Becoming a Director: Knowing your duties and potential liabilities
Becoming a director is a significant step in your career. As a director, you will be responsible for managing the company on a day-to-day basis with the rest of the board and you will have decision-making responsibilities, whether on an individual basis, as part of a committee or at board-level. As such, you will hold a significant amount of power within the company structure.
However, as the cliché goes, with great power comes great responsibility, and it is important that as a proposed director you are aware of your duties and potential liabilities in office.
What are your duties?
The Companies Act 2006 (CA 2006) sets out the general duties of directors. These require a director to:
- Act within powers - Directors must act in accordance with the company’s constitution and only exercise their powers for the purposes for which they were conferred.
- Promote the success of the company - Directors must act in a way they consider, in good faith, will promote the success of the company for the benefit of its members.
- Exercise independent judgement - Directors must exercise their powers independently and make their own decisions.
- Exercise reasonable care, skill and diligence - Directors must exercise the care, skill and diligence that would be exercised by a reasonably diligent person who has the skills, knowledge and experience of a director in the same position and of the specific director in question.
- Avoid conflicts of interest - Directors must not place themselves in a position where there is a conflict or a possible conflict of interest with the company’s interests.
- Not accept benefits from third parties - Directors must not accept any benefit which is given to them by a third party because they are or because they do (or do not do) anything as a director.
- Declare interests in proposed or existing transactions or arrangements with the company - Directors must declare to the other directors of the company the nature and extent of any interest, direct or indirect, in a proposed transaction or arrangement with the company.
Directors also have responsibilities under other legislation, including in relation to insolvency, environmental, health and safety and employment. In addition, corporate social responsibility requirements are becoming increasingly important to stakeholders, investors, banks and regulatory bodies and directors need to be on-board with these requirements as they affect the individual business, its industry and the market in general.
When will you be liable?
One of the principle tenets of company law is that a company is a legal person, separate to its shareholders and directors; it is an independent entity with its own legal responsibilities. Therefore, as a general rule, company directors cannot be held personally liable for the liabilities and debts of the company. In addition, in civil law, the acts and omissions of directors in the ordinary course of business will be attributed to the company.
However, notwithstanding the protection afforded to directors by virtue of a company’s separate legal identity, they still owe certain obligations to the company, the members and third parties and may therefore incur liability for breaching those obligations.
Where a company is in financial difficulty, directors must tread very carefully. If a director is found to have committed the offence of wrongful trading, they can be ordered by the court to contribute to the company’s assets. A director will risk such liability if, in the lead up to the company’s insolvency:
- they conclude, or ought to have concluded, that there is no reasonable prospect of the company avoiding insolvent liquidation (or administration, as appropriate); and
- fail to take every step that a reasonably diligent person would take to minimise the potential loss to creditors.
Wrongful trading is a complex area to negotiate; it does not require any dishonesty on the director’s part and a director cannot avoid liability by resigning from their post when the company enters a period of financial difficulty.
In addition, a company can itself bring an action against a director if they are in breach of their general duties under the CA 2006 and there are a number of potential remedies available.
Depending on which duty has been breached, the company could bring an injunction or a claim for damages against the defaulting director. Such a claim can also be brought by liquidators in an insolvency situation or, in some limited circumstances, by the company’s shareholders.
Other statutory duties
As mentioned above, directors also have responsibilities relating to other areas, such as environmental and health and safety legislation, breach of which can result in liability. For example, directors may incur criminal liability if it is shown that they have contributed to a breach by the company of the relevant environmental legislation, whether by consent or neglect and can also incur criminal liability if the company fails to comply with relevant health and safety legislation.
How can you avoid liability?
Although the potential liabilities of a company director are significant, there a number of practical steps that can be taken to reduce the risk of your breaching such duties and obligations.
- Know your company - While it may seem obvious that a director should keep abreast of the company’s performance and development, it is vital that you also know your rights, duties and responsibilities under the company’s constitutional documents. Proposed directors should read the company’s articles of association, review the company’s accounts from previous years and find out as much as possible about the company before being appointed as a director. Request to see recent board minutes and don’t be afraid to ask questions about the company, the business and how it is operated. It is also important for a proposed director to determine whether the company has, and the conditions attaching to, any directors’ and officers’ (D&O) insurance, which will cover liability attaching to directors in connection with a breach of their duties.
- Seek independent legal advice - As noted above, directors risk liability for wrongful trading when the company experiences financial difficulties. If a company runs into financial issues, directors should seek independent legal advice as soon as possible to avoid any potential personal liability. More generally, taking independent legal advice about your duties as a director before being appointed will ensure that you are aware of your key responsibilities and provide you with practical suggestions as to how to minimise risk.
- Refresh your skills - The skills required of directors are constantly changing. In recent years, the rise of social media, expanded reporting requirements and an increasing focus on sustainability have altered the priorities of, and the skills required within, boards globally. Now, more than ever, it is important that directors adapt to changing environments, keep up-to-speed with any changes to their legal obligations and ensure that their skills do not stagnate. Attend regular training, seminars and conferences, read relevant articles and have open discussions with other directors about their roles and responsibilities (subject of course to confidentiality requirements) to keep current.
For more information, please contact our Corporate team.
This note reflects our opinion and views as of 11 June 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.