CA 2006 does not deprive a person of any right they may have to compensation or damages payable by reason of the termination of any appointment. This means that if the director’s service contract (i.e. his employment contract) is breached by reason of his removal from the office of director under s.168 CA 2006, then he may be entitled to damages or compensation for breach of that service contract.

Payments under the terms of a director’s service contract need to be distinguished from any additional payment for loss of office which will require shareholder approval.

What if the director is also a shareholder?

Always check the articles to see if there is a Bushell v Faith clause.

A Bushell v Faith clause in the articles of association may give a director, who is also a shareholder, weighted voting rights at a general meeting at which a s.168 CA 2006 resolution is proposed. This is likely to mean that shareholders are unable to pass an ordinary resolution to remove the director concerned.

This type of clause is often found in the articles of association of smaller companies where the directors have played a key role in setting up the company and have an expectation that they will be able to continue to be involved in the running of the business. Any shareholders’ agreement should also be checked for similar provisions.

The articles should also be checked in order to determine whether there are any transfer provisions which may govern the transfer of the outgoing director’s shareholding in the company. From a practical point of view, if a director is to be removed, the company and the shareholders are unlikely to want him to retain his shareholding, so transfer provisions are usually found in a company’s articles of association and/or in any shareholders’ agreement. These transfer provisions would, for example, require the director to transfer his shares to the other shareholders if he is removed as a director.

Can you use a shareholders’ written resolution to remove a director?

No, the procedure cannot be used – see s.288(2)(a) CA 2006.

Can a director be removed from office by fellow directors?

The answer to this is not unless the articles specifically provide for this. Where the articles expressly provide that a director can be removed by the other directors, this power has been upheld by the courts (see Bersel Manufacturing Co Ltd v Berry [1968] 2 All ER 552). The Model Articles do not provide for this. If the directors were able to remove their fellow directors, this could lead to difficulties in decision making.

Introduction

• the directors have control of the company’s day to day management;
• directors necessarily have broad powers to carry out such management;

but

• statute places certain controls on directors which act as a check against abuse of their powers;
• directors must disclose certain information about themselves and their dealings with the company;
• shareholder approval must be obtained for certain transactions; and
• shareholders have certain important decisions reserved to them (such as amending the company’s articles of association).

Over the next few posts, I will provide an overview of the statutory provisions governing a shareholder’s power to remove a director from office and related issues. Also covered will be other ways that a director’s office may be terminated and a shareholder’s power to “forgive” (i.e. ratify) a director’s breach in certain circumstances.

General prohibition

A director acts as an agent for the company but from time to time may incur personal liability to the shareholders or to a third party. Under the general prohibition, a company cannot indemnify a director of the company or an associated company for any liability he may have incurred as a result of his negligence, default, breach of duty or trust in relation to the company of which he is a director. Any provision purporting to do so is void (s.232 CA 2006).

Companies are associated if one is a subsidiary of the other or both are subsidiaries of the same body corporate (s.256 CA 2006).

The aim of s.232 CA 2006 is to protect companies from loss caused by their directors. However, this protection must be balanced with the practical need to encourage people to become directors. The legislation attempts to achieve this balance by:

1. not preventing companies from purchasing and maintaining insurance for a director against such liability (ss.232(2)(a) and 233 CA 2006) (usually referred to as ‘Directors’ and Officers’ Liability Insurance’ or abbreviated to ‘D & O insurance’); and
2. not preventing companies from providing ‘qualifying third party indemnity provisions’ (‘QTPIP’) (ss.232(2)(b) and 234 CA 2006) and, in respect of companies which act as trustees of an occupational pension scheme, ‘qualifying pension scheme indemnity provisions’ (‘QPSIP’) (ss. 232(2)(c) and 235 CA 2006), to their directors.

QTPIP

QTPIP is defined in s.234 CA 2006. Under this definition, a company is permitted to indemnify its directors against liability incurred by the director to a person other than the company or an associated company provided that the indemnity does not include:

1. an indemnity for a director in relation to a fine he has to pay as a result of criminal proceedings or a sum payable as a penalty imposed by a regulatory authority for non-compliance with “any requirement of a regulatory nature”;
2. an indemnity for a liability a director incurs in defending criminal proceedings if he is convicted;
3. an indemnity for a liability a director incurs in defending any civil proceedings brought by the company or an associated company where the judgment is given against the director; or
4. an indemnity in relation to a director’s unsuccessful application to court for relief in connection with s.661(3) or (4) CA 2006 (acquisition of shares by innocent nominee) or s.1157 (general power to grant relief in case of honest and reasonable conduct).

The practical effect of this is that a company can indemnify a director against liabilities incurred by the director to anyone other than the company or an associated company. This may include the costs of defending those proceedings and the financial costs of an adverse judgment. However, a director can still be liable to the company itself and cannot be indemnified against this.

QPSIP

Section 235 sets out the meaning of qualifying pension scheme indemnity provision. A ‘pension scheme indemnity provision’ is a provision which indemnifies a director of a company that is a trustee of an occupational pension scheme against liability incurred in connection with the company’s activities as a trustee of the scheme. Again, it will only be ‘qualifying’ if certain conditions set out in s.235 CA 2006 are met.

QPSIPs were introduced by the CA 2006 in recognition of the fact that companies which act as occupational pension scheme trustees can find it hard to attract high calibre individuals as directors without such protection in respect of the personal liabilities they may incur in the position.

Expenditure on defence proceedings and in connection with regulatory actions or investigations

Section 205 permits a company to provide a director with funds to pay for his expenses in defending any criminal or civil proceedings in connection with any alleged negligence, default, breach of duty and breach of trust in relation to the company or an associated company or in making any relief applications in connection with s.661(3), s.661(4) and s.1157 CA 2006. These funds will need to be repaid if the director is convicted in the criminal proceedings or receives an adverse judgment in the civil proceedings or his relief application is unsuccessful.

There is a similar provision at s.206 CA 2006 in relation to a director’s costs in defending himself in investigations or actions by regulatory authorities. Note that shareholder approval is not required under the CA 2006 provisions requiring member approval for loans etc. for a company to provide a director with funds for defence proceedings or regulatory actions and investigations. Sections 205 and 206 CA 2006 expressly state this.

Indemnity provisions in the articles of association

The sections of the act discussed above set out the fullest extent to which a company may lawfully indemnify its directors in respect of negligence, default, breach of duty and breach of trust in relation to the company.

MA 52 provides companies with the authority but not the obligation to indemnify their directors, former directors (and those of their associate companies) to the fullest extent permitted by the CA 2006. However, they cannot indemnify beyond the scope of the CA 2006 provisions. Consequently under MA 52(2) no provision can indemnify a director against liability incurred to the company of which he is director or to an associated company.

A company is under no obligation to provide an indemnity to the fullest extent permitted by law and should consider the extent of the indemnity it is willing to provide. The Department for Business, Energy and Industrial Strategy’s guidance also suggests that the company needs to consider whether it is in the company’s best interests to agree to pay a director’s defence costs.

Disclosure

QTPIPs and QPSIPs need to be disclosed in the directors’ report (s.236 CA 2006). Copies of the indemnities must be kept by the company at its registered office (or a place specified in regulations under s.1136 CA 2006) during their term and also for one year after they have expired or terminated (s.237 CA 2006). Non-compliance with s.237 CA 2006 is a criminal offence. Shareholders have the right to inspect copies of the QTPIPs and QPSIPs and, on payment of a fee, to be provided with a copy (s.238 CA 2006).

A number of duties and obligations are imposed on directors in relation to conflicts of interest by CA 2006. Importantly, the duty of directors to avoid conflicts of interest (s.175) does not arise where the conflict arises in relation to a transaction or arrangement with the company (s.175(3)). Therefore the s.175 duty will not be relevant to the transactions involving a company and its directors, which you will consider during the LPC course.

Other directors’ duties, including, in particular, the duty under s.177 to declare an interest in proposed transactions or arrangements (or, in respect of existing transactions or arrangements, the requirements under s.182) will still apply in such cases.

There are also two exceptions to the conflict duties under ss.175 and 176 (duty not to accept benefits from third parties), namely:

• if the situation or benefit cannot reasonably be regarded as likely to give rise to a conflict; or
• for s.175 only, if the potential conflict is authorised by the directors (excluding the potentially conflicted director).

In addition to these, there is a further exception in s.180(2). If a transaction needs shareholder approval under CA 2006, and shareholder approval is properly obtained, it is not necessary to comply with the ss.175 and 176 duties.

The general rule is that shareholder approval by ordinary resolution is required before a company can make a loan to a director. This shareholder resolution must not be passed unless a written memorandum, setting out the nature of the transaction, the amount and purpose of the loan and the extent of the company’s liability, is made available to the members.

What transactions are caught?

The restrictions apply to four different types of transaction:

1. loans,
2. quasi-loans,
3. credit transactions, and
4. guarantees or the provision of security for any of the above.

Loans (s.197 and s.200 CA 2006)

A loan simply involves a straightforward lending of money.

Quasi-loans (ss.198 – 200 CA 2006)

The term quasi-loan is defined in s.199. An example of a quasi-loan would be where a company agreed to pay off an outstanding account owed by a director to a third party on the understanding that the director would later reimburse the company.

Credit transactions (ss.201–202 CA 2006)

A credit transaction is defined in s.202. A credit transaction includes any transaction entered into between the company and the director where the company provides goods or services on a credit basis which will be paid for at a later date. Only the company and the director will be parties to this arrangement.

Guarantee or the provision of any form of security (ss.197, 198, 200 and 201 CA 2006)

This is not defined but will be reasonably self-explanatory. An example of this type of arrangement would be where a director obtains a loan from a bank and his company stands as guarantor for the repayment of the loan or the company provides the bank with security over its assets.

Which companies are restricted?

For the purposes of the CA 2006, restrictions on loans and related financial transactions between a company and a director or connected persons of that director, it is important to distinguish between private companies on the one hand, and public companies and private companies that are associated with public companies on the other.

All companies:

No company may make loans to its directors or to directors of its holding company, or give guarantees or enter into security in connection with loans to such directors, without the transaction first being approved by the shareholders.

If the company in question is a private company that is not associated with a public company, these are the only transactions for which shareholder approval is required under the CA 2006 loan provisions.

Public companies and private companies associated with public companies:

There are additional restrictions that apply to public companies and private companies that are associated with public companies, namely:

1. Public companies or companies associated with public companies must obtain shareholder approval to make a loan to a person connected to a director of the company or a director of its holding company;
2. Public companies or companies associated with public companies also need shareholder approval to make quasi-loans to, or enter into credit transactions with, their directors and directors of a holding company or persons connected with such directors; and
3. Shareholder approval is also required for guarantees or security in respect of any such loans, quasi-loans or credit transactions by public companies or companies associated with public companies.

Definition of ‘associated companies’:

Under s.256, companies are associated if one is a subsidiary of the other or both are subsidiaries of the same body corporate. So, for example, a private company that is a subsidiary of a public company will be associated with the public company for these purposes.

Exceptions

There are a number of exceptions to the need for shareholder approval, the
principal ones being as follows:

Expenditure on company business – s.204

Shareholder approval is not required where a director is provided with a sum of money to pay for company expenses or expenses to enable him to properly perform the duties of a director.

This exception is limited to expenditure the aggregate amount of which is £50,000 or less. If the value of the transaction or arrangement cannot be ascertained, it will be deemed to exceed £50,000.

Expenditure on defending proceedings – s.205

Shareholder approval is not required where a company is providing funds (either by way of a loan, quasi-loan or credit transaction) for a director to defend proceedings in connection with any alleged negligence, default, breach of duty or breach of trust in relation to the company or an associated company or in making any relief applications in connection with s.661(3), s.661(4) and s.1157.

Minor and business transactions – s.207

Loans or quasi-loans to a director (or, under s.200, a person connected to a director) up to an aggregate amount of £10,000 can be given without the need for shareholder approval. This figure rises to £15,000 for credit transactions. There is an additional exception where the credit transaction is in the ordinary course of the company’s business and the terms of the transaction are not more favourable than the terms that the company would have offered to a person unconnected with the company. In this situation, no shareholder approval is required; this is irrespective of the value of the transaction.

Loans / quasi loans by a money-lending company – s.209

A company whose ordinary business includes the making of loans or quasiloans or the giving of guarantees or provision of security, can make any loan or quasi-loan or give a guarantee to provide security to any person; this is provided it does so under normal business terms. There is no permitted maximum amount for this.

Sanctions for non-compliance

Section 213 provides civil remedies in respect of transactions involving all companies. The transaction will be voidable at the instance of the company unless:

1. restitution is no longer possible;
2. the company has been indemnified for the loss or damage resulting from the transaction; or
3. bona fide rights have been acquired by a third party who was not a party to the transaction and such rights would be affected.

Section 214 allows for the arrangement to be affirmed by the shareholders of the company and the holding company (where relevant) by ordinary resolution within a reasonable period. If it is affirmed, the arrangement may no longer be avoided under s.213.

Irrespective of whether the transaction has been avoided, the director (and the person connected to the director, if relevant) and any other director who authorised the transaction must account for any gain made directly or indirectly from the transaction and indemnify the company for any loss or damage resulting from the transaction (s.213(3) and (4)).

Is there any defence/exemption?

If a transaction contravenes ss.200, 201 or 203 and is entered into with a person connected with a director, that director will not be liable if he took all reasonable steps to ensure the company complied with those sections (s. 213(6)).

There is also a defence under s.213(7) for any connected person (if relevant) and any director that authorised the transaction who can show they had no knowledge of the circumstances constituting the contravention.

Wholly owned subsidiaries: approval is not required by the members of any company which is a wholly-owned subsidiary of another company.

What is a substantial property transaction?

Section 190 CA 2006 controls any arrangement whereby:

1. a director or connected person acquires a non-cash asset from a company, or
2. a company acquires a non-cash asset from a director or connected person.

If the non-cash asset is a substantial non-cash asset, then the arrangement must either be approved by an ordinary resolution of the company or be conditional on such approval being obtained. Where an arrangement is conditional on approval being given, the company must not be subject to any liability for failure to obtain the approval (s.190(3)).

Anything to which a director is entitled under his service contract is excluded from being a substantial property transaction (s.190(6)).

Who is a connected person?

Under s.252 a connected person is (broadly speaking):

1. a member of the director’s family (being a spouse, partner, civil partner, child or step child or a parent of the director, as specified in s.253(2));
2. a company with which the director is associated (a company in which the director and persons connected with him together own at least 20% of the share capital);
3. a trustee of a trust in which the director or a person connected to a director have an interest; or
4. a person acting in the capacity of a partner of the director, or of a person connected to a director.

What is a non-cash asset?

Section 1163 defines a non-cash asset as ‘any property or interest in property other than cash’.

What is a ‘substantial’ non-cash asset?

This is explained in s.191.

• An asset worth £5,000 or less is not a substantial asset.
• An asset worth more than £100,000 is a substantial asset.
• An asset worth more than £5,000, but not more than £100,000 is a substantial asset only if it is worth more than 10% of the company’s net asset value. A company’s net asset value is that shown in its most recent statutory accounts.

If the company is only recently incorporated and no accounts have yet been prepared, then the net asset value is taken to be the amount of the company’s called up share capital.

What happens if the directors do not obtain shareholder approval?

The transaction is voidable by the company (s.195) unless:

1. restitution is no longer possible;
2. the company has been indemnified by another person for the loss or damage suffered by it; or
3. bona fide rights have been acquired by a third party who was not a party to the transaction and such rights would be affected by the avoidance of the transaction.

Section 196 allows for the arrangement to be affirmed by the shareholders of the company and the holding company (where relevant) by ordinary resolution within a reasonable period. If it is affirmed, the arrangement may no longer be avoided under s.195.

And

Irrespective of whether the transaction has been avoided, the director (and the person connected to the director, if relevant) and any other director who authorised the arrangement are liable to account to the company for any gain made directly or indirectly out of the transaction, and to indemnify the company for any loss or damage resulting from the transaction (ss.195(3) and 195(4)).

Is there any defence/exemption?

If the transaction is between a company and a person connected with a director, and the director concerned shows that he took all reasonable steps to ensure the company’s compliance with s.190, the director will not be liable under s.195(6).

There is also a defence under s.195(7) for any connected person (if relevant) and any director who authorised the transaction who can show they had no knowledge of the circumstances constituting the contravention.

Wholly owned subsidiaries: Under s.190(4)(b), approval is not required by the members of any company which is a wholly-owned subsidiary of another company.

Companies are owned by shareholders but for the most part are managed by a board of directors.

CA 2006 reserves certain important decisions for shareholder approval, such as changing the company’s name (unless the articles provide otherwise), amending the articles of association, removing directors and so on.

Directors’ authority to manage the company

Outside of this finite number of decisions which are reserved for shareholder approval, the board is usually free under a company’s articles to make decisions for the company on all other matters.

MAs 3 and 5 deal with the power of the directors to manage the company.

The directors can therefore, on behalf of the company, employ individuals and decide what they will be paid, enter into contracts with customers and suppliers, buy and sell company property, raise funds by borrowing from banks and authorise the company’s assets to be used as security. The directors are also responsible for putting together company accounts and for supplying information to auditors. These are just a few examples of the decisions directors are free to make without shareholder approval.

Directors’ accountability

The power delegated to the directors is therefore extremely wide and, if this power were left unchecked and unregulated, the less ethically minded might start using companies as a medium for a variety of corrupt practices. Certain directors may, for example, decide to lend themselves company funds on very favourable terms, award themselves excessively large salaries, acquire company property at an undervalue or award contracts with the company to their family businesses or associated companies on lucrative terms. They may
even give false or misleading statements in the accounts to make the company look more attractive to investors or banks. In order to prevent such practices and to ensure companies are run for the benefit of, amongst others, their shareholders and for the protection of the company’s creditors, directors’ actions and powers are restricted and regulated by statute. The key provisions are included in Part 10 of CA 2006, which includes directors’ general duties and other specific restrictions.

Directors can be, and very often are, made to account for wrongs done through civil and criminal actions taken against them for breaching the Companies Acts. They have also been found guilty of criminal actions and sentenced under other legislation.

The type of offences directors can and have been found guilty of include:

1. the general offence of fraud under the Fraud Act 2006, and/or offences under the Theft Act 1968;
2. insider dealing under the Criminal Justice Act 1993;
3. money laundering under the Proceeds of Crime Act 2002;
4. market abuse, making misleading statements or carrying on regulated activities without authorisation under FSMA 2000;
5. wrongful and fraudulent trading under the Insolvency Act 1986; and
6. bribery offences under the Bribery Act 2010.

Directors’ duties

A director of a company owes duties to the company and is subject to obligations which derive from statute, for example under the CA 2006 and Insolvency Act 1986. In this post, we are considering a director’s general duties under the CA 2006 (specifically ss.170–177). It is important to note that s.170(5) CA 2006 provides that the general duties of directors apply to shadow directors where and to the extent that they are capable of so applying.

Under a company’s articles, directors are generally empowered to exercise all the powers of a company in order to manage the company’s business on a day-to-day basis. Directors must exercise these powers in accordance with their statutory duties.

Statutory duties under CA 2006

The statutory duties under CA 2006 are:

• to act within their powers;
• to promote the success of the company for the benefit of the members as a whole;
• to exercise independent judgment;
• to exercise reasonable care, skill and diligence;
• to avoid conflicts of interest;
• not to accept benefits from third parties; and
• to declare any interest in a proposed transaction.

Under the statutory duty to promote the success of the company, there is a list of non-exhaustive factors to which the directors must have regard. These include ‘the interests of the company’s employees’ and ‘the impact of the company’s operations on the community and the environment’.

Remedies for breach of duty against directors

Directors owe their duties to the company, rather than to individual shareholders. If directors breach their duties, it is obvious and established that the company has a claim against them in law.

Under s.178, the consequences of a breach of directors’ duties are the same as for breach of the corresponding common law or equitable principles. With the exception of the duty to exercise reasonable care, skill and diligence under s.174, the statutory duties are enforceable in the same way as fiduciary duties owed by directors to their company.

The remedy for a breach of the duty of care, skill and diligence is therefore usually damages. Remedies for breaches of other general duties include:

• an injunction;
• setting aside of the transaction, restitution and account of profits;
• restoration of company property held by the director; and/or
• damages.

A breach of duty could also be grounds for the termination of an executive director’s service contract or for disqualification as a director under the Company Directors Disqualification Act 1986.

However, given that the directors are in day to day control of the company and are its directing minds, they may not be inclined to cause the company to bring proceedings against them. For this reason, shareholders are in some cases permitted to institute a derivative action against the directors. This would be an action seeking relief on behalf of the company, in respect of a cause of action vested in the company, but where the claim is instituted by the shareholder(s).

Section 260 gives shareholders an express right to bring a derivative claim where directors have, for example, breached their statutory duties or acted negligently. This applies even if the directors have not benefited personally from their actions or default.

In most cases, if a majority of shareholders support action against the director for breach of duty, a derivative action will not be necessary. This is because the directors will cause the company to bring a claim in any event, knowing that, if they do not do so, the majority of shareholders can remove intransigent directors from the board and appoint more co-operative individuals who are prepared to bring the claim.

A derivative action is likely to be commenced, therefore, where only a minority of shareholders want to take action in a case, for example, where the majority are prepared to accept the director’s behaviour or where the delinquent directors hold sufficient shares to block any moves against them.

Section 260 is wider than under the previous law and some commentators expressed concern that it would lead to a raft of claims by activist shareholders. So far it would seem that the worst predictions of the litigation floodgates opening have not materialised. However, the legislation includes a requirement to obtain permission from the Court to continue such a claim (proving a prima facie case) and provides that claims cannot be brought where a majority of shareholders approved the directors’ conduct in advance or where the shareholders have since ratified that conduct. A further reason why these fears do not seem to have been well founded is that damages awards under s.260 CA 2006 are made for the benefit of the company and not for the benefit of the shareholder(s) who brings the claim.

Former common law duties of directors

Before CA 2006 was introduced, directors’ duties derived, for the most part, from common law and equity. These sources of law are still valid to the extent not expressly provided for in CA 2006. Indeed, CA 2006 provides that the statutory duties shall be interpreted and applied in the same way as the common law duties. The duties under the former regime were as follows:

• common law duty of skill and care;
• fiduciary duties / duties in equity, e.g.:
  • duty to act bona fide in the interests of the company;
  • duty to act within powers and for proper purposes and not for any collateral purpose (e.g. not for personal gain or with a conflicting interest);
  • duty not to misapply company property (e.g. making a prohibited loan to a director);
  • duty to account for a secret profit (i.e. a profit made by virtue of one’s office, perhaps involving a contract between the director and a third party, which is not approved by the company);
  • duty to avoid conflicting interests and duties; and
  • duty not to fetter their own discretion.

Issuing debt securities

I previously covered the restrictions on the issue of shares under s.755 CA 2006 and the Financial Services and Markets Act 2000 (‘FSMA’).

These restrictions also apply to the issue of debt securities. Therefore, private companies can only issue bonds to targeted investors and not to the public indiscriminately. To do otherwise risks contravention of s.755 CA 2006. Similarly, if a private company makes an ‘offer to the public’ of bonds within the meaning of s.85 FSMA and cannot take advantage of an exemption, it will be required to produce a prospectus.

However, the other formalities of share issues, such as authority to allot and disapplication of pre-emption rights, do not apply to debt securities (unless they are convertible into shares).

Giving advice on financing – FSMA

If you are giving your client advice in relation to their financing requirements you should bear in mind the rules governing such advice under FSMA (which will be considered in detail in the Professional Conduct and Regulation module). Shares and bonds are regulated (‘specified’) investments and ‘advising’ is a specified activity if the advice concerns the merits of the investments e.g. making a recommendation relating to a particular bond or share, rather than simple abstract advice as to the difference between bonds and shares.