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Published: Fri, 02 Feb 2018

Duties and responsibilities of directors

The Impact of the Legal Duties and Responsibilities of Directors on a Corporation, Enforcement of Director’s Duties, Breach of Duties and Remedies

Introduction

The welfare of a company depends on the shoulders of the directors and the directors are also responsible for the interests of the company as well as shareholders. Directors are basically fiduciary agents and they owe duties to the company, directors’ are appointed by the company’s shareholders to run the company’s affairs for the benefits of the shareholders. Moreover, no company can get success without having the good and honest directors, so company success can only be achieved, if the directors of the company fulfil their duties and complete enforcement of the director’s duties. Therefore directors play very significant role in any corporate governance system. Director’s general duties are based on the certain common law rules and equitable principles. Lord Judge Bowen explains director’s duties in these beautiful words that “directors are described sometimes as agents, sometimes as trustees and sometimes as managing partners. But each of this expression is to be used not as exhaustive of their powers and responsibilities, but indicating useful points of view from which they may for the moment and for the particular purpose be considered.” The Chapter 1 of this paper is amid to critically analyze that what are the duties and responsibilities of directors under Companies Act 2006.

The duties of directors alone are of no importance if they cannot be fully enforced, the chapter 2 of this piece of work relates to the system of enforcement which provides the different kind of controls which gives assurance than how these duties of directors are implemented. Basically Common law provides three ways of enforcement such as state enforcement which is carried out through Department for Business, Enterprise & Regulatory Reform (BERR) formally knows as DTI , secondly Statutory enforcement which are governed by Companies Act 2006 and thirdly derivative actions which are also governed by Companies Act 2006.

Where there is a duty there is also a chance of breach of that duty and where ever there is a breach of a duty it gives rise to the various remedies. So where there is a breach by the director of a company there are also available certain remedies against him. The Chapter 3 of the paper critically analyze how these duties are breached and what remedies are available to company, shareholders and other stakeholders under the Companies Act 2006. There are also some other laws who deal with the breaches committed by the directors and remedies available against them these are Company Directors Disqualification Act 1986 (C.D.D.A) and Insolvency Act 1986.

Directors’ duties Under Companies Act 2006

The section 170 of the Companies Act 2006 states that the general duties of the directors are those which are laid down under section 171 to 177 of the Companies Act. These are the duties which directors of a company owe towards the company.

Duty to act for Proper Purposes:

Duty to act for proper purposes is a duty of directors which is only codified in section 171 of Company Law 2006. According to this rule the directors have to use their powers within the company constitution and only for the reasonable purposes in the best interests of the company. The directors must observe the constitution of the company while they exercising director’s powers and they must exercise their powers bonafidely for the best interest of whole company and under this duty directors are also compelled to act for the best interest of shareholders. Furthermore, directors are fiduciary agents of company, so they cannot use their powers beyond the company’s constitution and for their own benefits. This rule infact gives a remedy to the shareholders to prosecute directors. Where directors misuse their powers and their acts are not in accordance with the constitution of the company shareholders can challenge them in the court of law. This rule is further explained in a case Hogg v Cramphorne where the directors of targeted company intentionally allotted new shares of the company to those persons who can oppose the fearing take over bid. The only reason behind this allotment was that they want to save their jobs in the board. It was held that the directors did not use their powers properly and the new allotment of shares was also not based on honestly, so court declared this allotment void. In another case Criterion Properties plc v Stratford UK Properties LLC where the managing director of the company had entered in an agreement with a substantial shareholder that the company must buy out his shareholding at a high price, any change in board of director or removal of the managing director will not effect on the agreement. Subsequently, that managing director was terminated from office and then the company went to the court for cancellation of agreement because, director did not act within his power and then it is liable to declare an improper purpose. It was held that the agreement was not a proper exercise of a director’s powers, therefore could not be binding against the company. In Howard Smith Ltd v Ampol Petroleum Ltd it was held that the main purpose behind issuance of new shares to reduce the percentage of two shareholders stake in the company, who refused the intending take over bid. Lord Wilberforce said that the new allotment of shares by director in this kind of circumstance could be set aside although there was no self interest involved. Because, their intention at that time of allotment of new share was based on malafide. It was further held in this case that any act or decision of directors which is not within the company’s constitution is called as void act, if there is merely exceed of director powers, then it is declared as avoidable decision.

If we do critically analysis of this section, then we can say that section 171 of the Companies Act provides a parameter to judge whether director’s purpose was proper or improper and that parameter is a constitution of the company. Under Section 172 of the Companies Act it is the duty of directors to function in good faith and to promote the success of the company as well as its members. So where director acts slightly beyond while using their powers to promote the success of the company in the benefit of its members therefore it is not fair in these circumstances to declare those acts or purposes improper merely on the base that these functions are slightly beyond their powers and these acts or purposes are also not in the constitution of the company.

Duty to Promote the Success of the Company:

This core duty is set out in the section of 172 of the Companies Act 2006. Lord Greene explained this duty in Re Smith & Fawcett Ltd in these beautiful words that directors are bound to exercise their power “bonafide in the way that what they consider in the best interest of the company not what a court may consider”

Berle recommends that the entire powers which are given to a company or to the management of the company are inevitably for use every time only for the benefit of the all shareholders of the corporation. In Hutton v West Cork Railway Co where, it was held that there is only one kind when directors can promote interests of other groups which are ultimately in the interests of the company in future. Lord Bowen further held in this case that there is no “cakes and ale” except such as are necessary for the benefit of the company’s shareholders. Whereas Dodd observes that where on one hand corporations are institutions to maximize shareholders wealth, on same time on other hand, they have a corporate social responsibility role as well to play in a society.

Section 172(1) of the Companies Act 2006 describes and imposes significant following duties upon a director, which a director must discharge; (a) The likely consequences of his any decision in the long-term on a company, (b) A director must watch interests of the company’s employees first, (c) A director must try to foster the company’s business relationships with suppliers, customers and others, (d) A director of a company should always watch the overall impact of the company’s operations on the community and the environment, (e) A director has a desirability of the company maintaining a reputation for high- standards of business conduct, and (f) The need to act fairly as between the all members of the company.

In Lonrho Ltd v. Shell Petroleum Ltd Lord Diplock, held in this case that company’s directors should not only watch shareholders interests, they should consider about company’s creditors as well. In Liquidator of West Mercia Sofetwear Ltd v. Dodd it was held in this case that when insolvency approaches towards company, then company’s director should start to consider in the interests of the creditors. So where a case of insolvency come the director’s fiduciary duties shift towards creditors of the company.

Therefore the interests of a company must remain paramount for a director, whatever happens except company insolvency. Director must take all those entire steps to enhance company success and reputation among community and ensure company members prosperity in his every decision.

So, in my humble view that directors should not only focus to make the profits solely for shareholders and then they can get more bonuses and pay rise, directors of companies should discharge their responsibilities towards employees, suppliers, customers, and environment and to the whole community as well. Directors must take special notice on the company’s corporate social responsibility (CSR) strategy. Because, better CSR leaves company’s brilliant impact on the community, as a result it helps well to any company of its speedy enhancement in the market business , good reputation in the society and thus good profit for shareholders also.

Duty to use Independent Judgment:-

Section 173 of the Companies Act 2006 set out the duty upon director of independent judgement and this section require from directors that they must exercise independent judgement rule and must not fetter their discretion under any body influence. They owe the duties towards company not towards any individual. They must only work and watch the company’s interests, affairs and always use their independent opinion in the best interest of the company rather than any other person’s interests. Furthermore, section 172(2) (a) and (b) provides exception of this duty that “exercise independent judgement is not infringed by his acting in accordance with an agreement duly entered into by the company that restrict the future exercise of discretion by its director, or it is authorised by company constitution”. In Fulham Football Club Ltd. v Cabra Estates it was held that directors could not enter in any contract, which will restrict them to exercise of their future discretion and how they will vote in future election. However, they can do an agreement, which can be proved very beneficial for the company, where they are acting in a good faith in the best interest of the company.

Nominee directors:

Nominee directors usually appointed in a company or in subsidiary companies by the parent company or creditors to protect their interests in the company. The law draws no distinction between these two positions of a nominee director or any other normal company director. A nominee director owes the same duties towards company like a holding company director. Therefore, a nominee director can not blindly follow the judgement of those people who appointed him.

In Boulting v ACTT Nominee directors are not bound to act accordance with the wishes of the nominator, they can refuse nominator’s directions, where these intrusions have clash with the interests of the company. It comes clearly in breach of director duties, if a director of a subsidiary company acts solely in the interests of the parent company. Where a nominee director commits any wrong done in the company, so his nominator can not be liable for his personal wrong done.

Where companies are working in a group shape, there this independent judgement rule and do not fetter the discretion rules apply also in same way like in any other company. In Charter Bridge Corporation Ltd v. Lloyds Bank Ltd, it was held here that ‘each company in the group is a separate legal entity and the directors of a particular company are not entitled to sacrifice the interest of the company’.

The Duty of Care and Skill:

The duty to exercise reasonable care, skill and diligence is consider one of the most important duties of the directors. This duty of reasonable care, skill and diligence has got huge attention in recent years also. This duty has been codified in section 174 of the Companies Act 2006. The duty of care and skill is based on the contract, trust, tort and equality principals. As J Birds contends that UK Company Law actually reveals the traditions of a common law system which is set up on the notions of contract and equity. However section 174 states that a director of any company must display the highest level of care, skill and diligence, while performing a director duty. Furthermore, director duty of care, skill and diligence which is normally overlap in daily routine, these duties can distinguished that care to be understand as carefulness, though not caution, skill suggests ability, whereas diligence might be understand as requiring a director to use his skills devotedly in the affairs of the company, in the particular matter in hand.

Not only section 174 of Companies Act states about standard of care and skill it is also codified in section 214(4) of the Insolvency Act 1986 which also requires from a director of a company to exercise knowledge, skill and care that would have been exercised by a reasonable and prudent person who have general knowledge, skill and experience which is required from a person performing same kind of duties which directors also have to perform.

In Re City Equitable fire Insurance it was stated that for a director it is not required to possess the higher level of skill and performance as comparison with an ordinary person having same knowledge and experience.

In a case Dorchester Finance Co v Stebbing where directors did not act with reasonable care and signed the blank cheques, which allowed the company managing director to embezzlement. So it is declared a negligent act on the part of the directors. In an other case Re D’ Jan Of London Ltd where company’s director was held negligent, because he signed the company’s insurance policy without even reading its contents.

On these above stated circumstances, the critical question is that what is the reasonable standard to be expected from a director while a director performing as director in the company. On the other hand, courts have not been able to describe clearly that point, what is the compulsory level of care and skill required from a director of a company, although courts explain a general level. In Lagunas Nitrate Company v. Lagunas Syndicate it was held in this case that if a director discharged his responsibility with particular care, used his powers properly within company constitution and he maximum utilizes his experience and knowledge while acting as director, so it will consider that he has discharged both his duties to company, equitable duty and his legal duty as well. Because the directors of a company acted within his powers, and with reasonable care, and honestly in the best interest of his company, are not personally liable for losses which the company may suffer by their mistakes.

In Re Brazilian Rubber Plantations and Estates , Limited it was held in this case that ‘such reasonable care must I think be measured by the care an ordinary man might be expected to take in the same circumstances on his own behalf. He is clearly I think not responsible for damages occasioned by errors of judgment.’

In those circumstances, J Parker observed In RE Barings plc there are no set principals which can layout the duty of directors, the level of the duty of director and there is no question that they performed their duty but is totally dependant on the circumstances of each case involving the role of director in the company’s management.

Directors are elected by the shareholders to run the company affairs on their behalf. So directors should work with reasonably care and use their best knowledge and skill whilst working as a director and always work like that they are working for their own work or their on behalf.

Avoid conflicts or No Personal Secret Profit:-

The directors must not enter into any agreement in where company’s interest is clashed with their own interests. Furthermore, directors cannot make a secret personal profit by unfair using of their position or authority as a director. In Aberdeen Rly Ltd. v Blaikie Brothers it was held that it can not be allowed to anyone to enter an agreement for his own interest or he would have get an interest with this agreement or there may be a chance of clashes of others members of company’s interests.

In Industrial Development Consultants v. Cooley here the managing director of the plaintiff company was a successful architect also. He could not obtain a huge local gas contract for his company. Later, he contracted in his private capacity with this same local gas firm to ask the contract for his private firm. Further, he asked from his company to release him from company’s service due to his so called health problems, while he concealed all his private correspondence with local gas board to his present company. It was held that he was responsible for account to the company for the profit which he made and caused loss to the company. Furthermore, court observed his act as a conflicting act of the company’s interests. In another case Guinness Plc. v Sanders here a director tried to redundant remuneration for himself without the prior consent of board or company, which was a clear conflict between director and the company policy. In Plus Group Ltd v. Pyke it was held that a director of a company cannot be held as breached of his fiduciary duties towards company, which was occurred in the company after he was excluded from the company matters. In my humble view, there should be no conflict of interest and conflict of policies between the companies and their directors. Moreover, directors should always avoid taking all those steps, where is possibility of clash with their own and company interests.

Section 176 of the Companies Act 2006 states directors undisclosed ‘secret profits regulations, which they make by the using of the director’s powers. According to this section, directors can be accountable for undisclosed profits which they obtained as a director’s position. Section 176 (2) of the Companies Act 2006 explains a “third party” definition a person other than the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate. Moreover, it is stated in section 176 (3) that ‘benefits received by a director from a person by whom his services (as a director or otherwise) are provided to the company are not regarded as conferred by a third party.’

In a case Regal (Hastings) Ltd v. Gulliver here the directors of Regal invested their own money to buy the subsidiary company shares and then they sold the whole group in a take over bid and then got an instant profit from the acquired shares of a subsidiary company. Later, court declared this act a clear breach from their fiduciary director’s duties.

This section covers those secret profits also, which a director received during the business deal negotiation on the company’s behalf as a director. Directors of a company held in breach of their duty towards company, where they were appointed for a negotiation on the company behalf, but they had taken the benefit from this particular company project. Similarly, another important case is here CMS Dolphin Ltd v. Simonet where it was held that any profit which a director earned through the malafide use of the company’s confidential information is accountable under the secret profit rule, which he knows by virtue of his position as a director, and any leakage of the company’s confidential information by seeking of hidden profits comes also under secret profit rule. In General Exchange Bank v. Horner if a director receives any benefit in course of a take bid of the company shares also comes in the secret profit definition. If a company’s director misused his power and derives a secret profit from any contract and did not disclose it, subsequently the company can recover this secret profit from him.

However, any conflict can be resolved by the due disclosure of in front of company’s general meeting and directors only can protect their any acts which can become conflict later by the due authorisation and prior consent of the company AGM. But this kind of ratification or authorisation should not be permitted where there is a threat that company will become insolvent soon.

Duty to Disclosure Interest in proposed Transaction:

Section 177 of the Companies Act 2006 is about disclosure of interest by a director towards proposed transaction or arrangement. According to section of 177(1) that director of any company who has an interest or could be beneficiary in company any ongoing or future transaction or arrangement. Therefore, that director has to disclose his interest with full details, “nature and extent” of that interest in on ongoing or proposed transaction immediately. Section 177(2) of the Companies Act, provides the different modes of director disclosure, which could be written notice, disclosure at meting of directors and a general notice as well. Furthermore, in essence of the section 177(4) any kind of the interest, which a director has in transaction or arrangement, must be disclosing prior to the company entered in this matter or transaction. A director, who was a former member, shareholder or any executive post must disclose to his present company, if his present is going to sign a contract to his former company. Otherwise, he will be held interested in this contract.

It is worth mentioning here that Company Act 2006 provides no mechanism for the shareholders to discover whether any disclosure has been made under the section 177 of the Company Act 2006. Conversely, under the Company Act 1985, companies were compelled to include details of director’s interests in material transaction with the company in the notes to the company accounts, but this provision was not carried forward by the Company Act 2006. In the absence of this provision it is the responsibility on the big companies now they should consider or work on it, how they can furnish this disclosure information to the company’s shareholders.

Enforcement of Director’s Duties

In first chapter, we have discussed the directors’ duties, now we discuss the most important part in corporate governance regarding the director’s duties, which is the enforcement of these director’s duties. The duties of directors of company laid down in companies Act 2006 are not at the will of directors to do or not to do. They should perform their duties with due diligence and the breach or threatened breach is a serious matter within the domain of corporate governance. These duties are not of any importance if they can not be fully enforced and if they cannot be enforced by any reason then they are of no importance and are useless. Followings are the mechanisms by which directors can be compelled to discharge the director duties in their real essence and then help to enforce these duties in according to the director’s general duties provisions.

State Enforcement:

The DTI (Department of trade and industry) is one of the states Department which was replaced by the Department for Business, Enterprise & Regulatory Reform, (‘BERR’) in 2007; this department is responsible to regulating and interference in the company’s matters, where public interest is involved. The BERR has the power to investigate the company’s affairs in the public interest, where a wrongdoing is found in the affairs of a company, and then BERR has power to order for a criminal prosecution against a director, to ask court winding up company in public interest and director disqualification alone. Moreover, according to section 124A Insolvency Act 1986 secretary of the state can apply a petition in the court for seeking the company winding up ‘where any information or documents obtained under section 165,171 172,173 or 175of that Act, (c) any information obtained under section 2 of the Criminal justice Act 1987 (d) any information obtained under the section 83 of the companies Act (powers exercisable for purpose of assisting overseas regulatory authorities), that it is expedient in the public interest that a company should be wound up, he may present a petition for it to be wound up if the court thinks it just and equitable for it to be so. (2) This section does not apply if the company is already being wound up by the court.’ Furthermore, the companies including in winding up process in recent years, almost all have those elements to attracting money from the public which is invariably prove to be irrecoverable of public money for them and in respect of which minimal no services or products are provided.

In serious kind of cases Secretary of state can appoint inspectors under the Companies Act 1985 sections 431 or 432, which have been replaced as section 446A, 446B in Section 1035 in the new Companies Act 2006. According to section 432(1) of CA 1985 the secretary of state usually appoints inspectors when court declares that company affairs ought to be so investigated. The investigation by the inspector under this section is not deemed a judicial proceeding. The secretary of state has power under section 1035 of Companies Act 2006 to give any kind of directions to inspectors, and the secretary may order him to take no further action and he can also direct inspectors to terminate the investigation. A worth mention case is here in R (on the application of Clegg) v Secretary of State for Trade and Industry where it held that the inspector can interview any one to gather the information about the alleged matter upon rogue director but on the other hand before making final report of investigation they must give him a fair chance for correcting or opposing what people said against him.

Statutory Enforcement:-

There are various written statutes in Great Britain also; which strongly emphasizes on the enforcement of the director’s duties, which mainly are Companies Act 2006, Disqualification Act 1986 and the Insolvency Act 1986 etc. The part 10 of the Companies Act 2006, where one hand it explains the directors duties on other hand in this same part emphasizes on the enforcement of these duties also. Moreover, section 178 clearly provides a mechanism for enforcement of these duties, section 178 Companies Act further states that the consequences of breach of director’s duties are to be treated in the same way as would apply if the corresponding common law rule or equitable principle applied and these directors duties which are stated in part 10 therefore enforceable upon the companies directors in the same way as any other fiduciary duty owed to a company by its directors. The company may also institute a claim in a court of law against a rogue director and can seek an injunction to stop the director to doing and continuing with the complained breach conduct, damages by way of compensation where the director has been negligent, restoration of the company’s property and the rescinding of a contract in which the director had an undisclosed profit. A contract or other arrangement entered into by the director in breach of a duty will be void, though it may be open to the company to ratify the agreement if it wishes to do so.

The Companies Act 2006 section 171 provides an enforcement device also, about the director’s duties enforcement, section 171 states that the directors must use their powers within the company’s constitution the powers given to him only for the proper and reasonable purposes in the best interests of the company. The section 41 of the Companies Act 2006 defines importance of the enforcement as well. According to section 41 that directors those only acts are consider valid which were done accordance with the company constitution and directors those acts which were not accordance with the constitution of the company are consider to be void acts.

In J.J Harrison (Properties) Ltd v. Harrison, where a former director of a company was declared accountable for the profits which he made secretly on land which he had acquired from the company. In this case Chadwick LJ recognized, the powers about the disposing of the company property which a director has by the article of the company, so a company directors always must use these power in larger interest of the company only if director did not act in the interest of the company and made his own personal profits, then director can declare accountable for that profit. A worth mentioning case here is Bairstow v Queens Moat House plc where it was held that former directors who had declared unlawfully dividends of the company, they were completely accountable to repay the whole amount of unlawfully dividends which they declared, regardless that the company at that time can adopt other mechanism to be declared such dividends lawfully, consequently due to this there was no loss to the company. The loss is not issue here, but the liability of directors to make good any application by them of the company’s assets.

Derivative Actions:-

The improved Derivative claims are introduced in the Companies Act 2006 to help shareholder to enforce director’s duties in the real essence of the director’s duties in accordance to the Companies Act 2006 against the wrongdoer directors. Because, any infringement of these duties by the companies director duties can not be restrain without a proper or effective enforcement.

In the case of Foss v. Harbottle , where it was held first time that ‘proper plaintiff’ is the company itself to proceed against any wrong done towards company. Any individual shareholder or minority shareholder group can not take any action or sue against majority. Wigram VC’s judge further states in this case that court should not interfere, where a majority of the company’s shareholders can ratify the alleged director’s wrong done. So, minority shareholder can not bring any action where it is possibility that majority can ratify this director wrong done later.

The majority rule, which is established in Foss v. Harbottle is recognised later in another case Edwards v. Halliwell here court held that “where the alleged wrong done is a transaction which might be made binding or on the company association or all the members of the company, no individual member of the company is allowed to maintain an action in respect of that matter.” In the nineteenth century, ‘Victorian judges’ had been found under the great influence of this majority rule judgment and they were always adopted a gradually more restrictive attitude to giving relief upon minority actions for breach of the articles or breach of duty by directors.

After the commencement of the Companies Act 2006, the whole situation has been changed now. The part 11 of the Companies Act entirely ignores the majority rule which is established in Foss v Harrbottle case. The Companies Act 2


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