What Fiduciary Duties do Directors have in the UK?August 2, 2019
In 1993, a vicious fire ripped through the premises of D'Jan of London Ltd, destroying approximately £174,000 worth of stock. (Roughly £350,000 in 2019.) While the fire was devastating, the company’s director, Mr D’Jan, believed that his insurance would cover the losses. He was wrong. In fact, the fire was about to cost Mr D’Jan significantly more.
Several months earlier, Mr D’Jan had signed an insurance policy without reading it. The form claimed he had never been the director of a company that went into liquidation—but he had. After the fire, his insurer discovered the mistake and refused to pay out on his policy.
When D'Jan of London Ltd went into liquidation, the liquidator sued Mr D’Jan to recoup the lost funds. At the end of the trial, the judge concluded:
“[In] failing even to read the form, Mr D'Jan was negligent… I accept that in real life, [not reading forms] often happens. But that does not mean that it is not negligent. People often take risks in circumstances in which it was not necessary or reasonable to do so. If the risk materialises, they may have to pay a penalty.”
The judge ruled that Mr D’Jan was liable for the lost funds owed to the company’s creditors—some £500,000 in total. (Roughly £1,000,000 in 2019.)
The judge’s verdict set an important precedent: directors have a duty to act with care and skill. That duty—to exercise reasonable care, skill and diligence—was later codified in the Companies Act 2006.
Nowadays, all limited company directors are expected to perform seven key duties detailed in the Companies Act. They are:
- Follow the company’s constitution;
- Promote the success of the company;
- Use independent judgement;
- Exercise reasonable care, skill and diligence;
- Avoid conflicts of interest;
- Decline third-party benefits; and
- Disclose interests in a transaction.
In this article, we’ll look at each of these seven duties in more detail. Then we’ll discuss how a director’s duties change during insolvency.
Director Duties under the Companies Act 2006
As I mentioned earlier, the Companies Act 2006 sets out seven specific duties that all company directors must perform.
While there are several additional duties scattered throughout the Act (for example, directors must deliver accounts to Companies House), I'm just going to deal with the seven main duties.
#1 Follow the company’s constitution
The first duty is sometimes worded as 'acting within the directors’ powers' but it means the same thing. As a director, you must follow your company’s constitution and articles of association.
A company’s constitution and articles of association set out rules for running the company, covering things like how shares are created or transferred, how loans are issued, how directors are appointed and how the company responds to conflicts of interest.
Generally speaking, a company’s articles will specify that its directors are responsible for the management of the company’s business and may exercise all the powers of the company. However, a company may specify whatever restrictions it pleases in its articles as long as it doesn't contradict any legislation.
#2 Promote the success of the company
The second rule states that directors must act in the way they believe would promote the success of the company. For example, if a director wants to give herself a massive pay rise when the company is struggling for cash, she must ask herself whether that action will promote the success of the company. In this case, it probably won’t so she ought not to do it.
Since early 2019, companies with more than 250 staff must explain how they have fulfilled this specific duty in their annual report.
#3 Independent judgement
According to the Act, directors ought to represent the best interests of the company as a whole and not specific individuals. Therefore, you're not allowed to permit other people to control your power as a director.
That said, you are allowed to solicit and accept advice—but you must use your own judgement to make the final decision.
#4 Exercise reasonable care, skill and diligence
This duty simply states that directors must perform to the best of their ability. In the introduction, we saw how Mr D’Jan failed this duty by not reading an important insurance contract.
Generally speaking, the more experienced a director is, the more is expected of them, especially if they have specialised skills like being a qualified accountant.
#5 Avoid conflicts of interest
As we just discussed, directors are required to act in the best interest of their company. So you must avoid situations where your loyalties are split.
For example, if you are selling off an asset to a family member, you might feel inclined to offer them a discount—but this probably isn’t in the best interest of the company.
Whenever it is not possible to avoid a conflict of interest, you must usually disclose this to fellow directors and company members.
#6 Third-party benefits
The penultimate duty says that you must not accept benefits from a third party offer because you are a director. This is usually because it can create a conflict of interest.
However, most companies will allow you to accept benefits—for example, corporate hospitality—if it is clear there is no conflict of interest.
#7 Interests in a transaction
The final duty is very similar to the fifth duty—avoiding conflicts of interest—but specifically refers to transactions. Where you or your family members will benefit from a company transaction, you must disclose this to other directors and company members.
For example, if you plan to award a contract to a company owned by one of your siblings, parents or children, you must disclose this to your fellow directors and members.
What are a Director’s Responsibilities during Insolvency?
Up until now, we’ve dealt with directors in charge of healthy and profitable companies. But what happens when your company experiences financial difficulties? Do your duties change?
The short answer is yes.
- When a company is solvent, your duty as a director is to the company and its shareholders.
- When a company becomes insolvent (or when you believe it will become insolvent), your duty switches to protecting the position of the company’s creditors and suppliers.
It is your duty, as director, to not blindly carry on trading but instead face up to the financial hardship.
Navigating insolvency is difficult for even the most experienced directors and, if not handled correctly, can leave you personally liable for company debts.
If your company is insolvent or struggling, I strongly advise you contact an insolvency professional like an insolvency practitioner as soon as you can. The earlier you get in touch with an insolvency expert, the better your chances of recuperation.
Stay away from self-identified financial experts roaming the internet and find a local, regulated, insolvency practitioner that can help you steer your company.
Taking advice from a seasoned professional has two big advantages:
- If appointed early on, an insolvency practitioner might be in a position to help save the company or part of the business
- Appointing an insolvency practitioner can help protect you from criticism and future liability as, in your defence, you have taken proper advice
Once appointed, the insolvency practitioner will investigate if you can reasonably trade out of insolvency. Whether there is a good prospect of trading and paying off the debts or not - the insolvency practitioner will work to quickly stop your creditors’ position getting worse.
What precise business rescue action is taken, will be determined by the severity of the debts in relation to the estimated trading potential.
At 180 Advisory Solutions, we never charge for an initial exploratory meeting with directors to discuss whether we can help. You shouldn’t try to go through this alone, so get in touch and we will do our best to help you out of your difficult situation!