Why directors need to consider their duties, often

Thursday 20th June, 2024

Companies remain a popular vehicle through which individuals, entrepreneurs and investors alike conduct their business. According to the UK Government,[1] between 2010 and 2023 the total number of UK companies increased by 782,000 (62%) with the overall business population increasing by 1.1 million in the same period, while in contrast the number of ordinary partnerships fell by 90,000 (20%). At the start of 2023 there were estimated to be 5.6 million UK private sector businesses, with 2.1 million actively trading companies. 

Individuals may hold a number of directorships (and former directorships), especially within a single company structure, and an increasing focus on corporate governance and ESG (environmental, social and governance) considerations combined with ever-complex transaction structures requires directors to ensure they comply with their duties, especially the duties relating to conflicts of interest, which should remain at the forefront of their mind in any proposed transaction. 

In this note we provide a brief overview of the duties of a director under the Companies Act 2006 (the “Act”) in relation to conflicts of interest and provide some practical considerations that a director should be alert to, in relation to conflicts, to ensure proper corporate governance of a company. 

Who is a director 

The Act does not expressly define the term director. Instead, section 250 of the Act provides that the term “director” includes any person occupying the position of director, by whatever name they are called. 

This is important as there may be various types of directors commonly differentiated for the purposes of a company, including executive directors, non-executive directors, a chairperson, alternate directors and nominee (or investor) directors. However, the provisions of the Act that apply to directors do so regardless of a person’s title or whether they have been formally appointed to the board. This may be in addition to other responsibilities and liabilities an individual takes on board, for example an executive director may have rights and duties as an employee under their employment contract which are separate from those arising from their position as a director of a company. 

The Act also makes provisions for shadow directors, which section 251 of the Act defines as someone “in accordance with whose directions or instructions the directors of the company are accustomed to act.” Many of the statutory responsibilities and liabilities (including general duties) that apply to directors apply equally to shadow directors. 

Directors’ duties and conflicts of interest 

Directors’ duties arise both under statute (notably the Act) and under common law. 

Directors’ general duties under the Act are set out in sections 171 to 177 of the Act and as stipulated in section 170, they are owed by a director of a company to the company. The general statutory duties are: 

          to act within powers (section 171); 

          to promote the success of the company (section 172); 

          to exercise independent judgementjudgment (section 173); 

          to exercise reasonable care, skill and diligence (section 174); 

          to avoid conflicts of interest (section 175); 

          not to accept benefits from third parties (section 176); and 

          to declare an interest in proposed transactions or arrangements (section 177). 

Other duties and requirements of directors have been codified elsewhere in the Act or are set out in the common law, all of which are applicable to directors. This includes the common law duties of confidence in respect of confidential information and a duty in certain circumstances to consider or act in the interests of a creditor. The scope and impact of the creditor duties are not considered in this overview. 

There are a number of additional considerations which directors should bear in mind when considering their duties, obligations and responsibilities, including to whom the duties are owed, where the duty arises from (be it common law, statute, the body of fiduciary law), the articles of association and any shareholders’ agreements of a company, and the duration for which the duties are owed. There exists an extensive body of case law, commentary and guidance in relation to these (and other) matters of directors’ duties. 

Broadly speaking, there are three general duties under the Act that deal with directors’ conflicts of interest, namely to avoid conflicts of interest (section 175), to not accept benefits from third parties (section 176) and to declare interest in proposed transactions or arrangements (section 177). The following sets out a brief overview of such duties. 

Directors’ duty to avoid a conflict of interest 

The duty to avoid a conflict of interest arises under section 175(1) of the Act, which provides that: 

“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 duty appears particularly likely to arise where a person holds multiple directorships across different companies, whether as part of a group structure or investment alongside other parties. 

As drafted, this is clearly a wide duty which covers all actual or potential conflicts between the interests of the director (directly or indirectly, which potentially expands the duty to include interests of persons connected with the director) and interests of the company. 

This duty is not infringed if the situation cannot be reasonably regarded as likely to give rise to a conflict of interest or if the matter has been authorised by the directors. However, there are also certain transactions that the Act expressly provides require the approval of members, including directors’ long-term service contracts, substantial property transactions and loans to directors, which may otherwise also be a potential breach of the duty to avoid a conflict of interest and regardless of whether or not authorised by the directors. 

Authorisation may be given by the directors of a private company where nothing in the company’s constitution would invalidate 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. 

Such authorisation is effective only if given at a quorate meeting (without counting the director in question or any other interested director) and where the matter was agreed to without their voting or would have been agreed to if their votes had not been counted; and where disclosure is, in the circumstances, sufficient. Certain case law and commentary suggests that what amounts to authorisation in a given case will also likely depend on the facts. 

As noted below, this duty continues, in certain circumstances, even after a directorship ceases. 

Directors’ duty to not accept benefits from third parties 

Section 176(1) of the Act, provides that “a director of a company must not accept a benefit from a third party conferred by reason of – 

(a) his being a director, or 

(b) his doing (or not doing) anything as director.” 

A “third party” means a person other than the company, an associated body corporate or a third person acting on behalf of the company or an associated body corporate (section 176(2)). While “benefit” is not defined in the Act, commentary suggests that it would take on its ordinary dictionary meaning. 

Benefits received by a director from a person by whom his services (as a director or otherwise) are provided to the company are not regarded as conferred by a third party (section 176(4)), and this duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest (section 176(5)). 

Section 176 does not provide the directors with authority to approve a director accepting benefits from third parties, although arguably the members may approve a director accepting a benefit in advance and the articles of association of a company may contain provisions for dealing with conflicts of interest. This may be helpful where directors participate in business development activities for the company. 

As noted below, this duty also continues, in certain circumstances, even after a directorship ceases. 

Directors’ duty to declare interest in proposed transaction or arrangement with the company 

In accordance with section 177(1) of the Act: 

“If a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors.” 

The declaration may be made at a meeting of the directors or by notice to the directors in accordance with the Act. 

Importantly, directors must make declarations prior to the company entering into the transaction or arrangement and, if a declaration of interest under section 177 of the Act proves to be, or becomes, inaccurate or incomplete, the director must make a further declaration. 

Section 177 of the Act does not require a director to make a declaration of an interest of which the director is not aware or where the director is not aware of the transaction or arrangement in question. However, section 177(5) stipulates that for this purpose a director is treated as being aware of matters of which he ought reasonably to be aware. 

Further, a director need not declare an interest if it cannot reasonably be regarded as likely to give rise to a conflict of interest (section 177(6)(a)), if, or to the extent that, the other directors are already aware of it (and for this purpose the other directors are treated as aware of anything of which they ought reasonably to be aware) (section 177(6)(b)) or if or to the extent that it concerns terms of his service contract that have been or are to be considered by a meeting of the directors or by a committee of the directors appointed for the purpose under the company’s constitution (section 177(6)(c)). 

One situation where this duty may arise is where a company is proposing to buy an asset from a director. The directors of the company must comply with their duties and obligations, including to promote the success of the company (and, by extension, pay as little as possible for that asset) while the individual director from whom the company proposed to acquire the asset will, in their personal capacity, likely want to achieve a higher price. In that situation, a conflict of interests for that director would likely have arisen. 

It is also worth noting for completeness that section 182 of the Act requires a director of a company who is in any way, directly or indirectly, interested in a transaction or arrangement that has been entered into by the company, to declare the nature and extent of the interest to the other directors in accordance with that section. The application of section 182 is expressly stated to not apply if or to the extent that the interest has been declared under section 177 (i.e. the duty to declare interest in proposed, as opposed to existing, transaction or arrangement). 

Application of certain duties after a director ceases to be a director 

By virtue of their role as a director, a person will have access to confidential and commercially sensitive information. The very nature of the role necessitates that a person must observe their duties for the duration of their directorship. Additionally, certain duties must be observed notwithstanding a person’s resignation or removal as director of a company with regard to the information they held, or actions taken (or not taken), while they were a director, relevantly including duties’ relating to directors’ interests. 

To that end, section 170(2) of the Act provides that: 

a person who ceases to be a director continues to be subject: 

        (a) to the duty in section 175 (duty to avoid conflicts of interest) as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was a director, and 

(b) to the duty in section 176 (duty not to accept benefits from third parties) as regards things done or omitted by him before he ceased to be a director. 

To that extent those duties apply to a former director as to a director, subject to any necessary adaptations.” 

Certain case law and commentary suggests that section 170(2)(a) implies that a claim for breach of the section 175 duty may be founded entirely on acts that take place after a person ceases to hold office. Accordingly, individuals must remain vigilant as to their ongoing exposure in relation to and duties owed to any company they were previously a director of with regards to their acts both during and after their directorship. 

Potential consequences of a breach of duty and directors’ liability 

There are a number of potential consequences of a breach of duty under the general duties, which depending on the circumstances may be relevant in relation to a director’s breach of the duties relating to conflicts of interests. Section 178(1) of the Act relevantly provides that: 

“(1) The consequences of breach (or threatened breach) of sections 171 to 177 are the same as would apply if the corresponding common law rule or equitable principle applied. 

(2) The duties in those sections (with the exception of section 174 (duty to exercise reasonable care, skill and diligence)) are, accordingly, enforceable in the same way as any other fiduciary duty owed to a company by its directors.” 

As the duties are owed by the directors to the company, it is generally the company that enforces them. However, in certain circumstances shareholders may be able to bring a claim on behalf of the company (e.g. a derivative action). 

Ultimately, the particular circumstances and the details of any alleged breach would determine the potential consequences, although these could include: 

          a court order to pay money to the company following a claim for damages for compensation; 

          setting aside a transaction; 

          a claim for restitution or account of profits; 

          restoration of company property held by the director; 

          termination of a director’s service contract; 

          the grant of an injunction to restraint breach of fiduciary duty; 

          disciplinary proceedings brought by the relevant applicable regulator; 

          in some cases, criminal proceedings; and 

          disqualification. 

It is worth mentioning a few further factors relevant to directors’ liability: 

          Insurance: a company is not able to exempt a director from any liability attaching to him in connection with any negligence, default, breach of duty or breach of trust in relation to the company (section 232), and generally indemnities (including provided in the company’s articles or in any contract with the company or otherwise) from such liability are void. However, that section does not stop a company from purchasing and maintaining for directors of the company insurance against any such liability (section 232), which would appear a prudent factor including for former directors in respect of ongoing duties (see above); 

          Member approval and ratification: the approval of members, including where it is expressly required to be given by the Act, may assist a director in reducing or avoiding liability for a breach of a duty in certain circumstances, although this is not always the case and depends on the circumstances of the potential (or actual) breach. Additionally, section 239 of the Act provides that conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company must be made (i.e. ratified) by resolution of the members of the company, disregarding the votes in favour by the director or any connected person; 

          Statutory relief: section 1157 of the Act provides that if in proceedings for negligence, default, breach of duty or breach of trust are brought against the directors (among others), it appears to the court that they acted honestly and reasonably and that having regard to all the circumstances of the case, they ought fairly to be excused, the court may relieve them (either wholly or in part) from their liability on such terms as it thinks fit. A director may also apply to the court for relief where they have reason to expect that a claim may be made against them (section 1157(2)). 

Conflicts of interest: practical considerations 

A company and director should consider the following, in particular, in relation to any potential conflicts of interest of a director: 

          where a transaction arises, whether intra-group or not, has the director carefully considered their circumstances (including any other directorships or otherwise, whether current or former) and whether they have, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company; 

          has the director disclosed any potential interest in the transaction in accordance with the Act; 

          do the articles of association of the Company allow the other directors to authorise the conflicted director to continue to participate and vote on relevant matters and, if so, has that authorisation been given; 

          have the members of the company authorised the conflict of interest; 

          is there any benefit being received by the director by virtue of his being a director or his doing or not doing anything as director; 

          does the company have any policies in place in relation to conflicts of interest that the director must adhere to; 

          has the director considered their other statutory and common law duties, and other obligations as a director, as well; and 

          has the director undertaken the relevant mitigatory steps to avoid any potential consequences of a breach of duty and any personal liability. 

Conclusion 

Where a director is or may be conflicted with a proposed transaction, it is not clear that simply omitting to be part of the process, by a director absenting themselves from the necessary decision making processes in relation to such proposed transaction, would be an effective discharge of their duties. 

It would instead appear prudent for that director to make a full and proposed disclosure to the other directors of a company as soon as possible, comply with the articles of association of the company, seek director authorisation (and member approval if required), not accept any benefits by virtue of their role or actions and observe any other obligations and requirements to which they are subject. 

As more companies are incorporated and more people become directors, prudent directors will need to ensure they have a thorough understandingremain alive to of thean increasingly complex legal governance framework with sometimes competing duties and obligations. 

This article has provided a snapshot of the duty of a director under the Act to avoid conflicts of interest and provided some practical considerations for company directors to ensure proper corporate governance measures are enacted and followed in relation to their interests. 

 

 

[1] The UK Government’s Business population estimates for the UK and regions 2023: statistical release https://www.gov.uk/government/statistics/business-population-estimates-2023/business-population-estimates-for-the-uk-and-regions-2023-statistical-release#:~:text=At%20the%20start%20of%202023%3A,aside%20from%20the%20owner(s) (last accessed 27 March 2024).