To: The Board of Directors, Tech Company From: Legal Counsel Date: 24 May 2024 Subject: Overview of Directors’ Duties and Specific Guidance for New Directors
This paper provides an overview of the general duties of company directors under the law of England and Wales. It is intended to inform all board members, and particularly to orient new members, of their legal responsibilities. The duties are primarily codified in the Companies Act 2006 (CA 2006) and are owed to the company itself.
1. The General Duties of Directors
The CA 2006 sets out seven general duties. The most significant are described below.
a) Duty to Act Within Powers (Section 171 CA 2006) A director must act in accordance with the company’s constitution (its articles of association) and only exercise their powers for the purposes for which they are conferred. This is known as the ‘proper purpose’ doctrine.
- Application: For example, the power to issue shares is for raising capital, not for diluting the voting power of a particular shareholder to block a takeover. In Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821, directors were found to have breached this duty by issuing shares to frustrate a takeover bid, which the court held was an improper purpose.
b) Duty to Promote the Success of the Company (Section 172 CA 2006) This is the central duty. A director must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. The Act lists factors directors should consider, including the long-term consequences of decisions, the interests of employees, and the company's impact on the community.
- Application: This requires a director to balance competing interests. For instance, a decision to invest in research and development may reduce short-term profits and dividends, but it could be justified as promoting the company's long-term success and sustainability. The test is subjective; the court will not easily challenge a business decision made in good faith (Re Smith & Fawcett Ltd [1942] Ch 304).
c) Duty to Exercise Independent Judgment (Section 173 CA 2006) Directors must not delegate their decision-making powers or be improperly influenced by others. While they can and should take advice, they must exercise their own independent judgment in making board decisions.
- Application: A director cannot simply act as a nominee for a shareholder or another party, voting as instructed without applying their own mind to the issues.
d) Duty to Exercise Reasonable Care, Skill and Diligence (Section 174 CA 2006) This duty sets a minimum standard of competence. The standard has two parts: an objective test (the care, skill, and diligence expected of a reasonably diligent person performing the director’s functions) and a subjective test (the care, skill, and diligence actually possessed by that particular director). A director with special expertise, like an accountant, is held to a higher standard.
- Application: In Re D’Jan of London Ltd [1994] 1 BCLC 561, a director was found to have breached this duty by signing an insurance proposal form without reading it, resulting in the policy being void when the company needed it. This shows that basic diligence, such as reading key documents, is required.
e) Duty to Avoid Conflicts of Interest (Section 175 CA 2006) A director must avoid any situation in which they have, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. This duty is very strict. It includes conflicts of loyalty and profiting from corporate property, information, or opportunities.
- Application: In Cook v Deeks [1916] 1 AC 554, directors diverted a railway construction contract away from their company to a new company they had formed. This was a clear breach of their duty, as they had taken a corporate opportunity for themselves.
2. Specific Guidance for New Directors
The following section provides tailored advice for our new board members regarding potential issues arising from their specific circumstances.
a) Chris (Spouse of the Largest Shareholder)
- Potential Issue: A conflict may arise between your duty to the company and any perceived loyalty to your spouse, the largest shareholder. For example, your spouse might desire short-term dividend maximisation, whereas the company's long-term success (as required by s.172) might demand reinvestment of profits.
- Key Duties: The duty to promote the success of the company for the benefit of all members (s.172) and the duty to exercise independent judgment (s.173).
- Direction: You must ensure your decisions are made in the best interests of the company as a separate entity and are not dictated by the wishes of your spouse. You must exercise your own judgment on all matters, even if it conflicts with the views of the largest shareholder.
b) Jesse (Consultant with Existing Contracts)
- Potential Issue: Your role as a consultant for companies that have contracts with Tech Company places you in a direct conflict of interest.
- Key Duties: The duty to avoid conflicts of interest (s.175) and the duty to declare an interest in a proposed transaction or arrangement (s.177).
- Direction: The duty under s.175 is strict. You must immediately disclose the full extent of your existing consultancy relationships to the board. Your situation may require authorisation from the non-conflicted directors under s.175(4)(b) of the CA 2006, if the company’s articles permit. For any future transactions between Tech Company and your other clients, you must formally declare your interest under s.177 and should recuse yourself from any discussion or vote on the matter to avoid breaching your duties.
c) Lynn (No Prior Industry or Board Experience)
- Potential Issue: Your lack of experience in the technology industry or corporate management could expose you to a risk of breaching the duty of care, skill, and diligence.
- Key Duty: The duty to exercise reasonable care, skill, and diligence (s.174).
- Direction: While the law does not expect you to possess technical expertise you do not have (the subjective part of the test), it does require you to meet an objective standard. You must actively engage with your role. This includes preparing for board meetings by reading all papers, making diligent inquiries about the business, and asking questions when you do not understand something. You cannot be a passive or "sleeping" director. You are expected to acquire a general understanding of the company's business. Relying on your skills from politics in areas like governance and stakeholder relations will be valuable, but this does not replace the fundamental duty to be diligent about the company’s affairs as a whole.
References
- Cook v Deeks [1916] 1 AC 554
- Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821
- Re D’Jan of London Ltd [1994] 1 BCLC 561
- Re Smith & Fawcett Ltd [1942] Ch 304
- Companies Act 2006. (2006) <a href="https://www.legislation.gov.uk/ukpga/2006/46/contents">c.46</a>. UK Public General Acts.
