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The legal position of company directors

The directors of a company are the people given the responsibility to run it on a day to day basis. A private company must have at least one director (there is no maximum number) and essentially the directors are appointed by, and must report to the shareholders, who own the company. Of course, in many private companies, the directors and the shareholders are the same people, but they need not be.

Board meetings

If there are two or more directors the powers they have are given to them collectively, meeting as a board. Meetings can be held wherever and whenever the directors like, and can be held by telephone, etc. Any decision the directors make can be concluded in writing signed by them all. The directors must keep minutes of their meetings and decisions.

Individual directors

If the company only has one director, s/he can do anything a board of directors can do, but should still make a record of important decisions. If there are two or more directors, the board collectively should authorise directors to undertake particular matters, or authorise the individual directors to act generally for the company, and this should be recorded in minutes of the board meeting.

Limits on directors’ powers

There are some things directors cannot do because under the Companies Acts a resolution of the shareholders is needed. These include:

  • changing the company’s name;
  • changing its articles;
  • issuing more shares;
  • some cases where directors have a personal interest in a transaction with the company;
  • winding up the company.

The directors should take legal advice on any of these matters.

Legal responsibilities to the company

Directors are subject to new legal duties under the Companies Act 2006 and they must be careful to ensure these are always complied with. The main provisions came into effect on 1st October 2008 and they apply to all directors’ activities from that date. There are seven general duties as follows:

1. To act within the company’s powers and those of the directors

This may require consideration of the company’s memorandum and articles, particularly if the company is long-established or has non-standard documents. The company’s objects and powers are set out in its memorandum and articles. If the company is a ‘general commercial company’ it will be able to carry on any trade or business and there should not be a problem. If the objects are not expressed in this way (as can be the case with older companies) care must be taken to ensure that any proposed act is covered by the wording. There may also be provisions in the company’s articles that affect the powers of the directors to undertake certain transactions, and sometimes resolutions may have been passed restricting the directors’ powers. If there is any doubt about these matters, legal advice should be sought. In some cases, it may be desirable to amend the memorandum and articles.

2. To promote the success of company

This seems obvious, but there can be circumstances where an action is taken by a company for some other purpose, for example to benefit a particular director or another company. If there is any potential doubt about this, the issue should be considered carefully and legal advice sought. The Act goes on to say that when seeking to promote the success of the company the directors must specifically consider not just the prospect of immediate profit, but also:

  • the likely consequences of any decision in the long term;
  • the interests of the company’s employees;
  • the need to foster the company´s business relationships with suppliers, customers and others;
  • the impact of the company´s operations on the community and the environment;
  • the desirability of the company maintaining a reputation for high standards of business conduct; and
  • the need to act fairly as between members of the company.

These matters should all be considered, if relevant, but there is no requirement to give any of them any particular weight. For example, a proposed course of action may affect the interests of the employees. If so, the effect on the employees should be evaluated and considered, but the company is not precluded from going ahead if the proposed course is, overall, intended to promote the success of the company.

Consideration of all these matters is a legal duty for company directors and it is important that the minutes of board meetings should record the fact that the matters listed above have been considered, where they are relevant. This may also require the minutes to include a copy of any report or other evidence used by the board in making their decision.

3. To exercise independent judgement

This is really an issue for individual directors who must ensure that they personally consider the decisions that have to be made and are satisfied that they meet the requirements set out above.

4. To avoid conflicts of interest

A conflict can arise where a director has a personal interest in a transaction (which is considered in more detail below) or for other reasons, such as the director’s connection with another company involved in a proposed transaction. If there is any actual or potential conflict the director should make sure that the other directors are informed and the situation is carefully considered. If there is any significant conflict of interest, legal advice should be sought.

5. Not to accept benefits from third parties

Directors must not personally accept any benefit of significant value from a third party that may affect a decision they have to make on the company’s behalf. Any potential issue of this kind should be discussed by the board and legal advice sought.

6. To exercise reasonable care, skill and diligence

This duty applies to the board collectively and to individual directors. Reasonable care means the care, skill and diligence that can be expected of a reasonably diligent person who has the knowledge, skill and experience that the director actually has and which may reasonably be expected of someone in his position.

7. To declare any personal interest in transactions or arrangements with the company

It is very important that any director who has a direct or indirect interest in any proposed or actual transaction with the company should declare that interest to the other directors at the earliest opportunity. Such a declaration should be recorded in the board minutes. If the situation changes, so that the declaration of interest becomes inaccurate, the board must be informed.

In many cases, the declaration is not enough. There are special procedures to be followed where a director has a personal interest in particular types of transactions with the company. These cannot all be listed here, and this is a complicated area of law, but legal advice should be sought in any such situation, and particularly in the following circumstances:

  • Assets worth more than £5,000 are to be sold to, or bought from, a director or anyone   connected with a director (including any other company in which the director has an interest);
  • The company is to lend a director (or a person or company connected with a director) any  substantial sum, and certainly if it is more than £10,000;
  • A director is to be given a service contract;
  • A director is to be given any gratuitous payment;
  • Any shares are to be allotted.

In many respects, these duties reflect established good practice. The duties under the new Act are in some cases stricter, however, and procedures for some particular transactions have changed. Note, in particular, that the new rules apply to all companies, large and small, and even where there is only one director. Such very small companies may not have systems in place for the formal recording of directors’ decisions. Even if it seems rather artificial and bureaucratic, following the rules and making a record that this has been done is strongly advised. If in doubt on any of these matters, please seek legal advice.

Responsibilities to Companies House

Every company director has a personal responsibility to deliver statutory documents to Companies House as and when required by the Companies Acts. These include the company’s annual accounts, an annual return (a sort of annual re-registration form). In practice, the company’s accountants will usually attend to these, but the legal responsibility rests on the directors. There are heavy penalties for the late filing of accounts.

Directors are also responsible for seeing that Companies House is sent details of any changes, such as a change of directors or the registered office address, on the correct form. Most of these changes can be done on-line using the Companies House webfiling system.

Legal position if the company becomes insolvent

Basically, the directors of a limited company do not incur personal liability for the company’s debts. The liabilities are those of the company and only the company’s assets can be taken to pay those debts. In extreme cases, where the company has been allowed to run up debts which the directors know, when the debts are incurred, cannot be paid, the directors may be made liable for wrongful or fraudulent trading. Note that these apply only when the director’s conduct is seriously at fault.

Wrongful trading

This is where a company has gone into insolvent liquidation and a director of the company knew or ought to have known this would happen and failed to take all reasonable steps to minimise the loss to the creditors. Continuing to trade at a loss when the company cannot pay its debts, so that the deficit to creditors is increased, rather than stopping business or putting the company into liquidation, is clear failure to take reasonable steps to minimise the creditors’ loss. If wrongful trading is established the court may make the directors responsible personally liable for the company’s debts. In some cases the directors is made subject to directors disqualification order, so they cannot be a director of another company for a period of time.

Fraudulent trading

Fraudulent trading is where any business of the company has been carried on with intent to defraud creditors or for any fraudulent purpose. This includes where debts have been incurred by a company knowing that they cannot be paid. Note, however, that this can only happen where the director has acted fraudulently, deliberately incurring debts knowing they will not be paid. Fraudulent trading is a criminal offence, allowing the court to impose a fine or even, in serious cases, imprisonment, as well as the liabilities that apply to wrongful trading.

For further information, please contact Jonathan Waters.


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