Controls over directors' powers

The powers given to the board by a company are wide-ranging. This briefing outlines what controls are attached to these powers.

It is usual for the management and direction of a company to be entrusted to the directors by the company’s articles of association. The law seeks to impose restrictions and controls on the directors to prevent them from abusing their authority. Some of the restrictions and controls are contained in statutes principally within the Companies Acts and Insolvency Acts, but some originate in the common law of negligence and the equitable principles relating to fiduciary duties. A wide range of statutes impose additional duties on directors, including the seven general duties in the Companies Act 2006.

The law on directors’ duties was transformed by the Companies Act 2006, which codified the common law and equitable principles for the first time. The seven general duties are applicable to directors of all public and private companies as well as holding and subsidiary companies.

Act within powers

 Directors must act according to the company’s constitution and its powers, in the interests of the company.

Promote the success of the company

This new duty, is a re-casting of the old law that imposed a duty to act in good faith in the best interests of the company as a whole. A director of a company must act in the way that he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole and in doing so have regard to:

  • The likely consequences of any decision in the long term;
  • The interests of the company’s employees;
  • The need to foster the company’s business relationships with suppliers, customers and others;
  • The impact of the company’s operations on the community and the environment;
  • The desirability of the company maintaining a reputation for high standards of business conduct;
  • The need to act fairly as between members of the company.

Exercise independent judgement

A director must exercise independent judgement. They are on a board to act in the best interests of the company as a whole, not to represent the interests of just one shareholder or even a group of like-minded investors. This rule applies irrespective of the circumstances in which a director has been appointed.

Exercise reasonable care, skill and diligence

This duty sets a minimum standard required by law of all directors, which is increased should the director possess a higher standard of general knowledge, skill or experience. The director owes a duty to his company to exercise the same standard of care, skill and diligence that would be exercised by a reasonably diligent person.

Avoid conflicts of interest

A director has a duty to avoid any conflicts of interest. The Act distinguishes between three different situations in which directors have potential or actual conflicts of interest (in addition to the duty not to accept benefits from third parties). These are:

  • Conflicts with the interests of the company in relation to transactions or arrangements to which the company is not a party – such as the exploitation of an opportunity, whether or not the company could have taken advantage of it;
  • Conflicts in relation to proposed transactions or arrangements to which the company will be party;
  • Conflicts in relation to existing transactions or arrangements to which the company is party. The Act defines conflict of interest to mean both a conflict of interest and a conflict of duties.

Not to accept benefits from third parties

A director must not accept a benefit from a third party unless acceptance of such a benefit “cannot be reasonably regarded as likely to give rise to a conflict of interest”.

Declare interests in proposed transactions with the company

If a director 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 can be given orally at a board meeting, or in writing to each director.

Defaulting directors may expect not only personal or criminal liabilities as a consequence of a breach of duty, but may also face a court order disqualifying them from acting as a director for up to 15 years.

It is important to remember that there is no expectation by the courts of perfection or infallibility on the part of directors. Provided directors have a proper understanding of their role and take basic protective measures, the risks of committing a breach of a general duty can be kept to an acceptable level.

© Institute of Directors. All rights reserved.

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