Introduction
Until recently, matters relating to directors’ duties and liabilities as well as corporate governance, (for larger private companies and listed companies) were seen as dull and of no real interest to many/most directors. The role of the directors in the Post Office Scandal may well have changed all that. Some 25 years of inaction by the Post Office board (and much worse from some individual directors) including their failures in carrying out some of their core duties, contributed to the biggest miscarriage of justice/cover-up in English legal history. The company is now being accused openly of perverting the course of justice and being a criminally corrupt organisation.
Over the decades, more than 80 people have sat on the Post Office board including some high-profile City figures. The Chairman, who it is said, has held many dozens of directorships during his career, was asked to depart, very recently, by the Department of Business and Trade which is the sole shareholder in Post Office Limited. Ironically that department is responsible for UK company law. The current board includes two ex-partners from major international law firms (one is about to leave) and an ex-partner from a Big 4 accountancy firm. Ultimate responsibility for the Post Office Scandal is with the board of directors. That is a basic concept of English company law.
Having provided written Submissions to the Post Office Enquiry regarding directors’ duties among other matters, I thought I should update and recirculate a general introductory note I prepared some years ago. Although this is another technical area of company law, some understanding could prove useful in these days of heightened litigation and disputes involving companies and their boards, generally.
In summary, don’ t be like a Post Office director!
This paper is an overview of various key issues describing what the law requires from a director. I appreciate not all the matters mentioned, will apply to all (perhaps even most) companies. Note the law generally makes no distinction between executive and non- executive directors, so far as liability is concerned, therefore knowledge about the company is crucial. The issues below relate as much to private / family-owned companies as large publicly listed companies. Although the latter have many extra levels of compliance, the core duties and responsibilities below, are the same. You may be surprised to know, Post Office Limited itself is a private company.
Finally, experience has shown that many of the issues/difficulties I’m asked to advise on around these matters, are as much about personalities/friction between individual directors, as they are technical legal issues. Please bear that in mind.
Directors’ duties and responsibilities
A company director takes on a new set of responsibilities and, with other board members, will set out the strategy of the business. This is an outline the key duties that come with being a director.
The role of the board
The board of directors of a company is responsible primarily for:
Determining the company’s strategic objectives and policies;
Monitoring progress towards achieving the objectives and policies;
Appointing senior management; and
Accounting for the company’s activities to relevant parties, e.g. shareholders.
Making the first appointment
The first directors of a company are appointed at the time of its incorporation. All appointments are governed by the company’s articles of association (Articles), but any shareholders’ agreement should also be checked. Typically, the Articles will provide for the board of directors to fill any casual vacancies or to appoint additional directors up to the maximum number which it specifies.
On appointment, a new director will be asked to provide some personal information (full name, address, date of birth, nationality, country of residence, former names and business occupation) to be included in the relevant form which the director is required to sign to signify consent to act as a director. A director may file a service address at Companies House as well as their home address. It will be the service address (which can be the registered office of the company) that appears on the public record.
On a practical note, a new director should, whenever appropriate, make sure that they receive some basic information about the company, including a copy of the company’s Articles, recent board minutes and management accounts; and the statutory reports and accounts for the past two years.
What powers do directors have?
The directors are generally responsible for the management of the company and may exercise all the powers of the company. However, the extent of their authority may be limited by the Companies Act 2006 (Act) and the Articles and by any shareholders’ agreement. For example, Articles might include restrictions on borrowings by the company, matters relating to the issue of new shares and transfers of existing shares.
Generally, the directors must act collectively as a board to bind the company. However, the Articles usually entitle the board to delegate powers to individual directors as appropriate. In practice, individual directors will normally carry out many of the company’s activities. A director is a personal appointment – so can’t appoint a proxy, although, again, subject to the Articles, can appoint an alternate director.
What are the core duties?
Statutory Duties
Directors need to be aware that they are personally subject to statutory duties in their capacity as directors of a company. In addition, the company as a separate legal entity is subject to statutory controls and the directors are responsible for ensuring that the company complies with such statutory controls.
Section 172 of the Act, which you should have a look at, sets out the main general duties of directors, which are:
Act within their powers. A director must act within their powers under the company’s constitution and only exercise those powers for the purpose for which they were conferred.
Promote the success of the company for the benefit of its members (shareholders) as a whole.
This duty is often referred to as the "section 172" duty. Every director needs to be aware, particularly, of this section of the Act. It is probably referred to as much as any other provision in the Act.
In promoting the success of the company, directors must have regard to the following:
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.
The likely consequences of any decision in the long term.
The duty is, however, a single duty owed to the company to promote success The directors must decide, using their own business judgment in good faith, what is most likely to promote the success of the company and what weight to give to each of these factors (e.g., some may be irrelevant in a particular case). This list of factors is not exhaustive.
In deciding whether a particular course of action is in the best interests of the company the directors must have regard to all six factors. There is no priority between them, and they are not exhaustive, but the individual factors do not override the primarily obligation to promote the success of the company for the benefit of the members as a whole. It might help if I give you an example.
A board is faced with a decision which will result in a loss of UK jobs and damage to the environment but is likely to promote the success of the company, perhaps by doubling profits over the next two years and enabling the company to expand overseas. What course should it follow? A further conflict on interpretation is shown when, in another example, on the one hand the board is trying to maximise long term profitability – one of the ways of measuring “success”, as this was one of the government’s initial wishes when it started this discussion years ago- while on the other hand it is seeking to negotiate tough terms into contracts with its suppliers to obtain the best financial result for the company.
The Act gives no definition of what is meant by “success”, although for commercial companies it will normally mean long term increases in value. How are you, as directors, going to work this out? The decision as to what will promote the success of the company and what constitutes such success is one for the directors’ judgment acting in good faith. Strategy and tactics are for the directors and should not be subject to decisions by the courts, again subject to good faith. Directors must be able to prove they have paid due regard to the six listed factors. The Act doesn’t specify how directors are to do this but merely “ticking the box” is not going to be enough. The obvious method directors can use to protect themselves is to keep detailed board minutes setting out their considerations and how decisions were reached.
Larger companies (with more than 250 employees) have to explain how they have fulfilled this duty in their annual report. When making decisions, directors must also consider the likely consequences for various stakeholders, including employees, suppliers, customers and communities.
A duty to promote the success of the company may seem like an obvious task for a director. However, it brings with it a number of implications. Board decisions can only be justified by the best interests of the company, not on the basis of what works best for anyone else, such as particular executives, shareholders or other business entities. But directors should be broad minded in the way that they evaluate those interests – paying regard to other stakeholders rather than adopting a narrow financial perspective.
It is also subject to the relevant existing law requiring directors in certain circumstances, such as a potential insolvency situation, to consider or to act in the interests of the creditors of the company.
All that said, it is suggested that many (most) decisions required by most boards of most private companies, need not / should not necessarily be unnecessarily complicated.
3. Exercise independent judgement
Directors should exercise their powers independently, without making their powers subject to the demands/ wishes/ requirements, of others. They are meant to develop their own informed view on the company’s activities. Directors should not simply implement the commands of other parties (such as major shareholders). Nor should they avoid their responsibility to make independent decisions by relying on the knowledge or judgement of other directors or experts.
Director should form their own view, which may require some effort – especially if they are not already familiar with key aspects of the company’s activities. It is important for directors to take a critical (not necessarily over-critical) view of information supplied, before making key decisions.
4. Exercise reasonable care, skill and diligence
A director must exercise such reasonable skill, care and diligence as would be exercised by a reasonably diligent person with:
the general knowledge, skill and experience that could reasonably be expected from a person carrying out the director’s functions; and
the director’s actual general knowledge, skill and experience.
There was a time when directors could be appointed purely for their name or reputation, without the expectation that they would do any work as a board member! Those days are now (almost) over, due to the duty on directors to exercise reasonable skill, care and diligence in their role. The benchmark is that of a reasonably diligent person with the general knowledge, skill and experience that could reasonably be expected from a person carrying out the director’s functions. Also, directors with specific professional training or skills (such as a lawyer or accountant) are held to a higher standard in related issues than less qualified colleagues. It is not necessarily easy for a director to decipher this complex legal code. However, once again for most companies the difficulties connected with these concepts should not be over exaggerated.
5. Avoid conflicts of interest
Directors must avoid situations in which they have a direct or indirect interest which conflicts, or possibly may conflict, with the interests of the company. This applies particularly to the exploitation of property, information or opportunity regardless of whether the company could take advantage of it. It applies to a conflict of duty, as well as a conflict of interest and includes the interests of “connected persons”. Examples of conflicts of interest include situations where the director has relationships of a business or personal nature with persons or entities that are affected by the company’s activities.
6. Not accept benefits from third parties
A director has a statutory duty not to accept a benefit from a third party which is given because of the position held by the director or because of anything the director has done in his capacity as a director. In brief, acceptance of benefits is not subject to any ‘de minimis’ limit and is only permitted where the matter is approved by the company’s members, or it can reasonably be regarded that it will not give rise to a conflict of interest with the company.
7. Declare interests in transactions or arrangements
Directors have a statutory duty to disclose any direct or indirect interest they have in a proposed transaction or arrangement with the company., They have a duty to declare any interest held, direct or indirect, in an existing transaction or arrangement.
Looking at the previous three duties, which should perhaps be read together, how can directors protect their positions? Some suggestions:
Inform new directors, and remind others, of their duties to avoid conflicts of interest.
Put in place policies governing how and when directors should notify the board of any potential conflicts, and how the board will decide whether or not to authorise them. Such policies will ensure that all directors understand their obligations and carry them out consistently.
Make sure the board carefully consider any requests for pre-authorisation of a conflict, having regard to each director’s duty to act in the company’s best interests.
Record all authorisations in a central record, detailing the basis upon which they were agreed to, and any conditions attached.
Implement common sense policies regarding gifts and corporate hospitality and make sure the board is aware of these.
It is important to note that these statutory duties, which replaced previous fiduciary or equitable duties, are still interpreted by the Courts in accordance with the previous case law. These statutory duties cannot be seen in isolation because directors are also subject to a wide range of regulations and laws which “compliment” them.
Directors may be liable to penalties if the company fails to carry out its statutory duties. However, they may have a defence if they had reasonable grounds to believe that a competent person had been given the duty to see that the statutory provisions were complied with.
Liabilities
A director can be held personally liable for losses incurred by a business which are proved to be the result of board decisions, or a failure act properly. For this reason, directors’ liability insurance is an essential protection for a company director.
Directors should be aware at least of the existence and the basic effects of the Company Directors’ Disqualification Act 1986, which could lead to disqualification from acting as a director of a company for between two and 15 years; the Insolvency Act 1986 by which directors could be made liable personally for the company’s debts; and if relevant, the Health and Safety at Work etc Act 1974; and the Corporate Manslaughter and Corporate Homicide Act 2007. I am not including further details in these brief notes.
Collective responsibility
Directors are responsible for the internal governance (or organisation) of the company.
Directors’ powers are given to them collectively as a board and must generally, subject to any proper delegation, be exercised by the board, as a whole. Directors have a collective responsibility to manage the company. This is the case even if some directors are given special responsibilities or titles (e.g., “finance director” or “chief executive officer”) and regardless of any distinction between executive or non-executive directors. The constitution will govern how the directors are to proceed, e.g., usually that a majority vote will prevail.
Delegation of tasks
The Articles may authorise directors to delegate the exercise of their powers to a committee consisting of one or more directors, or to a managing director, or other executive director. However, this does not absolve directors of all their responsibility for the management of the company. Others may be appointed others to act or undertake specific actions (e.g. company employees) or to undertake a wide class of activities (e.g. employed as managers). This too does not relieve the directors of their ultimate responsibility. Practical considerations on internal governance may vary depending on the particular company. Directors of smaller companies may be more fully involved in day-to-day activities than those of larger companies and so may not delegate functions to the same extent.
Corporate governance codes
Directors of very large private companies must report on their corporate governance arrangements. However, corporate governance is a separate topic and will not be relevant for the majority of private companies.
Directors’ loans
With some exceptions, a company may not make a loan to its director (or to a director of its holding company) or give a guarantee or provide security in connection with a loan made by any person to that director without the prior approval by resolution of the shareholders of the company (and of the holding company where relevant). The resolution must be accompanied by a memorandum containing specified information concerning the transaction. Exceptions to these requirements for shareholder approval include:
the provision by the company of funds to a director for expenditure on company business if the value of the transaction does not exceed £50,000; and
loans or the provision of a guarantee or security for a loan if the value of the transaction does not exceed £10,000.
Where the company enters into more than one such transaction with the director, there are provisions requiring it to aggregate the value of the transactions in calculating the relevant maximum value.
Directors’ asset transactions
Shareholders’ prior approval is required for the acquisition or disposal of a substantial non- cash asset from or to a director or a person connected with the director; if no approval, the company has various remedies, including reversing the transaction. Substantial non-cash assets are those which either (a) exceed 10% of the company’s net asset value and are more than £5,000 or (b) exceed £100,000.
Indemnities and insurance for directors
A company cannot absolve a director from any liability for negligence, default, breach of duty or breach of trust in relation to the company. It may, however, indemnify the director against certain legal defence costs, if that defence is successful. A company can also buy insurance for its directors against liability for negligence, default, breach of duty or breach of trust by them in relation to the company of which they are a director.
Accounting records
Directors are responsible for keeping “adequate accounting records”. This means records that are sufficient (a) to show and explain the company’s transactions; (b) to disclose with reasonable accuracy, at any time, the financial position of the company at that time; and (c) to enable the directors to ensure that the company’s annual accounts comply with relevant accounting requirements.
Accounting records must be kept for at least three years for private companies. However, accounting and other records will often need to be kept for longer than this to meet other legal requirements. Tax records should be kept for at least six years.
Annual accounts and reports and audit
All companies must prepare annual accounts that give a true and fair view of the assets, liabilities, financial position and profit or loss of the company.
The annual accounts must be approved by the board of directors and signed on behalf of the board by a director of the company. The approval of defective accounts is a criminal offence if the director knew the accounts did not comply, was reckless as to whether they complied or failed to take reasonable steps to secure compliance.
The directors of a company (other than a micro-entity) must prepare a directors’ report for each financial year of the company. The directors’ report must be approved by the board of directors and signed on behalf of the board by a director or the secretary of the company. The information required to be disclosed varies depending upon the size or other characteristics of the company.
With certain exceptions, mainly small companies and micro-entities, companies must prepare a strategic report. The report must be approved by the board of directors and signed on behalf of the board by a director or the company secretary.
Keep a record
How can directors prove they have tried to comply with relevant legal duties described in this note? One of the important purposes of the minutes of board meetings is to provide a record of the board’s decision-making process. By law, these minutes must be kept for 10 years. Years, even months, from now, it may be difficult for you to remember if you fulfilled your directors’ duties in respect of some key decision. The minutes can provide evidence that you did – something that you may well have cause to be grateful for. In simple terms – paper trails are key.
From an individual director’s point of view, it may also be useful to keep you own notes of meetings and important decisions. Finishing where this note began, a significant criticism of many those giving evidence at the Post Office Enquiry has been a general inability to recall key facts and key decisions. As I was once told by a very experienced litigating solicitor, if it comes down to evidence at a trial, then all other things being equal (and I understand they aren’t always) the judge may well be likely to believe the person who made as near contemporaneous notes of what was agreed or discussed, than believe someone relying on memory only.
Finally, “The smell test” [Which may not be legal or technical, but is, to my mind, crucial]
These are final paragraphs from my Submissions to the Post Office Enquiry. It all ought to be fairly obvious, but maybe not to everyone.
“Did anyone stand back and ask themselves the simple question – is this right?”
Justice Neville Owen, Royal Commission into the collapse of HIH Insurance, 2003.
Owen J said: “There’s a moral underpinning to our system of values and we have to keep re- examining them. When you read the reports coming out of the Royal Commission, you ask the question – forget about issues of right and wrong – but what in the hell were they thinking? Did they ever apply the olfactory [“smell”] test? Did they ever go back and ask themselves, ‘What would my grandmother have thought of this?’”
As I noted it may not be a technical legal point but using the “smell test” and some common sense is often a useful yardstick when thinking about many of the matters described in this note.
Article by Nick Gould (Partner) – 14 February 2024