It’s remarkable how often the title ‘director’ is used to describe someone’s position in a business. The title confers a sense of importance which is why it is often used but being a ‘real’ director brings with it a considerable degree of responsibility and potential liabilities, and if this was more widely understood there would be a greater reluctance to so casually use the title.
It is vital that directors are aware and comply with legal obligations. These duties are clearly set out in statute and anyone formally taking an appointment as a director should ensure they understand their duties and responsibilities, and be mindful of the requirement to comply with them in their everyday business decisions on behalf of the company. There are serious consequences if directors are found to be in breach of their duties and so it is imperative that directors exercise these duties with care and attention.
The proper use of the title ‘director’ describes a person who is an officer of a company, who has been formally appointed to a board of that company and has signed the appropriate forms which have been duly lodged at Companies House. The first directors of a new company will be those named as directors in the statement of proposed officers and will automatically become directors on the date of incorporation. Subsequent directors will be appointed in accordance with the articles of association and the procedure will usually involve an ordinary resolution being passed by the shareholders at a general meeting or a board resolution by existing directors.
Appointing a Director
The appointment of the director must be notified to Companies House within 14 days of the appointment and the register of directors must be updated. All directors’ details are then in the public domain.
Shadow Directors
English law also recognises the concept of a ‘shadow’ director who is identified as someone who is taking decisions and directing the company as if they were a director without having been registered as such at Companies House. The concept of who might be a shadow director comes into particular focus at the time when companies find themselves in financial difficulties and questions are being asked as to how much influence the shadow director had over the decisions the company took, whether the directors had acted properly and whether they should be held personally liable for some of the debts of a company.
Service Agreements
Directors are usually issued with Service Agreements as opposed to ordinary contracts of employment which detail the responsibilities imposed on a director as an office holder as well as reflecting the restrictions that any business would want to impose on someone with key skills and knowledge which may be of considerable value to a business. Key protections such are restrictive covenants and duties of confidentiality are built into such agreements to minimise any harm which may be caused to business as a result of a director.
A directors ‘duties’
In brief, a director must:
act in a way they consider would be most likely to promote the success of the company and have regard to the likely long-term consequences of the decisions they make. In most cases this duty will relate to ensuring the long term profitability of the company and any behavior within their role or outside their role (for example setting up a competitive enterprise) which has a detrimental impact on profits will leave the director in breach of their duty.
exercise independent judgment on the company's behalf. This duty will not prevent directors seeking advice, as long as the directors exercise their own independent judgment as to whether to follow that advice or not.
carry out day-to-day duties with the relevant care, skill and diligence expected a reasonably diligent person with the general knowledge, skill and experience expected of a person carrying out the functions carried out by the director within their particular role. In the case of those with specialised knowledge, skill and experience, the standard will be higher and judged subjectively according to the area the director specialises in. For example, where a Financial Director is making financial decisions, they will be required to have a higher standard of making these decisions than the Marketing Director.
avoid situations of direct or indirect interests that conflict, or may conflict, with the interests of the company. For example, the purchase of new office furniture from a company with which a director has a personal connection may give rise to a conflict. The definition of ‘connected’ is very wide and includes family members and corporate bodies. In the event of a potential conflict of interest, directors should seek approval from other directors before any proposed transaction or clarify with the board that there cannot reasonably be a conflict.
not accept any benefit such as a financial inducement or bribe, from a third party which is conferred because of the director’s position. Understandably in the world outside of lockdown, this duty is not infringed with the acceptance of corporate hospitality and any other such benefits that the company’s articles allow. Therefore, directors should be alive to the acceptance of any offers of gifts or experiences being potential breaches of their duties.
declare the nature and extent of any interest they may personally (directly or indirectly) have in a proposed or existing transaction with the company. This declaration should be made to the other directors and it is good practice to declare such an interest even if this interest is already known by the board.
Protection against breaches of director’s duties
Directors can be protected against potential breaches of their duties through the company indemnifying them or insurance cover, however directors should be mindful that there are occasions where protection will not apply. A director will not be indemnified by a company against personal liability in the event where:
the company sues the director – only liability to third parties can be the subject of an indemnity;
there are fines for criminal conduct or fines imposed by a regulator such as the Financial Services Authority (FSA);
other liabilities (such as legal costs) in criminal cases where the director is convicted, or in civil cases brought by the company where a final judgment is made against a director.
A director can will be indemnified against costs such as:
directors’ legal costs in civil claims brought by a third party;
damages against directors if they lose civil claims brought against them by a third party;
legal costs if they are acquitted in criminal proceedings;
cost in fighting civil proceedings brought by the FSA.
A director should ensure that they have examined the company’s articles to see what they will indemnify against. However, it is a mistake to think an indemnity in the articles is all that is required as a separate commitment from the company is needed in a service contract or other document.
Given the increasingly litigious environment that business operates within, directors are understandably keen to be protected as fully as possible but it is up to the board to further decide each individual case of breach and whether to indemnify the director. Indemnity against a breach in the articles and a service contract does not guarantee protection and directors should remain vigilant in regard to their duties.
The second form of protection for directors is a Directors and Officers’ insurance policy. It is considered best practice for companies to take out insurance to cover liabilities incurred by its directors. A policy will usually protect those who sit on the main board and those who are also directors of subsidiary companies.
A company may want to take out insurance to cover those risks that a company cannot indemnify a director against. But there is no standard policy that covers all needs and circumstances and the exact terms of the policy will have restrictions. It is therefore a big risk for directors to assume that insurance cover is in place without taking the time to establish exactly what protection the policy affords.
Furthermore, a director should check for how long they are insured once they leave the company as a claim may not arise for some time after the director has stepped down. Equally directors of a newly acquired business should check when the insurance cover starts; from when the business is acquired or for acts committed preceding the start date. An insurance policy will not cover fraud, deliberate dishonesty and illegal acts; nor will fines and penalties imposed by the criminal courts and by regulators such as the FSA be included.
It will also be necessary to check:
what costs are covered and how they are recovered.
whether the policy covers claims made outside the United Kingdom as some jurisdictions may be excluded
the directors’ position if the claim is being made by their own company.
any ‘excesses’ or ‘deductibles’ and where they apply, are they payable by the company or by the director?
The Covid 19 Pandemic
The devastation of the Covid 19 pandemic has caused to companies means directors’ duties are particularly relevant in the prevailing economic conditions and in the unfortunate event of potential insolvency. If insolvency is a real possibility, directors need to pay particular attention to their duty to act in the interests of the company and in turn, of the company’s creditors. A breach of this duty may result in a claim for wrongful trading which can be brought against directors personally once a company is in liquidation.
A claim for wrongful trading will be brought where, before the commencement of the winding up of the company, a director knew or ought to have concluded that there was no reasonable prospect that the company could avoid going into insolvent liquidation. This means that directors must not trade so as to disadvantage creditors when insolvent and therefore should not be taking on any more debts. To avoid liability for wrongful trading, directors need to show they took every step possible with a view to minimising the potential loss to the company's creditors.
In May 2020, the government published the Corporate Insolvency and Governance Bill, which provided amendments to the Insolvency Act 1986 and the Companies Act 2006 for the purpose of dealing with distressed companies during the Covid 19 pandemic. The bill brought in the following changes:
A new statutory moratorium process
This moratorium is available to companies and LLPs that are, or are likely to become, unable to pay their debts, but where it is considered likely that a moratorium would result in the company being rescued as a going concern. The new moratorium lasts for an initial period of 20 business days but may be extended without creditor consent for a further period of 20 business days and with creditor consent or by the court for up to a year or more. For companies facing short-term financial issues, this may provide a lifeline and give companies the breathing space and tools required to maximise their chance of survival.
A new restructuring plan procedure
This is similar to s scheme of arrangement and allows solvent and insolvent companies to propose a plan to creditors. The principal difference from a scheme of arrangement is that the court can confirm a plan even where a class of creditors has voted against it, therefore giving directors more decision-making power as to whether to opt for this procedure.
Contractual termination clauses
The Bill also invalidates contractual termination clauses where there is a contract for the supply of goods or services and where termination is purportedly triggered by the company’s entry into insolvency proceedings In relation to director’s duties, it is important to be aware that the Bill also includes the following retrospective COVID-19 provisions:
Wrongful trading
Courts will ignore the period between 1 March 2020 and 30 September 2020 (one month after the Bill came into effect on 26 June 2020) when assessing the amount of compensation payable by a director who is found liable for wrongful trading.
Winding-up petitions
No winding-up petitions can be presented on the basis of a statutory demand served during the relevant period. Petitions are also not able to be presented relating to that period on other evidence of an inability to pay debts unless the creditor has reasonable grounds for believing that the corona virus has not had a financial effect on the company or that the debt issues would have arisen anyway.
Conclusion
As can be seen use of the word ‘Director’ has the potential to bring with it all sorts of responsibilities and liabilities and is not a word to be used lightly. As with all legal issues it is best to obtain advice before accepting an appointment as a director to understand the role and duties. In many cases businesses will arrange for specific training to take place when an individual is appointed as a director to ensure a clear understanding of their role.
