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