Introduction
Company Directors are in a position of trust within their companies. The knowledge and power they acquire through their offices creates a potential framework for abuse, whereby Directors act for personal gain. The media is filled time and again with scandals concerning misappropriation of company funds, bribes and secret profits. It is well known that a Director faces severe criminal penalties for such conduct.
What is less well known however, is the vast array of duties and obligations placed on Directors by contracts and the law. Breaching these duties and obligations can result in a Director being disqualified for a fixed period at the discretion of the court and having to pay compensation, in addition to the criminal sanctions already referred to.
Directors ought to note the following duties:
- Fiduciary Duties
- Duty to act in good faith in the best interests of the Company
- Duty to act for proper purposes
- Duty not to make secret profits
- Duty to avoid conflicts of interest
- Common Law Duties
- Duty of skill and care
- Duty of Mutual Trust and Confidence
- Statutory Duties
- Duties to creditors and employees
- Duty to disclose interests in contracts
- Duty to observe restrictions on, inter alia, loans to Directors and substantial property transactions
- Health and Safety duties
- Procedural requirements
- Contractual Duties (depending on the
extent to which they are incorporated into the service agreement)
- Confidentiality
- Non compete
- Post termination restraints
Fiduciary Duties
Fiduciary duties emanate from general common law principles which have been developed by the courts over time, including those relating to trust and unconscionable behaviour. These duties are extremely general in nature since they are based on the courts’ interpretation of what amounts to fair and reasonable behaviour. Although there is no fixed definition of what amounts to fair and reasonable behaviour as this changes with social norms, the standard duties imposed are: to act in good faith in the best interests of the company; to act for proper purposes; not to make secret profits and to avoid conflicts of interest.
There are obvious examples of how these standard duties operate. Accepting bribes to endorse a contract which is not as advantageous as could otherwise be achieved is not in the best interests of the company. In addition, directors must be open and honest in their dealings with the company and freely acknowledge any personal profits they expect to achieve from the company’s activities. This said, it is unclear how far the general duties to act in good faith in the best interests of a company extend. Courts have been unwilling to define key terms further as this would limit their discretion and ability to achieve 'justice'.
'Good Faith' has long been equated with honesty although a recent employment law case, Street v Derbyshire Unemployed Workers' Centre (21 st July 2004), seems to suggest that honesty is not enough and some purity of motive is required. This, although not necessarily increasing the onus on directors, is indicative of the courts' gradual shift towards imposing more stringent duties of good faith generally.
A key case in this area in 2004 was Fassihi -v- Item Software (UK) Ltd in which the Court of Appeal held that the director owed a duty to confess his own misconduct to the company. In that case the director, Mr Fassihi, had set up a competing business and attempted to secure a lucrative contract from an existing customer of the company. The Court decided that Mr Fassihi had acted in breach of his fiduciary duty to act in good faith by failing to disclose his personal misconduct and conflict of interests. This meant that he had to account to the company for the profit that he had made.
Common Law Duties
Aside from the fiduciary duties detailed above, there are general common law duties imposed on directors in various circumstances. There will always be a duty to carry out tasks with reasonable care and skill. This is interpreted as the reasonable care and skill of someone competent to do the job and does not mean 'to the best of one's incompetent ability'.
In the case of executive directors, there are common law terms implied into the contract of service. These are implied into all contracts of employment and are designed to protect the director as an employee of the company. The duty of mutual trust and confidence is a duty owed by the director to the Company (and vice versa) in the context of the employer/employee relationship. It is entirely separate from the fiduciary duties outlined above which apply to the office of director. The duty of mutual trust and confidence is one such duty. Directors as officers of the company owe this duty to other directors as employees of the company. This usually becomes an issue when an executive Director brings a complaint of unfair dismissal or the company seeks to remove and executive director.
Most companies will not be content to rely on the common law and will have codified terms into a contract of employment. You should be aware though that a contract of employment is not always definitive and the courts will often infer the existence of implied terms to fill any gaps. In doing so, they will usually rely on what they see as 'reasonable' in the circumstances.
Statutory Duties
Statutory duties of directors are mainly procedural in nature. There are many duties set out in the Companies Act 1985 and supporting legislation concerning requirements such as filing appropriate annual returns and keeping company records. There are also important duties of disclosure imposed on directors, and accompanying restrictions on voting on issues in which a director is interested although some companies could opt out of such restrictions through altering their articles of association. Furthermore there are significant restrictions on financial assistance, substantial property transactions involving directors and on a company making loans to directors. Breach of these restrictions can have severe consequences.
Of greater concern to many directors is the personal liability they may incur to the company and/or third parties if they exceed their authority as a director or to creditors and employees if the company becomes insolvent. For example, there are some instances in which the courts could hold directors personally liable for debts incurred by a company where the directors ought to have known that the company was insolvent. Please refer to our Insolvency pages, found in the Litigation section of our Website, for general guidance on how to minimise your potential liability if your company is in financial difficulties.
To avoid exceeding your authority as a director, you should ensure that the remit of your powers are defined to your satisfaction and that you are acting within them. If in doubt you should always call a Board or, if necessary, general meeting of the company to ensure that your decisions are approved.
Contractual Duties
These will mainly be of concern to executive directors with detailed service agreements. It should be remembered that, even if there is an express term in your contract, there are certain duties and rights which the courts will not enforce. For example, post termination covenants are regarded by the courts as void unless they are reasonable and seen to be addressing a legitimate concern of the company. Please see the Employment section of our Website for a fuller discussion.
It is also important to recognise that contractual obligations are voluntary, and that contracts can be varied by consent (subject to certain limitations), unlike the other obligations discussed above. However, please note that you cannot contract out of many of the legal obligations discussed above.
Recent Developments
2004 has been hasen an important year in this area and the changes are set to continue throughout 2005. The Government has published, in the Companies Bill, proposals to codify duties of Directors and to allow companies to reach agreements with auditors for the apportionment of liability to third parties. There have also been a number of important cases which have confirmed or expanded on the principles discussed above. For further information and individual advice on this complex and rapidly developing area of the law, contact Christopher Sykes.
Please note that this area of the law is a complex subject and you should not take or refrain from taking any step without full legal advice on your particular circumstances. The content of this article is of a general nature and no liability is accepted in connection with it or if any reliance is placed on it.
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