If anything, Covid-19 has certainly refocused many directors’ attention to their duties as directors and there is nothing like a crisis to bring about focus.
The duties of directors have three sources:
- Statute law (Companies Act 2006)
- The company’s governance documents (Articles of Association and Shareholders Agreements)
- They are implied under Common Law
The ultimate decision-making body of a company is its board of directors acting collectively.
It is absolutely essential in the current environment to ensure that t a company’s governance, culture and conduct at all levels are not compromised by the COVID-19 pandemic.
The statutory duties of directors are set out in the Companies Act 2006 and set out below is a summary of each of those duties:
Duty to act within powers
A director must act in accordance with the company’s constitution and must only exercise their powers for a proper purpose in accordance with the Act, the company’s articles of association, and where applicable, the shareholders agreement.
Duty to promote the success of the Company
A director must act in good faith in a way that they consider would be most likely to promote the success of the company for the benefit of its shareholders as a whole.
Requirements on directors to promote the success of the company
Directors 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; and
• the need to act fairly as between the shareholders of the company.
The main consideration is how decisions are made by a director, whether formally via a board meeting or otherwise.
This is one area in particular that is important to focus on in the current environment.
Directors should be talking to one another on a more regular basis than they would under normal circumstances.
Sometimes these interactions will be informal and sometimes they will be formal.
Whatever approach the board adopts, it is recommended that contemporaneous notes be kept of all meetings and all decisions taken at those meetings.
As most all boards will be meeting using some form of video conferencing then it may be worthwhile recording the meetings, and the recordings be preserved as a record if someone is not then going to go and take direct notes from that meeting.
Duty to exercise independent judgement
A director must exercise independent judgement when making decisions on behalf of the company.
This does not mean that directors cannot rely on the advice of third parties, provided that they comply with their other duties.
In fact, most if not all boards should be taking some form of advice at the minute, be it from us or from their lawyers, just to ensure that they are across the latest developments in legislation and also best practice being adopted by other businesses.
Duty to exercise reasonable care, skill and diligence
A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with:
a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the directors’ functions; and
b) the subjective knowledge, skill and experience of the actual director.
Where a director has specialist knowledge, this subjective element of the test imposes a higher duty on the relevant director. For example, if a director is a lawyer or an accountant, then that director would be expected to meet a higher standard of diligence, care and skill.
Duty to avoid conflicts of interest
A director must avoid situations where there is, or could potentially be an interest that conflicts with the interest of the company, whether directly or indirectly.
This particularly applies to the exploitation of property, information, or opportunity and is an objective test (that is, it does not depend on whether the director is or was aware of the conflict).
The duty to avoid conflicts of interest will not be breached if the situation cannot reasonably be regarded as likely to give rise to a conflict.
The duty to avoid conflicts of interest will continue to apply to former directors who have left the service of the company.
Where a director has an interest in a proposed transaction or arrangement with the company, the director must declare this to the company.
For private limited companies, provided that there are no prohibitions in the company’s articles of association, the board of directors may authorise a director’s conflict of interest; however under the current business environment, directors need to pay particular attention to any conflicts.
For example, if there is a loan repayment schedule in place with a party related to one of the directors, and the directors do not revisit that repayment schedule in light of a cash squeeze, then the conflict between preserving valuable cash and repaying a loan to a related party might be a real conflict that the board are no longer prepared to authorise.
Duty not to accept benefits from third parties
Directors must not accept any benefit from a third party that is given by reason of their position as a director, or their action/inaction as a director.
This duty will continue to apply to former directors who have left the company.
This duty will not be infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest.
Or where the benefit is conferred by either the company itself, or its holding company or subsidiaries.
Duty to declare interest in a proposed transaction or arrangement with the company
Directors must declare the nature and extent of any interest in a proposed transaction or arrangement with the company (whether direct or indirect) to the other directors.
A director will not need to make a declaration of interest if their interest cannot reasonably be regarded as likely to give rise to a conflict of interest.
In addition to those duties set out above, there are other obligations under the Act, such as the obligation to prepare and file at Companies House annual reports and annual accounts.
This is in addition to other duties such as those relating to anti-bribery, under health and safety rules and in certain sectors, the environment etc.
Consequences of breach of directors’ duties
As the duties are owed to the company, it is generally only the company that may enforce them or the company’s shareholders in the form of a derivative action on the company’s behalf. If a serious breach has been committed, this may incur criminal liability, or result in the director being barred from office.
The company’s shareholders may ratify certain breaches of the directors provided that ratification does not depend upon the vote of the relevant director or their connected persons (for example, family members).
A company’s articles may indemnify directors against defence costs to any claim brought against them. Directors insurance can also be purchased by the company to mitigate the risk of claims brought on account of director liability.
What can be done to reduce the risk of breaching these duties?
One of the simplest ways is to regularly remind directors of these duties and we recommend to clients that on at least an annual basis, the directors be given a document by the company setting out these duties and ensuring they are discussed at the board meeting.
The current Covid-19 situation has been very sobering for many directors and many have re-visited their duties to ensure they are not inadvertently exposing themselves through breaching these duties as a result of decisions being made to deal with the impact of Covid-19 on their respective businesses.
Under normal circumstances, the duties of a director are to the shareholders, however where the continued solvency of a company is in doubt, the duties of the directors switch from promoting the success of the company to acting in the best interest of creditors.
If a company’s continued solvency is in question, directors do need to take independent advice, as wrongful trading could see a director personally liable under the Insolvency Act 1986.
The current impact of Covid-19 has likely forced many companies to cross this line, often inadvertently.
The current situation has threatened the very existence of a vast number of companies and to provide directors with some protection against decisions taken in these times, the government announced a temporary easing the rules on wrongful trading for a period of three months commencing from 1 March 2020.
Wrongful trading occurs when a director knew, or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent administration were it to continue trading.
The proposed relaxation of the wrongful trading rules will be welcome to most company directors, but a relaxation in this area does not mean that directors are not still bound by their other duties and there is no protection against negligent or fraudulent trading and the director disqualification regime is still in place.
While the current situation persists, it is crucial that no director “puts their head in the sand” and engages with regular dialogue with other directors, and where appropriate, advisers.
As the situation is so dynamic it is imperative to ensure that the board has access to robust and current financial information to assist in decision making and that the board require management to report on the company’s performance against any banking / investor covenants, and that there are clear “triggers” to address a worsening in each company’s financial position.
SRC-Time are one of the South East’s leading accountancy firms in advising individuals and businesses in all aspects of their accounting and tax affairs and we are able to assist in any issue raised above.
Our expert team is available to provide you with advice and can be contacted on 01273 326 556 or you can drop us an email at firstname.lastname@example.org or speak with an account manager to get any process started.