Directors’ Duties

The directors of a company have duties which are codified in legislation or derived from common law rules. The key source of legislation for directors’ duties is the Companies Act 2006. 

Directors’ Duties Under The Companies Act 2006

1. Directors’ duty to act within powers (section 171)

Under section 171 of the Companies Act 2006. A director of a company must:

• Act in accordance with the company’s constitution (section 171(a)).

• Only exercise powers for the purposes for which they are conferred (section 171(b)).

Section 171(a)

For the purposes of this section, “constitution” is widely defined and includes not just the company’s articles of association but also certain resolutions and shareholder decisions. 

Directors will be in breach of the section 171 duty where they cause the company to do something beyond its powers or which it otherwise cannot lawfully do e.g. causing the company to make unlawful distributions or entering into a transaction that has not been authorised by the board.

Section 171(b)

The duty under section 171(b) of the Companies Act 2006 is widely known as the “proper purpose” rule. The Supreme Court, in the case of Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas plc [2015] UKSC 71, reaffirmed the rule emphasising that the rules is concerned with an abuse of power rather than an excess of power i.e. the rules is concerned with acts that are within the scope of a director’s power but which are done for an improper reason. Therefore the test as to whether the rules has been broken in a subjective one.

The subjective nature of the proper purpose test means that board decisions are open to challenge even where there is no suggestion of bad faith. 

Examples of directors breaching the section 171(b) duty include:

• Misappropriating or misapplying funds.

• Operating directors loan accounts on non-commercial terms.

• Exercising powers to control or influence the outcome of a general meeting.

2. Directors’ duty to promote the success of the company (section 172)

Section 172 of the Companies Act 2006 provides that a director must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole. In so doing the director must have regard to:

• The likely consequences of any decision in the long term.

• 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.

Where the company’s purposes consist of or include purposes other than for the benefit of members, the directors must act in the way they consider, in good faith, would be most likely to achieve those purposes.

The section 172 duty is also subject to any enactment or rule of law requiring directors in certain circumstances to consider or act in the interests of the creditors of the company.

3. Directors’ duty to exercise independent judgment (section 173)

Section 173 of the Companies Act 2006 codified the principle under which directors must exercise their powers independently, without subordinating their powers to the will of others. For example a director cannot:

• Defer to the wishes of a shareholder, another director or another personality without bringing their own independent judgment to bear on the issue.

• Agree with a third person (such as their appointing shareholder) to vote at board meetings in any particular way, even if voting in that way would not otherwise have breached the director’s duties to the company.

4. Directors’ duty to exercise reasonable care, skill and diligence (section 174)

Under section 174 of the Companies Act 2006, a director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both: 

• The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company (the objective test).

• The general knowledge, skill and experience that the director actually has (the subjective test).

So, at a minimum, a director must display the knowledge, skill and experience set out in the objective test, but where a director has specialist knowledge, skill or experience, the higher subjective standard must be met. In applying the test, regard must be had to the functions of the particular director, including their specific responsibilities and the circumstances of the company.

In Wright v Chappell [2024] EWHC 1417 (Ch) two directors of a company were held to have breached the section 174 duty by (among other things) failing:

• To take legal advice.

• To call a board meeting, to consider and record why a proposed course of action was in the interests of a company and its creditors; and

• To attend board meetings.

5. Directors’ duty to avoid conflicts of interest (section 175)

Under section 175 of the Companies Act 2006, a director must avoid situations in which they have or can have a direct or indirect interest that conflicts with, or may conflict with, the company’s interests. That applies, in particular, to the exploitation of any property, information or opportunity, and whether or not the company could take advantage of the property, information or opportunity.

The duty to avoid conflicts of interest will continue to apply after a person ceases to be a director as regards the use of any property, information or the taking of any opportunity of which they became aware when they were a director.

The application of section 175 can be problematic for directors who sit on more than one board. Board authorisation of another directorship may not always be wide enough to cover the conflict in question and a director may be unable to disclose particulars to the company when they arise, for example for reasons of confidentiality. In such circumstances, directors should seek independent legal advice.

6. Directors’ duty not to accept benefits from third parties (section 176)

Under section 176 of the Companies Act 2006 directors must not accept any benefit from a third party which is conferred because of their being a director or doing or not doing anything as a director.

Companies may wish to provide in their constitutions that where directors accept benefits under a specified value, they will not be in breach of their duty to the company, for example to ensure that the acceptance of a certain level of corporate hospitality will not cause a director to breach section 176.

The duty will continue to apply after a person ceases to be a director in relation to things done or omitted by them before they ceased to be a director.

7. Directors’ duty to declare interest in proposed transaction or arrangement with the company (section 177)

Under section 177(1) of the Companies Act 2006, where directors are in any way directly or indirectly interested in a proposed transaction or arrangement with the company, they must declare to the other directors the nature and extent of that interest. 

Only full and frank disclosure is consistent with the purpose of the section 177 duty (to allow the other directors, on behalf of the company, to decide whether to enter into the proposed transaction or arrangement and, if so, on what terms).

The creditor duty

The duty in section 172 of the Companies Act 2006 to promote the success of the company for the benefit of its members as a whole is expressly subject to any enactment or rule of law requiring directors in certain circumstances “to consider or act in the interests of creditors of the company” (section 172(3)). Examples of these enactments or rules of law are:

• The wrongful trading provisions on the Insolvency Act 1986.

• The “creditor duty”.

The term “creditor duty” was adopted by the court in BTI 2014 LLC v Sequana SA and others to describe the common law rule existing before the Companies Act 2006 came into force that, for a director to discharge their duty to act in good faith:

• In certain circumstances, typically when the company is insolvent or borderline insolvent:

• those interests include the interests of the company’s creditors as a whole; and

• directors must consider those interests and give them proper weight, if necessary by prioritising them.

• At a certain point, probably when insolvent liquidation or administration becomes inevitable, creditors’ interests become paramount.

The majority of the court in Sequana discussed what was meant by “borderline insolvency” their view being that either:

• the company, while not insolvent, is bordering on insolvency (also referred to as imminent insolvency); in other words, the directors know or ought to know that an insolvency is just around the corner and going to happen; or

• an insolvent administration or liquidation is probable.

Scenarios in which it may be alleged that the creditor duty, having been engaged, has been breached include:

• Taking on a particularly high risk transaction which, in the not unlikely event that it were to fail, would result in the company’ assets being lost to creditors.

• Allowing the company to continue trading, increasing the deficiency to creditors and reducing their return on a probable formal insolvency.

• Excessive director remuneration.

• Asset transfers or loans to directors or related parties or group companies.

Consequences of breach of the creditor duty

The main consequence is that liquidators may apply for the court to examine the conduct of directors and potentially order them to make a repayment to the company’s assets on account of their breach of duty. The Directors may be disqualified from holding office.

Also, the court can declare that the directors did not have the authority to enter into the relevant transactions and declare them void.

Who owes directors’ duties?

Directors’ duties are owed by all persons who have been appointed directors and those who have assumed the responsibility to act as a director even though they were not appointed e.g. shadow directors.

The Companies Act 2006 makes no difference between an executive and a non-executive director.

Directors owe duties to the company

The starting position is that the Companies Act directors’ duties are owed by directors to the company. However:

Shareholders may be able to bring derivative claims on the company’s behalf.

Liquidators, creditors and shareholders can apply under section 212 of the Insolvency Act 1986 for the court to examine the behaviour of directors and potentially order them to make a repayment or contribution to the company’s assets in light of their breaches of duty.

Duration of duties

Generally, directors’ duties start on becoming a director and end when the director ceases to hold office. However, the duty to avoid conflicts of interest will continue to apply as regards the exploitation of any property, information or opportunity of which a director became aware at a time when they were a director. 

Also, the duty not to accept benefits from third parties will continue to apply as regards things done or omitted by directors before they ceased to hold office.

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