Directors can be the target of great scrutiny, and the requirement to demonstrate transparency means that they should ensure compliance with their duties. Below is a brief guide to the fiduciary duties and responsibilities of a company director.
The 7 Fiduciary Duties
Historically directors’ duties were derived from a series of legal cases which identified which interests the directors must serve; the need for independence, the need to act objectively, the need to remain loyal to the original purpose of the company, and the need to ensure good company management. Collectively these are known as “fiduciary duties”.
The word “fiduciary” is defined by common law as an individual or entity that acts for another in a particular matter, in circumstances which give rise to a relationship of trust and confidence. This reflects the power that shareholders given by leaving the companies day to day control to directors, and the duty directors accept to manage the company (or companies) over which they are appointed, solely in the interest of shareholders.
These duties were codified by the Companies Act 2006, which set out the 7 fiduciary duties of directors today.
1. A director must only act within the powers as granted by the Company’s constitution.
This first duty is that a director must act within their powers under the company’s constitution. The company’s constitution includes its articles of association, resolutions and agreements of a constitutional nature (for example, shareholder or joint venture agreements). Companies may have used the model articles available for private or public companies or created their own tailored articles of association.
It is important for directors to be familiar with these constitutional documents, as these will outline and detail any limits to a director’s decision-making powers. Directors must act in accordance with this, and only exercise their powers for the purposes for which they were given. If these powers are exceeded, then decisions may be reversed, transactions may be voided, and may leave the directors involved liable to pay for any financial losses to the company.
2. A director has a prime duty to promote the Company’s success.
This is one of the more well-known duties of a director. “Success” will generally be regarded as a long-term increase in value, but it is up to each director to determine in good faith, whether it is appropriate for the company to take a particular course of action, before making a decision.
When considering what is most likely to promote the success of the company, legislation states that a director must have regard to many factors including the likely consequences of any decision in the long term, including those on stakeholders, employees, suppliers, customers and communities. They must also keep in mind any impact on the environment, the reputation of the company and the need to act fairly between the shareholders (including minority shareholders).
This duty was taken further for companies with more than 250 employees, as a new reporting requirement in 2019 meaning that they now have to detail how they have fulfilled this duty in their annual report.
3. A director must exercise independent judgment.
Directors must make their own decisions and exercise their own, independent judgement and should not simply implement commands from shareholders as if they are orders. This means that they should not rely on the knowledge of other members of the company or experts, they must come to their own judgement through forming their own view.
This is particularly important when new directors come onto the board, as they have to familiarise themselves with the company’s activities before taking part in any decision making. It is important to note that this does not prevent them from acting in accordance with the company’s constitution or an agreement which the company has entered into.
4. A director must exercise reasonable care, skill and diligence in their role.
Directors must be reasonably diligent and exercise the same care, skill and diligence that would be exercised by a person with the general knowledge, skill and experience that was carrying out the same functions as that director in relation to the company.
A director must also exercise their role with any specific professional training or skills specific available to them, for example if they are a lawyer or accountant they will be held to the standard of knowledge of a reasonable lawyer or accountant in that position. A director’s actual understanding, and abilities may not be enough if more could reasonably be expected of someone in their position.
5. Conflicts of interests and benefits
The remaining three duties relate to directors and any conflicts of interest.
A director must avoid conflicts between their role and their personal interests, and must avoid situations in which they have, or could have, an interest that conflicts, or may conflict, with the interests of the company. This applies in particular to the exploitation of any opportunity, information or property, regardless of whether the company could take advantage of it.
A director cannot accept benefits from third parties which arise from their role. Directors must not accept a benefit from a third party given because they do (or do not do) something as a director. They must always declare to other directors their personal interest in any transaction or arrangement which the Company proposes to enter into.
If a director is in any way, directly or indirectly interested in a transaction or arrangement with the company, they must declare the nature and extent of that interest to the other directors. In the case of a proposed transaction they must do this before the transaction is entered into. In the case of an existing transaction they must do this as soon as reasonably practicable.
This duty is not infringed if the director’s interest in the transaction cannot reasonably be regarded as likely to give rise to a conflict of interest; or an interest has not been declared because the director was unaware that they have the interest or the other directors are already (or ought reasonably to be) aware of it.
Other Duties
The Companies Act 2006 sets out other duties and obligations for directors, including:
- A personal duty on directors in the preparation, content, circulation and filing of the company’s annual reports and accounts.
- Restrictions and conditions placed on transactions between a director and their company.
- Obligations relating to loans made by the company to a director.
What happens if a director breaches their duties?
Companies can indemnify their directors in respect of certain proceedings brought against them by third parties, but they aren’t obliged to. An indemnity can potentially cover both the cost of the claim itself and the costs involved in defending it, but unless the defence is successful, will never cover defence of, or fines imposed in criminal proceedings and penalties imposed by regulatory bodies.
It is common for a company to take out directors’ and officers’ (D&O) insurance for its directors. Policy cover and terms typically deal with directors’ liabilities arising from claims of negligence, breach of duty or other default. Unsurprisingly standard policy exclusions usually cover fraud, dishonesty and criminal behaviour.
To ensure confidence is maintained in the UK economy and the risk of fraud is mitigated, directors are subject to many legal requirements, a lot of these requirements exist within the Companies Act 2006, but a number of these are found elsewhere (see our blog post on non-fiduciary duties). Proelium Law is here to help you. Call or email us if you have an enquiry, we will call you back at a time convenient for you.
Alan Taylor is a business partner with Proelium Law. Formerly a senior officer and member of the Army’s general staff, Alan began his career transition to law in 2015. Following the successful completion of a graduate diploma in Law at Oxford Brookes University and the legal practise course at the University of the West of England, Alan joined Proelium Law in January 2018 becoming a partner in July.
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