Directors duties and Fiduciary duties

Directors can face many different types of claims for personal liability for wrongdoing whilst managing the company. Examples of where a director may incur personal liability include but are not limited to, the following:

• Liability to the company regarding a breach of the director’s general duties under the Companies Act 2006 or for wrongful trading under the Insolvency Act 1986.
• Liability to third parties, such as an investor, for misrepresentation.
• Liability to employees for discrimination under the Equality Act 2010.
• Liability under health and safety legislation, environmental legislation, the Financial Services and Markets Act 2000, the Corporate Manslaughter and Corporate Homicide Act 2007 and the Bribery Act 2010.
• Liability for the costs incurred in defending civil, criminal or regulatory proceedings.

As they are the most important ones for our purposes, this article will concentrate on the duties owed by directors to the company under the Companies Act 2006 (CA 2006).

The Duties – Generally

The CA 2006 states that a director’s general duties are based on and have the same effect as the preceding common law rules and equitable principles that they were governed by. The duties should therefore be subject to consideration of, and interpreted and applied in the same way as, those common law rules and equitable principles.

Who are the duties owed by?

The general duties as set out in the CA 2006 apply to all directors of a company. The CA 2006 defines the term ‘director’ to include any person who occupies the position of a director, regardless of their title, which includes de facto and shadow directors.

Duties owed to the company

Directors duties are owed to the company. it is therefore for the company to take action if these duties are breached.

Directors do not owe duties to individual shareholders of the company or its creditors. In certain circumstances shareholders can apply to be allowed to act in the name of the company, even if they own only a minority of shares (called a derivative action).

However, as the majority shareholder you can effectively consider yourself as being the company.

Duration

A director will begin to owe duties to the company from the day that they become a director of the company. The general duties will not be owed by a director after they resign or are dismissed from their position. However, there are aspects of certain duties which will continue to apply even after leaving office, such as the duty to avoid a conflict of interest that arises from their knowledge of certain information obtained whilst they were a director in that company.

Another example includes the duty not to accept any benefits from third parties, with regard to things the director should or should not have done whilst they were a director of the company.

Cumulative duties

It is common for more than one duty to apply at any given time to directors, and it is imperative that directors comply with each of those duties.  An example of two duties overlapping would be the duty to promote the success of the company and the duty for directors to act within their powers. In exercising the duty to promote the success of the company, the director(s) must not breach the latter duty.

Relationship between the duties and the company’s constitution

Companies may place more onerous duties on their directors than those which are required of them by the CA 2006. If a company wishes to do this then they must set out such duties in their articles of association.  On the other hand, companies are not able to dilute the duties of a director, except to the extent permitted by specific sections.

The Duties

1. The duty to act within powers

CA 2006 states that a director:

• Must act in accordance with the company’s constitution; and
• Must only exercise those powers which are conferred upon them.

A company’s constitution has a wide definition and includes the following:

• The company’s articles of association,
• Decisions of the company, which have been taken in accordance with the articles.
• Any resolutions and / or agreements which affect the company’s constitution.

2. The duty to promote the success of the company.

CA 2006 requires directors to act in a way that they consider to be in good faith and in the manner which would most likely promote the success of the company and in turn to the benefit of the shareholders of the company. When acting in such a manner and in such a position, the director must:

• Consider the impact and consequences of any decisions taken in the long term;
• Take into consideration the interests of the company’s employees;
• Consider the impact and the way in which the company’s operations would affect the surrounding community and environment.
• The company’s desire to maintain a good reputation and be known for its high standards of business conduct;
• Consider the need for the company to act fairly between all the shareholders of the company.

3. Duty to exercise independent judgment

The CA 2006 requires directors to exercise their powers independently, without allowing their judgment to be affected by other people’s opinions or perceptions, particularly when making decisions.

An example of a breach of this duty includes a director agreeing or promising a third party (even a shareholder of the company) that they would vote in a certain way at a board meeting. This is even if voting in such a way the director would not otherwise have breached this duty.

The government has previously stated that this duty does not prohibit directors from relying on advice, so long as the directors exercise their own judgment when making the decision as to whether or not they should follow the advice.

4. Duty to exercise reasonable care, skill and diligence

This duty requires directors to exercise the care, skill and diligence which would be required and exercised by a reasonably diligent person with both of the following:

1. The general knowledge, as well as the skill and experience that would reasonably be expected of a person carrying out such functions and responsibilities in respect of the company. This is known as the objective test.

1. The general knowledge, skill and experience that a director in question actually encompasses. This is known as the subjective test.

In considering the above, at a minimum a director must convey and encompass the knowledge, skills and experience as required and set out in the objective test.  But, if a director has specialist knowledge, than the higher subjective test will have to be met. For example, where a director has specialist knowledge in accounting, this will be taken into consideration when looking at the director’s responsibilities in the circumstances of the company.

5. The duty to avoid conflicts of interest

This duty requires directors to ensure that they do not place themselves into situations which will conflict with the responsibilities and duties owed by them to the company. Unless, they have obtained consent from the company.

Directors must therefore try to ensure that they avoid placing themselves into situations where they have or may have, direct or indirect interests that conflict with, or may conflict with, the company’s interests.  This particularly arises in relation to the exploitation of property or information.

An objective test is applied in order to determine whether the director has breached this duty. A director will therefore not be able to rely on a cliam that he had no knowledge of a conflict.

6. The duty not to accept benefits from third parties

Under this duty directors must not accept any benefits or bribes from third parties, which are given to them as a result of their position.  This duty will continue to apply even after the individual ceases to be a director if it relates to actions or omissions of the director prior to them leaving.

7. Duty to declare interest in a proposed transaction and / or arrangement with the company

This duty requires directors to declare to the other directors in the company (if any) the nature and the extent of any interest they have (or may have), either directly or indirectly, in a proposed transaction and / or arrangement with the company. For this duty to apply, the director himself does not need to be a party to the transaction in question. A director may need to make a disclosure if he is aware of someone else’s interest which will amount to a direct or indirect interest on his part.

Remedies

There are various remedies that can be applied in the event of a breach of directors’ duties. Which of these remedies will be applied will depend on the type of breach. The remedies available include:

1. Damages,
2. An injunction (to prevent or stop someone from doing something).
3. Restoration of the company’s property which is held by the director.
4. Disqualification as a director under the Company Directors Disqualification Act 1986.

Fiduciary duties

What is a fiduciary relationship?

Under common law a fiduciary duty arises where two parties (A and B) agree that A will act on behalf of or for the benefit of B in situations which give rise to a relationship of trust and confidence. In such circumstances, A has some discretion and power which affects B’s interests, and in turn B relies on A to provide information and advice.

When trying to determine whether a relationship gives rise to fiduciary duties, it is the substance of the relationship that must be examined. It does not depend on the title that is given to the relationship or the position the individual holds in the company. When examining such a relationship you must consider it in the light of its commercial context and all the obligations which have been undertaken by the individual (in this case ‘A’ above).

Who owes Fiduciary Duties?

1. Company Directors

Company directors have always owed fiduciary duties to their companies under equity. Chapter 2 of Part 10 of the Companies Act 2006 (CA 2006) codifies some of those duties. The relevant statutory duties under the CA 2006 are:

1. To act within powers.
2. To promote the success of the company.
3. To exercise independent judgment.
4. To avoid conflicts of interest.
5. Not to accept benefits from third parties.
6. To declare an interest in a proposed transaction or arrangement.
7. The statutory duty replaced the corresponding fiduciary duty when the relevant provision came into force.

For information on actions against directors under the Companies Act 2006 see the article above.

2. Senior Employees of a Company and Contractors

Senior employees and in certain cases contractors will owe fiduciary duties to the company if they are in positions of trust in respect of the business and its assets  and they have the discretion to make decisions which can impact the company significantly.

Fiduciary duties require an employee/contractor to act in the best interests of the company. This requires them to:

1. 1. disclose any wrongdoing on his part to the company; the ‘disclosure rule’.
   2. avoid and not let any of his personal interests come into conflict with the interests of the company; the ‘no conflicts rule’.
   3. disclose and account to the company for any profits the senior employee has made because of the position he holds; the “not profits rule’.

Are Fiduciary Duties Important?

Fiduciary duties provide companies with an additional layer of protection beyomd the contraxtual relationship it may have with an employee or contractor, if an employee/contractor breaches their duties and obligations.

Proving the existence of fiduciary duties can be very valuable in cases, for example, where an employee/contractor resigns from his position/ends his contract and decides to set up their own competing business, using confidential information belonging to the company and/or using the contacts that they have made whilst being employed by the company.

In such circumstances the company would be able to enforce not only the express and implied duties which the employee/contractor owed to the company through an employment contract or contract for servies, but also breach of fiduciary duties.

Remedies

There are various remedies available to the company if an employee or contractor has breached their fiduciary duties.

1. Order for an account for the profits made. This will be particularly relevant where the employee/contractor has been enriched at the expense of the company, for example, receiving sums of money fron the compnay without authority or which should have been paid to the company, or using the company’s resources to generate money;

1. Order to pay damages for any losses incurred by the company resulting from a breach of fiduciary duties.

1. An injunction. This is a discretionary remedy. see the article above.

1. Disciplinary proceedings. In certain cases, it may be possible to bring disciplinary proceedings from an appropriate regulator against a senior employee. For example, where the senior employee held the role of a finance director and they were authorised under CIMA, the regulating body for management accountants.

Conclusion

If you own a company and you are aware of an employee or contractor who has breached their duties, take action to remedy the situation. It is not uncommon for employees or contractors to take advantage of the information they have obtained from their employer and set up their own business or use such information for their benefit inother ways.

It is important not to be hard on yourself, thinking that you may have been able to take certain steps to have prevented a situation from arising. The most important thing you can do is to act now to remedy the situation. Get in touch to speak to one of our members of the team to see how we can help.