Directors’ duties

As I have mentioned in the previous post, directors owe a fiduciaries duties to the company. They must act for the benefit for the company, and must not benefit from position as fiduciaries. 

In addition to the fiduciaries duties, Companies Act 2006 has provided a list of general duties which the directors owe to their companies. 

By virtue of section 179, a director may be liable for more than one of the general duties.

Section 170(1) mentions that directors owe a list of general duties to the company. This is essentially a restatement of the decision in Percival v Wright (1902), namely the directors of the company owe their duties to the company as a whole, and they do not owe duty to the individual members of the company.

Section 170(2) provides that a person who ceases to be a director continues to be subject to the duties under section 175 and section 176.

Section 170(3) and section 170(4) give effect to the common law rules and equitable principles which are relates to the general duties of the directors. In other words, Companies Act 2006 does not overrule common law rules and equitable principle, and the courts must interpret and apply CA 2006 in compliance with them.

All de jure, de facto and shadow directors are subject to the general duties. 

You can download Companies Act 2006 here: http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf

You can read You can read de facto, de jure and shadow director here: http://thewallyeffect.blogspot.my/2017/06/de-facto-director-and-shadow-director.html

You can read the role, appointment, removal and remuneration of directors here: http://thewallyeffect.blogspot.my/2017/10/the-role-appointment-removal-and.html

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Duty to act within the powers, section 171

Section 171 provides that a director of a company must act in accordance with the company constitution and, only exercise powers for the purpose for which they are conferred.

The company constitution is defined in section 17 as including the article of association, decisions taken in accordance with the article of association and other decisions taken by the members in accordance to section 29.  

The second limb is a restatement of the common law ‘proper purpose doctrine’, which was formulated by Lord Greene MR in Re Smith & Fawcett Ltd (1942). The proper purposes doctrine has frequently been applied, although not exclusively, in relation to the power to issue shares, which may adversely affect the voting rights of an existing majority shareholder.

If shares are allotted in exchange for cash where the company is in need of additional capital, which is for the purpose of benefiting the company as a whole.

However if the directors issue shares in order to dilute the voting rights of an existing majority shareholder (Hogg v Cramphorn, where the directors issue share to prevent a takeover which they believed that it would be bad for the company), or simply and solely to remain in control of the existing board (Piercy v Mills, Harlowe’s Nominees Pty Ltd v Woodside (Lake Entrance) Oil Co), the directors would be in breach of section 171.

On this point, Lord Wilberforce in Howard Smith Ltd v Ampol Petroleum Ltd  (1974) stressed that the court must examine the substantial purpose for which a power is exercised and must reach a conclusion as to whether that purpose was proper or not. If the purpose was improper, the exercise of the power in question will be voidable (Bamford v Bamford). In the case itself, the Privy Council held that the issue of shares by the directors with an intention to destroy the existing majority, was intra vires, but was exercised for an improper purpose. Besides, it was accepted that the test under section 171(b) is a subjective one and it was necessary to consider the actual motivation of the directors.

In Teck Corporation Ltd v Millar (1972), the British Columbia Supreme Court held that an allotment of shares designed to defeat a takeover was proper, even though it was made against the wishes of the existing shareholder and deprived him of control. Berger J stressed that, provided the directors act in good faith, they are entitled to consider the reputation, experience and policies of anyone seeking to take over the company and to use their power to protect the company if they decide, on reasonable grounds, that a takeover will cause substantial damage to the company.

According to Extrasure Travel Insurances Ltd v Scattergood (2003), in deciding whether a director is in breach of the duty to act within the power, the court must:

(a) Identify the power whose exercise is in question;

(b) Identify the proper purpose for which that power was delegated to the directors;

(c) Identify the substantial purpose for which the power was in fact in exercised;

(d) Decide whether that purpose was proper.

It is clear that directors also may have some personal interests in the company. In promoting the interest of the company they will also necessarily promote their own interest.

The fact that a director derives some incidental benefit from the action taken will not in itself mean that the fiduciary duty has been broken. In deciding whether they have acted in the best interests of the company, or acted for improper purpose, the test is what was “the moving cause” of the action of the directors (Mills v Mills).

In Mills v Mills, the court upheld a resolution to distribute bonus shares even though it has an adverse effect on the voting powers of the company’s managing director. The main purpose of the director’s resolution is to benefit the company as a whole, despite the fact that it incidentally also benefits a director.

Duty to promote the success of the company, section 172

Section 172 provides that a director must act in the way he or she considers in good faith, would be most likely to promote the success of the company for the benefit of its member as a whole. In doing so, the director should have regard to the factors listed in section 172(1).

The question of what will promote the success of the company is one for the director’s good faith judgment.

Generally a court will not interfere in the internal management of companies. This is known as the internal management rule. Thus the court will not make a value judgment on the merit of the decision by the directors in question, but rather, it is left to the directors themselves to decide, subject to the good faith requirement.  

It is settled that the duty is owe to the company as a whole, but not to the shareholders personally (Percival v Wright). The duty is not to promote the success of the shareholder, but the company as a whole. Following the non-exhaustive list under section 172(1), the interest of the stakeholder is also one of the factors to be considered, in determining whether a director has failed to promote the success of the company.

Section 172 is a restatement of Lord Grenne MR’s formulation of the duty in Re Smith & Fawcett Ltd, namely the directors must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interests of the company. However, objective considerations must also be taken into account, and a non-exhaustive list was provided in section 172(1).

If a director was acting in good faith and in the interests of the company as a whole and is not wilfully blind to the company’s interests, the director would not be liable for breach of fiduciary duty if they make a mistake and act unreasonably. However, he may be liable for breach of duty of care (per Leslie Kosmin QC in Colin Gwyer & Associates Ltd v London Wharf (Limehouse) Ltd (2003)). 

In Item software (UK) Ltd v Fassihi (2004), the defendant was employed as a director of the claimants company and his employment contract expressly provided that he should not use confidential information belonging to the company for his own purpose. In 1998 the claimant started to negotiate a distribution contract with Isograph Ltd. At the same time, unknown to the claimant, the defendant made secret approaches to Isograph Ltd with his proposals to establish his own company to take over the distribution contract. Despite the fact that the defendant has persuaded the claimant to adopt a tough bargaining stance with Isograph, the negotiation between the claimant and Isograph has failed for the reason that the claimants had pressed Isograph too hard, not because of the defendant’s influence. According to the CoA, a director owes a duty to disclose his misconduct to the company, and   this duty is tentamount to a duty of loyalty. Here, by failing to tell the claimant that he had set up a company and planned to acquire the contract for himself, the defendant was in breach of his duty of loyalty.

This was accepted by the court recently in GHLM Trading Ltd v Maroo (2012), in which Newey J stressed that in deciding whether a director is in breach of section 172 duty, the court must also consider that whether the director in question has breaches his duty to disclose a misconduct to the company. Where a director subjectively consider that the misconduct in question was done in the interest of the company, he is required to disclose the misconduct to the company otherwise he would be in breach of his duty of loyalty.

Where the directors are servicing a company, which part of the company group structure, the directors must act bona fide in the interests of the company which he is directly employed. In Extrasure Travel Insurances Ltd v Scattergood (2002), the directors of a subsidiary company had transferred company funds to the parent company, with the intention to enable the parent company to repay its creditor. It was held that the payment of a debt owed by the parent company was not in the best interests of the subsidiary company. The directors were therefore ordered to pay equitable compensation.

Section 172(1) provides a non-exhaustive list for the court to ‘have regard’, in determining a question that whether a director is in breach of his duty to promote the success of the company.

In Re Southern Counties Fresh Foods Ltd (2008), the court acknowledges that the non-exhaustive list under section 172(1) is to provide a more readily understood definition of the scope of the duty, and was not meant to open a floodgate of litigation against the directors.

In R (on the application of People & Planet) v HM Treasury (2009), which is a case concerning the application for judicial review advance by People & Planet, regarding the policy adopted by HM Treasury for RBS. It was alleged that the HM Treasury has acted unlawfully in adopting the policy as to how RBS should be managed, namely they sought change to policy that might be harmful to the environment by reason of their carbon emissions and insufficiently respectful to human rights. The court rejected the application and stressed that the factors listed under section 172(1) do not represent an absolute ground for a director to breach his section 172 duty, but rather, they are merely factors to take into account, in deciding whether a director has breaches his section 172 duty.

Lowry & Dignam observed that there are two significant problems with this duty. First, it could not be enforced in the same way as other fiduciary duty owed to a company by its director. Second, it was difficult to identify the precise scope of the duty for the purpose of determining whether it had been discharged or not.

Section 172(3) provides that section 172 applies, in certain circumstances, to consider or act in the interests of creditors of the company.

Section 172(3) is essentially giving effect of the common law principle that, where the company is insolvent, or is of doubtful solvency, the interests of the creditors have priority over the interests of the shareholder(per Nourse LJ in Brady v Brady). In such circumstances, the shareholders do not have the power to absolve directors from a breach of duty to the creditors as to bar the liquidator’s claim (West Mercia Safetywear Ltd v Dodd (1988)).

In Winkworth v Edward Baron Development Co Ltd (1986), Lord Templeman explained that directors owe a fiduciary duty to the company and its creditor, present and future, to ensure that its affairs are properly administered and keep the company’s property inviolate and available for the repayment of its debts.

In the event of insolvency, the fiduciary duty under section 172(3) is owed to the general body of creditors, but not to any individual creditor. If the directors act consistently with the interests of the general creditors but inconsistently with the interest of an individual creditor or section of creditors with special rights in a winding-up, the directors in question are not in breach of duty to the company (per Richard Reid QC in Re Pantone 485 Ltd). This was confirmed by the court recently in GHLM Trading v Maroo (2012).

In Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd (2003), it was held that a resolution of the board of directors passed without proper consideration (to the interest of the creditor) being given by certain directors would be open to challenge if the company had been insolvent at the date of the resolution. Leslie Kosmin QC expressed that in relation to an insolvent company, the directors when considering the company’s interests must have regard to the interests of the creditors. Modifying the test in Charterbridge Corpn Ltd v Llyod’s Bank Ltd (1970), he stood that the test of the general application is that, ‘could an honest and intelligent man, in the position of the directors, in all the circumstances, reasonably have believed that the decision was for the benefit of the company’. In all the case of insolvent companies the test is to be applied with the benefit of the creditors substituted for the benefit of the company.

Section 172(3) make express reference to ‘any enactment’. Hence, a director who is subject to section 214 of the Insolvency Act 1986, is required to consider the interests of the creditor.

In relation to the question of standing to sue to enforce this duty (locus standi), Toulson J in Yukong Line Ltd of Korea v Rendsburg Investment Corpn of Liberia (No. 2) (1998) held that a director of an insolvent company, who breached his fiduciary duty to the company by transferring assets beyond the reach of its creditors owed no corresponding fiduciary duty to an individual creditor of the company. Creditors have no standing, individually or collectively, to bring an action in respect of any such duty. The appropriate cause of action would lie with the liquidator to bring an action for misfeasance under section 212 of the Insolvency Act 1986.

Duty to exercise independent judgment, section 173

Section 173(1) provides that a director must exercise independent judgment.

Section 173(2) provides the duty is not infringed by his acting –

(a) In accordance with an agreement duly entered into by the company that restricts the future exercise of discretion by its directors, or

(b) In a way authorized by the company’s constitution.

The provision restate the principle developed in case law that directors must exercise their powers independently and not subordinate their powers to the control of others by, for example, contracting with a third party as to how a particular discretion conferred by the articles will be exercised. Directors are not permitted to delegate their powers unless the company’s constitution provides otherwise.

But where the board is able to establish that it was in the best interests of the company to enter into such an agreement, the duty will not be broken. For example, the directors may be able to point to some commercial benefit accruing to the company as a result of their undertaking to the third party.

In Fulham Football Club Ltd v Cabra Estates plc (1994), the directors signed an agreement with Cabra, who had applied for planning permission to redevelop the football ground in question. Fulham were to receive payment from Cabra, in return they would not providing witnesses or written material in support of the compulsory purchase order of the football ground by the local authority. The directors subsequently sought to renege on this promise and argued that it was an unlawful fetter of their powers to act in the best interests of the company. The CoA held that that the directors had not improperly restricted the future exercise of their discretion. The court stressed that directors can make a contract to restrict the future exercise of their powers, provided that it was commercially beneficial to the company.

A director can rely on the advice or work of others, but the final judgment must be his responsibility. In fact, in certain circumstances he is required to take appropriate advice of a third party (per Lord Goldsmith in the Lords Grand Committee).

According to Popplewell J in Madoff Securities International Ltd v Raven (2013), section 173 duty is discharged if it is legitimate for there to be division and delegation of responsibility for particular aspect of the management of a company. The division and delegation of responsibility cannot go beyond to the extent that it segregates his overall responsibilities, especially those inescapable personal responsibilities that the company is expected from him.

Duty to exercise reasonable care, skill and diligence, section 174

Section 174(1) provides that a director of a company must exercise reasonable care, skill and diligence.

Section 174(2) goes on to state that this means that care, skill and diligence that would exercise by a reasonably diligent person with –

(a) 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, and

(b) The general knowledge, skill and experience that the director has.

From the wording of section 174, it can be observed that the test is subjected to both subjective and objective standards. By virtue of section 174(2), subjective considerations will also be applied in determining whether a director has discharge his section 174 duty, in particular to any special knowledge, skill and experience that he has.

In Dorchester Finance Co Ltd v Stebbing (1989), an insolvent company brought a claim against its directors. The company has three directors, but only one was appointed full time. The non-executive directors signed blank cheques at the full time director’s request. Those blanked cheques were later used by the full time directors to commit fraud.

The court held that the two non-executive directors were negligent in signing the blank cheque. The facts that one of them is a chartered accountant, and one is an experienced accountant, have been taken into account in deciding whether they have met the standard that is expected from them. In fact, Foster J commented that even if they are inexperience and have no qualification of accountant, they would still be expected of a reasonable standard, otherwise it would be a total disregard of many section in the CA 2006. Besides, Foster J stressed that no distinction shall be drawn in principle between an executive director and a non-executive director.

In Lexi Holdings plc (in admin) v Luqman (2009), the managing director of the company has dishonestly misappropriated company’s fund. The question arise as to whether the two non-executive directors of the company, who were the sisters of the managing director, were in breach of section 174 duty due to their inactivity. In the first instance they escaped liability except to the extent that misappropriated money had been paid to them. The court took into account the fact that it was the managing director who was controlling the company and they had not caused the loss to the company. The CoA overturned the decision, and zooms in to the point that the sisters were aware of their brother’s previous conviction for fraud, and they have failed to prevent a loss to the company that they ought to have expected.

Inactivity on the part of the directors is no longer acceptable. Following the COA’s decision in Lexi Holdings plc (in admin) v Luqman, as well as the decision in Re Landhurst Leasing plc (1999), little weight is given to any contention to the effect that the director was unaware of a state of affairs because he had trusted others to manage the company. Rather, a modern non-executive director is reasonably expected to keep an eye on whether the executive directors of the company are exercising their powers legally and reasonably. 


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Duty to avoid conflict of interest, section 175

Section 175, section 177 and section 182 are restatement of the equitable obligations, which are generally described as the ‘no-conflicts’ rule, the ‘no-profits’ rule and the ‘self-dealing’ rule. 

Section 175(1) provides that a director of a company must avoid a situation in which he as, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. Hence, both actual conflict and potential conflict are caught by section 175(1).

The director is deems as holding the profit, that he made as a consequence of the breach of fiduciary duty, as a constructive trustee (JJ Harrison (Properties) Ltd v Harrison).

Section 175(2) provides that this applies in particular to the exploitation of any property, information or opportunity and it is immaterial whether the company could take advantage of the property, information or opportunity.

Section 175(3) provides that this duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.

In Regal (Hastings) Ltd v Gulliver (1967), Regal owned a cinema and were in negotiation to take long leases of two more other cinemas through its subsidiary company. However the owner of the cinemas was only willing to grant the leases if the five directors in the board of Regal could give personal guarantees, or increase the share capital to £5,000. The directors did not want to give personal guarantees and Regal was only able to contribute £2,000 to the share capital. The directors and the company’s solicitor each contribute £500 to the share capital. They later sold the business and made some profit. The new controller of Regal brought an action against the directors and the company solicitor on the ground that the profit was gained in breach of their fiduciary duty.

The House of Lords held that they were liable to account for their profit to Regal, despite the fact that they have acted bona fide, in the sense that they have contributed to the share capital using their own money and the company was financially incapable of purchasing the shares. The directors are subject to the overriding equitable principle that a person shall not make personal profit from his position as fiduciary. Lord Russell stated that any opportunity and special knowledge that had come to the directors qua fiduciaries, are belongs to the company in equity.

In Cook v Deeks (1916), the company has four directors. Three directors of the company had a disagreement with another director (Cook). The three directors took a project through a new company which is formed by them, in order to exclude Cook. They subsequently used their majority power to pass a resolution to declare that the company claims no interest in the contract. The Privy Council held that the directors were in breach of their duty and the profits made by them were to be regarded as holding it for the benefit of the company. A director must always bear in mind that they must always act in the best interest of their company and when there are any corporate opportunity come to them, the opportunity are belong to the company they represent.

In Bhullar v Bhullar (2003), a family company operated a grocery store, and also owned a commercial property which was leased to UK Superbowl Ltd. There has been a disagreement between the directors, in which some of them told the board that the company should not buy any further property. One day one of the directors of the company went bowling at the UK Superbowl. He noticed that the land next-door was on sale. He set up a company, which is controlled by him and another director, to buy the land. The court held that the directors had a duty to bring the opportunity to the attention of the company, even though the board may not want to take the opportunity. Hence, they were in breach of his fiduciary duty.

In Industrial Development Consultants Ltd v Cooley (1972), the defendant was the managing director of the company. He failed to obtain a contract for the company, but was offered to take the deal personally. He later resigned from the company, claiming that he was suffering from ill heath, in order to take up the contract. Roskill J held that he was accountable to the company for all the profits he received under the contract. The information was come to him while he was a managing director of the company. As such, he has a duty to forward the information to the company, despite that the opportunity was given to him in his personal capacity.

In Peso Silver Mines v Cropper (1966), the board was offered the opportunity to buy 126 mining claims, some which were on land which adjoined the company’s own mining territories. The board bona fide declined the offer because there was some doubt over the value of the claims which therefore rendered them a risky proposition, and the financial situation of the company was strained. A short while after the board had rejected the offer, the company’s geologist formed a syndicate with Cropper and two other directors to purchase and work the claims. When the company was taken over, the new board brought an action claiming that the defendant held his shares on constructive trust for the company. The claim was unsuccessful. It was held that the decision of the directors to reject the opportunity had been made in good faith and for sound commercial reasons in the interests of the company. The company’s geologist approached the defendant not in his capacity as a director of the company, but as an individual member of the public, it was therefore a personal opportunity, rather than a corporate opportunity belongs to the company.

Section 170(2) provides that a person who ceases to be a director continues to be subject to the duties under section 175.

However recent decisions suggest that the general fiduciary obligations of a director do not prevent him from:

(a) Making a decision, while still a director, to set up in a competing business after his directorship has ceased;

(b) Taking preliminary steps to investigate or forward that intention, provided he did not engage in any actual competitive activity while his directorship continued.

A director can immediately set up business in competition with that company, or join a competitor of the company, and he is not obliged to disclose his intention to the company (per Blackburne J in Framlington Group plc v Anderson).

In Balston Ltd v Headline Filters Ltd (1990), the director of the company agreed to lease certain commercial premises in order to start up his own business. He then resigned from the company. Shortly after his resignation, one of the company’s customers contracted him after being told that the company would be discontinuing its supply to him of a certain type of product. The director therefore began to manufacture and supply he product to the customer. The company sought to hold him liable to account. It was held that a director is not in breach of his fiduciary duty to start up a business in competition with his former company after his directorship had ceased, even where the intention to commence business was formed prior to the resignation.  

It is clear that a director would have acquire a general knowledge and expertise in the course of their work, and they are free to exploit any opportunity with the acquired knowledge and expertise after they have ceased to be a director of the company (per Hutchinson J in Island Export Finance Ltd v Umunna).

The director can utilize confidential information or ‘know-how’ acquired while working for the company after he departs but not ‘trade secrets’ (CMS Dolphin Ltd v Simonet).

Section 175(7) states that ‘any reference in this section to a conflict of interest includes a conflict of interest and duty and a conflict of duties’.

In London and Mashonaland Co Ltd v New Mashonaland Exploration Co Ltd (1891), it was held that no breach of duty arose where a director held office with two or more competing companies. However it shall be noted that in the case itself there was no actual conflict arose because the defendant company had not commenced business and therefore no damage was sustained by the claimant. This ‘double-employment rule’ was approved by the House of Lords in Bell v Levers Bros Ltd (1932).

According to Lord Denning in Scottish Co-operative Wholesale Society Ltd v Meyer (1959), as long as the interests of all concerned were in harmony, there was no difficulty. However, as soon as the interests of the two companies were in conflict, the directors were placed in an impossible position. The question of priority appears to have no answer.

Section 157(7) therefore brings competing directorships into the general prohibition of conflicts of duty. 

Section 157(4) provides that a director is not in breach of section 175 duty –

(a) If the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or

(b) If the matter has been authorized by the directors

Section 175(5) provides that authorization may be given by the directors

(a) In a private company, if nothing in the company’s constitution invalidates such authorization, by the matter being proposed to and authorized by the directors;

(b) In a public company, if the company’s constitution enabling the directors to authorize the matter, by the matter being proposed to and authorized by them in accordance with the constitution.

Section 175(6) provides that the authorization is effective only if the votes of the directors and any other interested director has been disregarded in the process of authorization.

Self-dealing directors, section 177 & section 182

Section 175(3) makes it clear that the duty to avoid conflicts of interest contained in 

section 175(1) ‘does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company’.

Anything relating to a conflict of interest arising in relation to a transaction or arrangement with the company is subject to section 177 or section 182.

Section 177(1) provides that ‘if a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors’.

At the common law a director, who is under a fiduciary duty, is prohibited from being interested in a transaction or arrangement, in which his company was a party to it. He is strictly prohibited from doing so (Aberdeen Rly Co Blaikie Bros (1854), Tito v Waddell (No. 2) (1977)).

It shall be noted that the statutory statement of directors’ duties in relation to section 177 does not follow the common law ‘self-dealing rule’, in the sense that it was replaced with a statutory obligation to disclose an interest.

Section 177(2) provides that the declaration may, but need not, be made at a meeting of the director.

Section 177(3) provides that if the declaration is proved to be inaccurate or incomplete, a further declaration must be made.

Section 177(4) provides that the declaration must be made before the company enters into the transaction or arrangement.

Section 177(5) provides that this section only applies to directors who is aware of the transaction or arrangement in question, or ought reasonably to be aware. It does not apply where the director is not aware of the transaction or arrangement in question.

As section 177(2) provided that, the declaration need not be made at the meeting of the director. It was held that informal disclosure to all members of the board would be sufficient (Lee Panavision Ltd v Lee Lighting Ltd (1992)). The board must be given precise information about the transaction in question (Gwembe Valley Development Co Ltd v Koshy (2003)).

Section 182(1) provides that ‘where a director of a company is in any way, directly or indirectly, interested in a transaction or arrangement that has been entered into by the company, he must declare the nature and extent of that interest to the other directors’.

The principal distinction between the two statutory provisions is that whereas breach of section 177 carries civil consequence (section 178), breach of section 182 results in criminal sanctions (section 183).

Section 177(6)(b) and section 182(6)(b) provides that the declaration of interest need not be made if no conflict is likely to give rise, or the other directors are already aware of it, or it is to be considered by another means.

Duty not to accept benefit from third parties, section 176

Section 176(1) provides that a director must not accept a benefit from a third party conferred by reason of:

(a) His being a director, or

(b) His doing (or not doing) anything as a director.

A third party is defines by section 176(2) as a person other than the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate.

Section 176(3) provides that benefit received as a result of his service to the company is not caught by section 176.

Section 176(4) provides that the duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.

Section 176(5) states that ‘any reference in this section to a conflict of interest includes a conflict of interest and duty and a conflict of duties’.

If the benefit in question amount to a bribe, the provisions of the Bribery Act 2010 will apply. A bribe is defined as giving someone a financial or other advantage to encourage that person to perform their functions or activities improperly or to reward the person for having already done so. It was accepted a fiduciary is in breach of the duty of loyalty if he accepts a bribe (Novoship (UK) Ltd v Mikhaylyuk (2012)). Hence, a recipient of the bribe, together with those who dishonestly assist him, will be liable to account for their profits.

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Remedies for breach of directors’ duties

Section 178(1) provides that the consequence of breach of section 171 to section 177 are the same as would apply if the corresponding common law rule or equitable principle applied.

Section 178(2) provides that the duties in those sections (with the exception of section 174) are to be enforced in the same way as any other fiduciary duty owed to a company by its directors.

If the company has suffered loss as a result of the breach of duties, damages or compensation may be ordered (Joint Stock Discount Co v Brown (1869)).

If the company’s property has been misappropriated as a result of the breach of duties, the director may be ordered to restore of the property in question, provided that it is possible to do so (JJ Harrison (Properties) Ltd v Harrison (2002)).

If the director has obtained benefit as a result of the breaches of duties, any profit that he made as a result of it is deem as holding it for the company as a constructive trustee, which means that he is liable to account for the profit (JJ Harrison (Properties) Ltd v Harrison (2002)). The company is entitled to elect whether to claim damages or an account of profits against the director in question (Coleman Taymar Ltd v Oakes (2011)).

The liability to account arises even where the director acted honestly and where the company could not otherwise have obtained the benefit (Regal (Hastings) Ltd v Gulliver).

A rescission of a contract may be granted where the director failed to disclose an interest (Transvaal Lands Co v New Belgium (Transvaal) Land & Development Co (1914)).

Relief from liability

There are three ways in which a director who is in breach of duty may be relieved from liability:

(a) By obtaining the ‘consent, approval or authorization’ by the members of the company

(b) Through ratification by the company under section 239

(c) By the court under section 1157

Consent, approval or authorization by members

Certain transactions require the approval of the members of the company. These include:

(a) Directors’ long term service contract (section 188)

(b) Substantial property transaction (section 190)

(c) Loans, quasi-loans and credit transactions (section 197-214)

(d) Payment for loss of office (section 215-222)

By virtue of section 180(1), if the requirement of authorization is complied with for the purposes of section 175, or if the director has declared to the other directors his interest in a proposed transaction with the company under section 177, these processes replace the equitable rule that required the member to authorize such breaches of duty.

This is made subject to any enactment (for example, the above transactions contained in Chapter 4 of Part 10) or any provision in the company’s articles which require the authorization or approval of members. Hence, the company’s constitution can reserve the statutory change and can insist on certain steps being taken requiring the consent of the members in certain circumstances.

Section 183(3) states that the compliance with the general duties does not remove the need for the approval of members to the transactions falling within Chapter 4 CA 2006.

Section 180(2) provides that the general duties apply even though the transaction falls within Chapter 4, except that there is no need to comply with section 175 or section 176, where approval of members is obtained.

Section 180(4) preserves the common law position on prior authorization of conduct that would otherwise be a breach of the general duties. Thus, companies may, through their articles, go further than the statutory duties by placing more onerous requirements on their directors (for example by requiring shareholder authorization of the remuneration of the directors).

Ratification by members of a director’s breach of duty, section 239

Section 239(1) states that the section applies to the ratification by a company of conduct by a director ‘amounting to negligence, default, breach of duty or breach of trust in relation to the company.’

Section 239(2) provides that the decision of the company to ratify such conduct must be made by resolution of the members of the company.

The common law is modified by section 239(3) and section 239(4), which provide that the ratification is effective only if the votes of the director in breach (and any member connected with him) are disregarded. Any person connected with the director in question includes his family (section 252(2)).  

Section 239(6)(a) provides that nothing in the section affects the validity of a decision taken by the unanimous consent of the members of the company. This section places the common law principle, which a breach of duty is ratifiable by obtaining the informal approval of every member who has a right to vote on such a resolution, on a statutory footing.

Court’s discretionary power to relieve, section 1157

Section 1157(1) confers on the court the discretion to relieve, in whole or in part, an officer of the company from liability for negligence, default, breach of duty or breach of trust, if it appears to the court that the officer has acted honestly and reasonably, and having regard to all the circumstances of the case, he ought fairly to be executed on such terms as the court think fit.

In Re D’ Jan of London Ltd, the director signed a change to an insurance policy without reading it, which lead to a result that the insurer could refuse to pay when the company claimed for fire damage. The company had gone into insolvent liquidation by the time that the director realized that the form had been incorrectly completed. The court granted the director partial relief from liability. Hoffman J thought that it was the kind of mistake that could be made by any busy man. 

Re Duckwari plc (No. 2) suggested that a director who intends to profit by way of a direct personal interest or indirect personal interest in a substantial property transaction could not be said to have acted reasonably and therefore would be denied relief under section 1157.

Complete inactivity as a director is clearly unreasonable and cannot, therefore, be relieved from liability by way of section 1157, even though he had acted reasonably and honestly (Lexi Holdings plc (in admin) v Luqman).

This section cannot apply to relief liability under Insolvency Act 1986 (Re Brian D Pierson (Contractors) Ltd).

Personal liability of directors under Insolvency Act 1986

Directors may be held personally liable to compensate creditors where they have been guilty of fraudulent trading, wrongful trading or some misfeasance.

The definition of ‘director’ and ‘shadow director’ can be found in section 251. 

You can download Insolvency Act 1986 here: http://www.legislation.gov.uk/ukpga/1986/45/pdfs/ukpga_19860045_en.pdf

Fraudulent trading, section 213 Insolvency Act 1986

Section 213 provides that if the course of winding up, it is found that company’s business was carried on with intent to defraud creditors or for any fraudulent purposes, then the court (on the applicant of the liquidator) may declare that any persons who were knowingly parties to the fraud shall be personally liable to contribute to the company’s assets.

Over the years the courts set a very high standard of proof for ‘intent to defraud’ because of the possibility of a criminal charge also arising (section 993). As in Re Patrick & Lyon Ltd, this involved proving ‘ac real dishonesty involving, according to current notions of fair trading among commercial men, real moral blame’.

This section includes ‘any persons who were knowingly parties to the fraud’.

The effect is that the director will not be able to hide behind the corporate veil and avoid personal liability for the company’s debts where he had used the company for fraudulent trading.

Wrongful trading, section 214 Insolvency Act 1986

Section 214(1) provides that in the course of winding up, the court (on the applicant of the liquidator) may declare a director to be personally liable to contribute to the company’s assets, if the conditions under section 214(2) are satisfied:

(a) The company has gone into insolvent liquidation, and 

(b) The director knew or ought to have realized that there was no reasonable prospect of the company avoiding insolvent liquidation and he didn’t took every step to minimize the potential loss to creditors as he ought to have taken (section 214(3)), and

(c) The person was a director of the company at that time.

Section 214(7) provides that in this section ‘director’ includes a shadow director.

In Re Produce Marketing Consortium Ltd, two managing directors were held personally liable for wrongful trading because they continued to trade on behalf of the company, despite knowing that the company was making losses for years and there is no chance to recover the business.

Criminal Liability for Fraudulent Trading, section 993 Companies Act 2006

In relation to the fraudulent trading, section 993 provides for a criminal offence of fraudulent trading.

Section 993(1) provides that if any business of the company is carried on with intent to defraud creditors or for any fraudulent purposes, every person who is knowingly a party to the carrying on of the business in that manner could be liable.

Unlike the provisions under Insolvency Act 1986, section 993 can applies whether or not the company has been, or is in the course of being, wound up. 

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