Corporate governance and compliance - Rights, duties, and powers of directors

Learning Outcomes

This article outlines the key legal principles governing the rights, duties, and powers of company directors in England and Wales. It covers the statutory duties under the Companies Act 2006, processes for appointment and removal, and potential liabilities directors face. After reading this article, you will understand the core responsibilities of directors and how these fit within the corporate governance framework relevant to the SQE1 assessments. This knowledge will help you apply the relevant legal rules to SQE1-style multiple-choice questions concerning directors' conduct and corporate compliance.

SQE1 Syllabus

For SQE1, you are expected to have a practical understanding of the corporate governance framework as it applies to directors. This involves knowledge of their appointment, removal, powers, and crucially, their statutory and fiduciary duties. You may be tested on identifying breaches of duty or advising on the correct procedures in specific scenarios.

Pay particular attention during your revision to:

• The process for appointing and removing directors.
• The general duties of directors as codified in the Companies Act 2006 (ss 171–177).
• The concept of directors' authority and how they bind the company.
• Situations requiring shareholder approval for directors' actions.
• Potential liabilities directors face, including disqualification.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which section of the Companies Act 2006 outlines the director's duty to advance the success of the company?
   1. s 171
   2. s 172
   3. s 174
   4. s 175

2. True or false? A director's duty to exercise reasonable care, skill, and diligence under s 174 CA 2006 involves only a subjective test based on that specific director's actual knowledge and experience.

3. Can shareholders remove a director by ordinary resolution even if the director's service contract has 3 years left to run?

4. What type of resolution is generally required for shareholders to ratify a director's breach of duty?

Introduction

Directors are central figures in the governance and management of a company. They hold significant power but are also subject to stringent legal duties and potential liabilities. Understanding the scope of their rights, duties, and powers is fundamental for advising companies and stakeholders. This article explores the legal framework governing directors under the Companies Act 2006 (CA 2006) and associated common law principles, focusing on aspects relevant to the SQE1 examination.

Appointment and Status of Directors

A company must have appointed directors to manage its business. The definition and requirements surrounding directors are key starting points.

Who is a Director?

The CA 2006 defines a director broadly.

Key Term: Director
Includes any person occupying the position of director, by whatever name called (s 250 CA 2006).

This definition encompasses not only formally appointed directors (de jure directors) but also those who act as directors without formal appointment (de facto directors) or those whose instructions the board typically follows (shadow directors).

Key Term: De Jure Director
A director who has been validly appointed in accordance with the company's articles and the CA 2006.

Key Term: De Facto Director
A person who assumes the role and functions of a director and acts as such, even though not validly appointed.

Key Term: Shadow Director
A person in accordance with whose directions or instructions the directors of the company are accustomed to act (s 251(1) CA 2006). Professional advisers acting in their professional capacity are excluded (s 251(2)).

For SQE1 purposes, remember that many statutory duties and liabilities apply equally to de facto and shadow directors.

Appointment Process

The first directors are usually named in the application for incorporation (Form IN01). Subsequent directors are typically appointed according to the company's articles of association.

Key Term: Articles of Association
The internal rulebook of a company, forming part of its constitution, which governs matters such as the appointment and powers of directors.

The Model Articles for private companies (MAs) allow appointment by either an ordinary resolution of the shareholders or a decision of the existing directors (MA 17).

Once appointed, the company must notify Companies House within 14 days (Form AP01 for individuals, AP02 for corporate directors) and update its internal register of directors (s 162 CA 2006) and register of directors' residential addresses (s 165 CA 2006).

Minimum Number and Eligibility

• Private companies need at least one director (s 154(1) CA 2006).
• Public companies need at least two directors (s 154(2) CA 2006).
• At least one director must be a natural person (s 155(1) CA 2006).
• Directors must be at least 16 years old (s 157 CA 2006).
• A person cannot be a director if they are an undischarged bankrupt or subject to a disqualification order under the Company Directors Disqualification Act 1986 (CDDA 1986).

Powers of Directors

Directors derive their powers primarily from the company's articles of association.

General Management Power

MA 3 grants directors broad powers: 'Subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company.' This empowers the board to make most day-to-day operational decisions.

Decision-Making

Directors typically make decisions collectively at board meetings (BMs) by passing board resolutions (BRs).

Key Term: Board Resolution (BR)
A decision made by the directors, usually by a simple majority vote at a quorate board meeting (MA 7) or by unanimous agreement outside a meeting (MA 8).

The MAs set the quorum for BMs at two directors (MA 11), unless the company only has one director (MA 7(2)).

Delegation

Directors can delegate specific powers to individuals or committees (MA 5). However, delegation does not absolve the board of overall responsibility for supervising the exercise of those powers.

Limitations and Shareholder Involvement

Directors' powers are not absolute. They are limited by:

• The company's articles.
• Statutory provisions requiring shareholder approval for certain decisions (e.g., substantial property transactions (s 190 CA 2006), long-term service contracts (s 188 CA 2006), loans to directors (s 197 CA 2006)).
• Shareholders' power to direct the board by special resolution (MA 4).

Authority to Bind the Company

As agents of the company, directors can bind the company contractually if they act within their authority. This can be:

• Actual authority: Expressly granted (e.g., in articles or service contract) or implied (e.g., based on the director's role or past conduct accepted by the board).
• Apparent (or Ostensible) authority: Arises where the company represents (by words or conduct) that a director has authority, and a third party relies on that representation.

Section 40 CA 2006 protects third parties dealing with the company in good faith, providing that the directors' power to bind the company is deemed free of constitutional limitations.

Directors' Duties

The CA 2006 codifies the main general duties directors owe to the company (s 170(1)). These largely reflect previous common law and equitable principles, which remain relevant for interpretation (s 170(4)).

Duty to Act Within Powers (s 171)

Directors must act in accordance with the company's constitution (usually the articles) and only exercise powers for the purposes for which they were conferred (the 'proper purpose' doctrine). Using powers for an ulterior motive, such as issuing shares solely to dilute a shareholder's voting power rather than raise capital, would be a breach (Howard Smith Ltd v Ampol Petroleum Ltd [1974]).

Duty to Advance the Success of the Company (s 172)

This is a fundamental duty. Directors must act in the way they consider, in good faith, would be most likely to advance the success of the company for the benefit of its members as a whole. Section 172(1) lists non-exhaustive factors directors must have regard to:

• Likely long-term consequences.
• Interests of employees.
• Need to nurture business relationships (suppliers, customers etc.).
• Impact on community and environment.
• Desirability of maintaining high standards of business conduct.
• Need to act fairly between members.

The test is primarily subjective ('the way he considers'), but must be exercised in 'good faith'. A decision no reasonable director could consider to be in the company's interest may breach this duty (Re Southern Counties Fresh Food).

Key Term: Enlightened Shareholder Value
The approach forming the basis of s 172 CA 2006, where the primary focus is the members' benefit, but with mandatory consideration of wider stakeholder interests and long-term consequences.

Crucially, if the company nears insolvency, the focus shifts towards the interests of creditors (s 172(3)).

Duty to Exercise Independent Judgment (s 173)

Directors must exercise their own judgment and not improperly defer to the will of others. They can rely on advice but must make their own assessment. This duty is not breached by acting in accordance with a prior company agreement or as authorised by the constitution (s 173(2)).

Duty to Exercise Reasonable Care, Skill, and Diligence (s 174)

This duty sets the standard of competence expected. It has both objective and subjective elements (s 174(2)):

• Objective: The care, skill, and diligence expected of a reasonably diligent person carrying out that director's functions.
• Subjective: The general knowledge, skill, and experience that the particular director actually has.

The director must meet the higher of these two standards. A director with specialist proficiency (e.g., an accountant acting as finance director) is held to a higher standard reflecting that proficiency. Directors must keep themselves informed about the company's affairs (Re Barings plc (No 5) [2000]).

Duty to Avoid Conflicts of Interest (s 175)

Directors must avoid situations where their personal interests conflict, or could possibly conflict, with the company's interests. This applies particularly to exploiting company property, information, or opportunities, even if the company could not take advantage itself (s 175(2)).

Worked Example 1.1

Asha is a director of TechBuild Ltd. She learns through a board meeting that TechBuild Ltd plans to bid for a lucrative government contract. TechBuild Ltd decides not to proceed due to resource constraints. Asha resigns and immediately forms her own company, which successfully bids for the same contract using information gained while she was a director at TechBuild Ltd. Has Asha breached any duties?

Answer: Yes, Asha has likely breached her duty under s 175 CA 2006. The duty to avoid conflicts applies even after resignation concerning opportunities or information obtained during her directorship. The fact that TechBuild Ltd decided not to pursue the opportunity is irrelevant (s 175(2)). She exploited an opportunity belonging to the company.

Authorisation by non-conflicted directors (for private companies, unless articles prohibit) or shareholders can permit a conflict (s 175(4)-(6)).

Duty Not to Accept Benefits from Third Parties (s 176)

Directors must not accept benefits (e.g., bribes, commissions) from third parties given because they are a director or because they do (or don't do) something as a director. There's an exception if acceptance cannot reasonably be seen as likely to create a conflict (s 176(4)). Authorisation for breach of this duty can only come from shareholders (s 180(4)).

Duty to Declare Interest in Proposed or Existing Transactions (s 177 & s 182)

Directors must declare the nature and extent of any direct or indirect interest in a proposed transaction or arrangement with the company to the other directors before the company enters into it (s 177). A similar duty exists under s 182 to declare interests in existing transactions as soon as practicable. Exceptions apply if the interest is not likely to cause a conflict, or if the other directors are already aware (or ought reasonably to be aware). Failure to declare under s 182 is a criminal offence (s 183).

Key Term: Connected Person
Includes a director's family members (spouse, partner, children, step-children, parents) and companies where the director and/or connected persons control >20% of voting rights (ss 252-254 CA 2006). Relevant for duties and transaction approvals.

Consequences of Breach and Relief from Liability

Remedies

Breaches of duties under ss 171-173 and 175-177 can lead to equitable remedies such as an account of profits, rescission of contracts, restoration of property, or an injunction. Breach of the duty of care (s 174) leads to common law damages for negligence (s 178).

Ratification

Shareholders can ratify (approve) a director's negligence, default, breach of duty, or breach of trust by passing an ordinary resolution (s 239 CA 2006). The votes of the director concerned (if a shareholder) and any connected persons do not count if their votes are decisive. Ratification absolves the director from liability to the company for that specific breach. Ratification is not possible for illegal acts or fraud on the minority.

Relief by Court (s 1157)

The court has discretion to relieve a director from liability if they acted honestly and reasonably, and ought fairly to be excused.

Removal and Disqualification

Directors can cease to hold office through various means.

Resignation or Retirement

Directors can resign at any time by giving notice (MA 18(f)). Retirement might occur under specific article provisions (e.g., retirement by rotation in PLCs) or upon reaching an age limit if stipulated.

Removal by Shareholders (s 168)

Shareholders have a statutory right to remove a director by ordinary resolution at a general meeting, regardless of any provision in the articles or the director's service contract (s 168(1)).

• Special notice (28 clear days) must be given to the company of the intention to propose the resolution (s 168(2), s 312).
• The director has the right to make representations and speak at the meeting (s 169).
• This resolution cannot be passed by written resolution (s 288(2)(a)).
• Removal under s 168 does not prejudice any claim for compensation or damages for breach of contract (e.g., under a service agreement) (s 168(5)).
• Weighted voting clauses (Bushell v Faith clauses) in the articles can sometimes frustrate removal.

Disqualification

The Company Directors Disqualification Act 1986 allows courts to disqualify individuals from being directors for 2-15 years on grounds including:

• Conviction for an indictable offence connected with company management.
• Persistent breaches of companies legislation (e.g., filing requirements).
• Fraudulent or wrongful trading (ss 213, 214 IA 1986).
• Being an unfit director of an insolvent company (most common ground).

A disqualified person cannot act as a director or be involved in company management without court leave. Breach is a criminal offence and can lead to personal liability for company debts (s 15 CDDA 1986).

Summary

Directors hold extensive powers to manage a company but are constrained by significant statutory and fiduciary duties owed to the company. Understanding these duties (ss 171-177 CA 2006), the procedures for their appointment and removal, and the potential for personal liability or disqualification is critical for advising on corporate governance and compliance matters. Shareholders retain ultimate control through their power to appoint/remove directors and approve certain key transactions.

Key Point Checklist

This article has covered the following key knowledge points:

• Directors manage the company and can be de jure, de facto, or shadow directors.
• Appointment usually occurs via board resolution or ordinary shareholder resolution, as per the articles.
• Directors' powers derive from the articles (e.g., MA 3) but are subject to statutory limits and shareholder direction (e.g., MA 4).
• Directors owe general duties to the company under ss 171-177 CA 2006, including acting within powers, advancing success, exercising independent judgment, and reasonable care, avoiding conflicts, not accepting third-party benefits, and declaring interests.
• Breaches can lead to remedies like damages, account of profits, or injunctions.
• Shareholders can ratify certain breaches by ordinary resolution (s 239).
• Directors can be removed by ordinary resolution (s 168) with special notice procedures.
• Disqualification under CDDA 1986 prevents individuals from acting as directors.

Key Terms and Concepts

• Director
• De Jure Director
• De Facto Director
• Shadow Director
• Articles of Association
• Board Resolution (BR)
• Enlightened Shareholder Value
• Connected Person