Chapter 5 - Directors Duties & Powers

Question 1

Why do companies need directors?

Answer 1

• The company is an independent legal personality and cannot operate itself
• Company cannot be solely operated from the AGM of shareholders. The board is chosen by the shareholders to run the company, it decides the strategy and appoints the management to achieve the strategy.

Question 2

What does CA2006 require regarding directors?

Answer 2

s.154(1)- private company to have at least 1director (does not confer any management powers on them.)

s.154(2) public company to have at least 2 directors.

s.250 a director is any “person occupying the position of director, by whatever name called” (so can include shadow directors)

Question 3

What is the main source from which directors derive their powers?

Answer 3

Articles of Association

Question 4

Where might one find limitiations on directors’ management powers?

Answer 4

• Article giving a specific restriction (ex. borrowing powers)
• Shareholder agreements
• Objects clause, if it has one (not required post- CA2006)
• Article allowing members to give instruction to directors
• CA2006 / other rules and regulations such as the Listing Rules (often procedural conditions)

Question 5

What are some special powers that are commonly conferred on directors’ by articles?

Answer 5

• Reject share transfers
• Delegation
• Forfeiture of shares
• Chair’s right to casting vote
• Power to set and pay directors remunerations/fees

Question 6

Is setting the company’s strategy a management decision?

Answer 6

Yes.

One of several management decisions per UKCGC which must be performed by board.

It would be wrong to suggest that the board delegates all management responsibility to the executive directors

Question 7

What is a de facto director?

Answer 7

Someone carrying out function / role of a director but without being formally appointed.

Per s.250 - Courts will treat them as directors

Question 8

What tests can be applied to establish if someone is a de facto director?

Answer 8

DTI v Chacra & Sapay [1998] the court provided the test for establishing a de facto director:

• Had he held himself out as a director?
• Did he use the title director?
• Did he have access to all relevant information to make decisions?
• Did he make major decisions for the company

Question 9

What is a shadow director?

Answer 9

s.251 CA20065- “person in accordance with whose directors and instructions the directors of the company are accustomed to act”

s.251(2) - giving professional advice will not count, nor is a holding company to be treated as a shadow director of any subsidiaries

Question 10

Can shareholders interfere in the management of a company?

Answer 10

• Articles must provide an express mechanism for them to do.
• Article 4 of the Model Articles for PLCs provide that shareholders can deliver instructions via Special Resolution for directors to take / refrain from taking specified action.
• Will not use often in practice (activists might for publicity but rarely expect success) - as it is easier to seek removal of a director or appoint new ones - both of which can be done by ordinary resolution (albeit special note required).

Question 11

What are the 7 general duties of directors per CA2006?

Answer 11

• S.171 - within powers/for reason conferred
• S.172 - promote success of company
• S.173 - independent judgement
• S.174 - reasonable care, skill, diligence
• S.175 - avoid conflicts of interest
• S.176 - not accept benefits from third parties
• S.177/S.187 - relate to transactions (before/after) but are not general duties

Question 12

To whom do the directors owe general duties?

Answer 12

The company as a whole - not directly to the shareholders. Represents directors carrying out their function as agents of the company (principal).

Question 13

What are the two primary duties owed to a company?

Answer 13

• Common law (relatively light)
• Equitable fiduciary (more onerous)

Question 14

What the main fiduciary duties trustees owe to beneficiaries?

Answer 14

• Act in good faith and in interests of the beneficiaries
• Act In accordance with trust deed
• Not to make profit from position (ex. bribes…)
• Not place selves in position own interest(s) conflict with fiduciary duties
• Not act own advantage/benefit of 3rd person without benficiariary’s informed consent
• Proper investment of trust property

Question 15

What are the reminders for a breach of the general duties?

Answer 15

Will depend on the nature of the breach
<br></br>Generally - made to repay any illegal payments received or repay any secret profits they have made
<br></br>Where a breach of duty of skill and care or have acted beyond powers company can be awarded compensation for any losses it has suffered
<br></br>Where directors act outside powers, the courts cannot normally declare the transaction void. Where they have used their powers for improper purposes, the transaction can be declared void.
<br></br>Where a director has failed to disclose interest in a transaction, the company can choose whether or not to treat that transaction as void.

Question 16

Where might a breach of s.171 arise?

Answer 16

• Individual/board do something beyond company’s powers
• Individual/board do something within powers of the company, but not within their own powers

Question 17

What conditions are set out in respect of s.171 by s.39 and s.40 ?

Answer 17

• CA 2006 s.39 – the validity of an act done by company shall not be called into question on grounds of lack of capacity by reason of the company’s constitution

<br></br>
- CA2006 s.40 – in favour of person dealing with a company company in good faith, the power of the board to bind the company be deemed free of any limitation in the company’s articles
Both mean third parties can generally enforce contracts against a company even if the directors entered into it illegally
<br></br>Will not affect personal liability of directors to compensate the company for any losses arising from a breach of duty
<br></br>If contract was entered into with a director - s.39/40 would not help as director concerned could not be considered as someone dealing with the company in good faith

Question 18

Can transactions be declared void on the basis that the directors have exceded their powers/used their powers for improper purpose?

Answer 18

Exceed powers - transaction still enforceable by third parties ‘dealing with the company in good faith’
<br></br>Directors can still be sued for any losses suffered by the company as a result of the breach. <br></br>
Where directors have used their powers for improper purpose, the transaction can be declared void.

Question 19

Why are directors rarely sued for exceeding powers?

Answer 19

• No more or very wide objects clause
• Where company has a restrictive objects clause - company must have suffered a loss to make it worth suing directors.

Question 20

Why might shareholders prefer a company has a restrictive objects clause?

Answer 20

Stop board unilaterally expanding the business into areas the shareholders and/or directors do not have any experience in.

Question 21

Why are cases regarding ‘improper purpose’ part of s.171 more common than the other part?

=

Answer 21

• Happens more often<br></br>
• Directors do not understand underlying rule - from AoA alone they genuinely believe their power is unrestricted
• Remedies the courts arewilling to apply include declaring the improper transaction void

Question 22

What can the Company Secretary ensure so directors are less likely to breach s.171 duty?

Answer 22

• Powers and delegation of authority are properly documented, for example:
  o Schedule of matters reserved for the board
  o Committee terms of reference
  o Authority matrix for management
• It’s clear that when powers being exercised that they are exercised by proper body/individual – whether the board, a committee or an individual such as the CEO.
• Directors are aware of what powers they have under the Articles and which are granted by shareholder resolution. Should be aware if/when those granted by shareholder approval should be renewed (for example. Authority to allot will expire after max of 5 yrs)

Question 23

What are the key factors directors should have regard to re S.172?

Answer 23

• Consequence in long-term
• Interests of employees
• Need to foster business relationships (customers, suppliers, etc)
• Impact on society and environment
• Desirability to maintain reputation for high standards of business conduct
• Need to act fairly between members of the company

Question 24

Who can enforce s.172?

Answer 24

The company - not stakeholders

Question 25

What is the purpose of the strategic report according to CA2006?

Answer 25

Inform members of the company and help them assess how the directors have performed their duty under s.172 to promote the success of the company - CA2006 s.414C

Question 26

***What is meant by 'promoting the success of the company"?***

Answer 26

* Should promote success in best **interests of the members as a whole**. * Must have **regard** to **consequences** of decision(s) in **long-term** and **various other matters** **(ss.B-F)** * **Success** can be **equated** as **whatever is in the best interests of company** and its **members**. Other **interests** can/should be taken into **account** but **primarily** is **shareholders** is paramount. **Benefit** to members **does not need to be immediate** (ex. longer term ROI) * Ex. as company main sustain a loss before becoming profitable (tech companies).- this won't be considered a breach of duty as long as the **directors truly believed it to be in best interests overall/at the time**. Recognises the need for an **happy** **workforce**, **good business rships** and a **reputation for high business standards**. Also **may hurt** company if **bad society/environmental impact due** to its decisions/activities.

Question 27

Do the directors need to consider stakeholder interests whenever they make a decision?

Answer 27

Where a decision **may impact** on the interest of shareholders, their **interests** should be **taken into account**, but **not all decisions** will **have** an **impact** on stakeholders. **Some** may **only** have a very **minor** or **theoretical** impact.
**No need to record** that the board has had **regard** for stakeholders who the decision has **little/no impact on**.
It is more **important** to **record** where a decision/action has a **major impact** on a stakeholder
The **fact** that is may **not** be **in** one stakeholder (or group's) **interests** will **not prevent** the company **making** the **decision** anyway.

Question 28

What key guidance is set out by ICSA's guidance regarding s.173 duty?

Answer 28

- **Personal Interests** - should not let these outweigh those of company (excuse themsleves where their personal interests a topic) - **Family Companies** - can consult with family but ultimate decision must be clearly independent - **Executive Collective Lines**- should not promote without due consideration, board members should have benefit to exercise their own independent judgement - **Shareholder representatives/JVs**: Shareholder reps should 'set aside all representative function. Care should be taken in the case of Joint Ventures. A director will not be in breach where acting in accordance with a JV agreement to which the company is a party. - **Subsidiaries**: directors of subsidiaries should take interests/needs of the parent/group into account where needed, but should ultimately act in the best interests of the company of which they are a directors - this can cause tensions (Scottish Coop Wholesale Society vs Meyer) - **Legal/other professional advice**: this can be obtained by directors, but their final decision must be independent - **Delegation** - directors may delegate but this must be appropriate and they must still exercise their own indepedent judgement. They cannot simply abrogate all responsibility.

Question 29

When will a director representing an outside interest *not* be in breach of s.173?

Answer 29

Where: - No **concealment** - **Consent** of the company - Can **preserve** a substantial degree indepedent discretion - Their outside interest does not **override** interests of the company

Question 30

What is the leading case law regarding s.174 duty?

Answer 30

Dorchester Finance Co. V Stebbing

Question 31

What are the two tests to determine a directors' responsibility under s.174?

Answer 31

Under s.174(2) - a director owes a duty to the company to exercise the same standard of care, skill and diligence that would be exercised by a reasonably diligent person with: - **OBJECTIVE TEST**: 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 (an objective test); and - **SUBJECTIVE TEST**- the general knowledge, skill and experience that the director has.

Question 32

To what extent can directors rely on other company officials?

Answer 32

Unless **specific grounds to suspect dishonesty/incompetance** – directors are entitled to leave routine day-to-day business conduct to management - If **management appears honest**- they/their **info** can be **relied on** by directors - **Not** part of **duty** of skill/care to **question** **reliability** of info/**whether** info **withheld**

Question 33

What would need to be proven for s.174 breach to suceed in court?

Answer 33

Courts in the UK are **generally reluctant** to **condemn** business decisions made by directors that appear, in hindsight, to show **errors of judgement**. Directors **can exercise** reasonable skill and care, **but** **still make bad decisions**.

Question 34

Can directors delegate s.174 duty? ## Footnote N

Answer 34

No, whilst directors have the power to delegate this will not absolve director completely from duty of skill/care. - Can **breach** by **failing** to exercise **adequate supervision** of delegated functions - Power **does not allow** them to **abdicate** **functions** in favour of some other / allow them to **place unquestioning reliance** upon **others** to do their job - must **retain overall control/oversight** of the function.

Question 35

What is a case example of the issues surrounding the delegation of duties relating to s.174?

Answer 35

Barings Bank PLC & Others

Question 36

What sort of conflicts does s.175 CA2006 apply to?

Answer 36

* Any direct/indirect interest which conflicts/could conflict with that of the company. * s.175(3) = will not apply to a conflict of interest arising in relation to a transaction or arrangement **with the company** in which a director has an interest (dealt with by ss. 177 & 182) * s.175(2) in particular: exploitation of any property, information or opportunity.

Question 37

When will s.175 not be infringed?

Answer 37

* If the situation **cannot reasonably be regarded as likely to give rise** to a conflict of interest * If it has been **authorised**

Question 38

How can an **actual/proposed** conflict be authorised?

Answer 38

- Authorised by shareholder **ordinary resolution** (interested director shareholders may vote) - Authorised by **director majority** (interesed directors may not vote)

Question 39

What is the difference for directors' ability to authorise conflict between public and private companies?

Answer 39

* Private : may do if not restricted by Articles * Public: Articles must specifically permit it

Question 40

What are the consequences of breaching s.175?

Answer 40

- A director who wrongly makes a profit by exploiting a business opportunity that belongs to the company can be made to **repay** that profit. - **Courts** may also rule that a **third party** acquiring company property through a breach of duty by directors holds that property on behalf of the company and, as a result, could be forced to return it (**CONSTRUCTIVE TRUSTEES**)

Question 41

What are some ways companies can **pre-emptively manage** conflicts of interest?

Answer 41

* **Induction** brief * Induction **questionnaire** to assist with identification (for **themselves** **or** **connected** persons) * Set **process** for authorising * Consider **committee** to review authorisations (poss NomCo) * Advise directors they may need **independent legal advice** if direct conflict arises * **Board papers** – details of each conflict for board to consider and/or authorise. * If considering directors authorisation by way of **WR** – **check AoA** that a WR be passed without all directors (those interested cannot vote) * Decide **how to record** authorisations (**register** rather than relying solely on BMs) * Decide **how to deal** with **conflicts** in respect of **directors of subisidaries**

Question 42

Can a conflict of interest under s.175 be authorised afterwards?

Answer 42

Yes - but **only by** a resolution of the **shareholders**. If an **interested director is a shareholder**, their vote **cannot count** in this instance (unlike before).

Question 43

How does the duty under s.176 link to other general duties?

Answer 43

- s.175 : by not accepting benefits, unlikely to give rise to conflict of interest; or - s.173 : impair independent judgement; or their ability to - s.172 : to promote the success of the company

Question 44

When will s.176 not be breached?

Answer 44

- Where accepting benefit **not reasonably regarded** as likely to give rise to a conflict of interest - If the **service** **provided** (as director or otherwise) is/are provided **via a third party** (ex. service firm) - **Policies** put in place to **comply** with **Bribery Act 2010** should **safeguard** against the duty being breached (but **CA2006** **compliance** should be **considered** as a **sub-objective** when forming such policies, for **example**, holding **directors** to **higher standards** than that of an average employee)

Question 45

What do s.177/s.182 cover?

Answer 45

Those conflicts of interest not covered by s.175. Duty to declare interests they have in: - **PROPOSED** trans/arrange with the company (s.177) - **EXISTING** trans/arrange with the company (s.182)

Question 46

Do directors' interest in transactions/arrangements need to be authorised?

Answer 46

A **conflict** of interest that arises out of a **director’s interest in a transaction or arrangement with the company** **does not need** to be authorised. The **transaction** itself **may need to be authorised** by the board if it is one of the **matters reserved **for its decision. However, the ***fact* that the director has an interest** in the transaction **does not need to be authorised** by the board or the shareholders.

Question 47

In what ways can interests be suitably declared?

Answer 47

- At a **director meeting** - General **notice** to **company** - **Written notice** to other **directors**

Question 48

When do interests in transactions/arrangements not need to be declared?

Answer 48

- Where not reasonably aware of interest - Where not reasonaby aware of transaction or arranagement - Cannot reasonably be regarded as **likely to give rise** to a conflict - If, and to the extent that, the **other directors are aware** - If, and to the extent that, it concerns terms of their **service contract** - A declaration under s.177 will serve as notice under s.182 if the company then enters into the transaction/arrangement

Question 49

What is a related party transaction/how does this relate to s.177 general duty?

Answer 49

**Listed** companies may need **shareholder approval** for **certain transactions** where **1 or more directors** have **interest** = RPT **DISCLOSURE REQUIREMENTS** for these types of transactions.

Question 50

Why are directors required to disclose their interests in **proposed** transactions?

Answer 50

- Ensure **other directors are aware** of interest before entering into that transaction or arrangement. - Ensure chair able to rule on **whether director can participate in the decision** on that matter (quorum considerations)

Question 51

Why are directors required to disclose their interests in **existing** transactions?

Answer 51

- Might otherwise be able to exert **covert influence** on continuation/management of contract/arrangement. - **Failure to disclose is a criminal offence under s.182 as soon as it becomes an existing** transaction (where the company enters into transaction and interest has still not been disclosed)

Question 52

What is a derivative action?

Answer 52

Special court procedure where shareholders can bring claim against director in name of company - actual/proposed act or omission re negligence, default , breach of duty / trust.

Question 53

What safeguards have the courts put in place to protect against unreasonable derivative action claims?

Answer 53

Should consider - Whether **hypothetical** **director** would **consider pursuing** in view of their **duty under s.172** - Where act/omission has already **occurred** – may **refuse** permission to continue if **authorised** before it occurred or has been **ratified** since it occurred. -Courts must also take into account any **available evidence** regarding **views of other members** on whether to pursue (these members must not have their own interest)

Question 54

What is fraudulent trading?

Answer 54

- S.213 Insolvency Act 1986 - Director has acted with the intent to defraud creditors - Criminal offence (under s.993 CA2006), even if the company does not then go into liquidation - May be liable to contribute to assets of the company

Question 55

What is wrongful trading?

Answer 55

- S.214 Insolvency Act 1986 - Criminal offence: director may become liable to contribute to assets of the company - Director has allowed the company to keep trading when knew/ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation.

Question 56

What do the concepts of fraudulent and wrongful trading show / indicate to directors?

Answer 56

- Wrongful trading: that directors should **insist** on **reviewing management accounts** at **regular intervals** - That if there is **any doubt** in respect of the company's **solvency**, directors should seek **legal advice** immediately in respect of both their own *and* the company's positions (immediate resignation is not necessarily/always the best idea)

Question 57

When might a director avoid being declared guilty of wrongful trading?

Answer 57

Where, once they **became aware** of the **prospect** of insolvent liquidation, they took **all reasonable steps** with a **view** to **minimising** **potential loss** to **creditors**.

Question 58

What is the purpose of D&O insurance?

Answer 58

Core purpose of a D&O policy is to **provide financial protection** for **directors** against the **consequences** of **actual or alleged “wrongful acts”** when **acting in the scope of their duties**. These include: – breach of trust – breach of duty – neglect – error – misleading statement – wrongful trading The D&O policy pays for defence costs and financial losses.

Question 59

Key sections pertraining to D&O insurance in CA2006?

Answer 59

s.232 - VOIDS any atempt to exclude directors from liability or indemnify s.233 - Clarifies and provides an exception authorising companies to hold/maintain insurance policies on directors' behalves s.234/235 - Exceptions (RE QTPIP/QPSIP) s.236 - disclosure of policies in place in financial year/at time report approved in Directors' Report ss.237/38 - inspection/copying of qualifying indemnity provisions by members (at registered office, for at least one yr after their date of expiry or termination)

Question 60

What is a **qualifying third party indemnity** ?

Answer 60

**Defined** by the exceptions **in s.234** CA2006 - **QTPIP** An indemnity **excluding WHERE**: * Against liability incurred by director to **company/associated** company * Against liability incurred by director to pay **criminal/regulatory** penalty * Against any liability incurred by the director: - Defending **criminal** proceedings in which they are **convicted** - Defending **civil** proceedings brought by **company or associated company** in which **judgement** given **against** them - Re any **application** to the court for **relief** under s.661(3)/(4) or s.1157 where **court** **refuses** such relief

Question 61

What exception regarding indemnification is provided by s.235?

Answer 61

**QPSIP** - Qualifiying pension scheme indemnity provision Where the company is acting as trustee of an occupational pension scheme - actions by directors in this capacity

Question 62

Under s.232, which liability **cannot** be indemnified against for any/all directors? | Thei

Answer 62

Directors' general duties because these are are owed **to the company**

Question 63

What are the reporting and disclosure requirements regarding QTPIP/QPSIP?

Answer 63

- S.236: any in force during the financial year / at the time the report is approved must be disclosed in the **directors'' report** - S.237/8: any QTPIP must be made inspectable at the company's registered office for at least 1 yr after their expiry/termination

Question 64

Can the company pay its directors' legal expenses?

Answer 64

Yes, and unlike rules on loans (s.197/198/200/201 CA 2006), **do not require member approval** as long as - Providing funds to meet expenditure incurred **defending criminal/civil proceeedings ** - Providing funds to meet expenditure **incurred during application for relief under s.1157 ** (re honest/reasonable conduct) Will also **not require member approval** where doing anything to enable directors to **avoid incurring expenditure** in the first place (ex. **insurance**) * **s.206** provides **similar allowances** in respect of **regulatory actions/investigations**

Question 65

What actions can be taken against Directors?

Answer 65

- Wrongful or fraudulent trading - Insolvency practitioner - Shareholder action (indvidiual - civil) - Derivative action (re actual/proposed act/omission involving negligeance, default, breach of duty or trust)

Question 66

What does the MoJ's guidance suggest companies might put in place in order to avoid committing an offence under BA2010 (which links to breaching the s.176 duty)?

Answer 66

- **Strict** internal anti-bribery **policies**- inc. gifts & corporate hospitality - May **preclude** directors **accepting** gifts - allow they to **accept small** gifts but **not to keep** - May **require** they **obtain clearance** **before** accepting benefits - AND/OR require all gifts / hospitality to be included in **register**

Question 67

Why are derivative actions relatively uncommon?

Answer 67

* Shareholders can bring a derivative action against directors in the name of the company. * **Compensation**, if successful, will be **paid to** the **company**. * **Other stakeholders** (charge holders, creditors etc.) most **likely** to be **main beneficiaries** of such compensation where the company has been in financial difficulty * If anything left - the **shareholders who brought** the claim will **share spoils** with **those** other **shareholders** **who did not** participate