Company directors are subject to a range of statutory duties geared at protecting the interests of shareholders and, to a lesser extent, corporate creditors. Where one or more of these duties are breached the consequences for the company can be serious, particularly where share value is affected or irretrievable financial difficulty ensues.
Some of the key duties are set out in sections 171 to 177 of the Companies Act 2006 and include an obligation to act within powers, to promote the success of the company, to avoid conflicts of interest, to refuse benefits offered by third parties, to declare an interest in a proposed transaction or arrangement and to exercise independent judgement and reasonable care, skill and diligence.
Breaches happen frequently, sometimes deliberately and sometimes through an innocent mistake or failure to appreciate that it is not just executive and non-executive directors who are bound by the rules but also shadow and de facto directors who call the shots from the sidelines.
Prompt legal advice is the key to dealing with breaches effectively.
Suspicions of a breach
Very often it is not clear whether a breach has actually occurred. This is particularly common with those duties that are subject to exceptions, such as the duty to avoid conflicts of interest which expressly excludes conflict situations which have been pre-authorised, for example under the company’s articles of association.
A lawyer can consider the action or inaction complained of and provide an opinion on whether the relevant duty has or has not been complied with.
Breaches capable of ratification
Some breaches can be retrospectively sanctioned by the company through a process known as ratification. A lawyer can advise on whether this is an option in any given case and highlight the bars that exist to using this process, for example where the breach involves unlawful behaviour or acts or omissions which amount to a fraud on minority shareholders.
Typically a minor breach causing no significant detriment to the company would be a suitable case for ratification, such as where a director is authorised to enter contracts on the company’s behalf up to £25,000 but inadvertently exceeds the power given to them by signing up to a contract worth £28,000.
Breaches that warrant court action
Breaches that have caused serious harm to the company, or which have the potential to do so, may well warrant the instigation of court proceedings. This might be the case where, for example, a director has diverted business opportunities to a rival company in which they are the major shareholder or where a high value contract has been awarded to a business with which the director has links (and from which they are likely to benefit) but where no advance disclosure of the link was provided.
Court proceedings can be used to:
- recover company property;
- set aside an improperly entered arrangement or transaction;
- recoup any personal profit the director has made;
- remove the director from office;
- seek compensation; or
- secure an injunction to prevent further damage being caused.
A lawyer can advise the company on the options available and on whether the cost of formal action is justified by reference to the likely outcome and the ongoing duty of the directors to promote the success of the company for the benefit of members or, where insolvency looks likely, the company’s creditors.
In some cases an out of court settlement may be possible, for example by the company agreeing to accept the repayment of diverted profits by instalments in return for the director agreeing to step down voluntarily and forgo any right they may have had to receive a severance package.
Breaches which could lead to a shareholders’ derivative action
As a general rule it is up to the company’s board to decide whether court action is appropriate, but there are limited circumstances in which it may be possible for one or more shareholders to take control via the issuing of what is known as a derivative action. In simple terms, this is a process that allows shareholders to issue proceedings on the company’s behalf where the directors have declined to act and where one or more shareholders believe that this was the wrong decision.
Derivative actions can be difficult to get off the ground because of the need to convince the court that the proceedings are justified before they can proceed. A lawyer can advise the company on the likelihood of a derivative claim being allowed so that this can be considered by the board when deciding whether proceedings should be issued by the company to buy out the risk of this occurring.
A classic example of a case where a derivative action may be appropriate is where a company has a sole director who has acted in breach of their duties to the detriment of minority shareholders and who refuses to acknowledge any wrong doing.
Action by an insolvency practitioner
Where the company is forced into an insolvency arrangement, responsibility for deciding whether to pursue the director will be transferred from the board to an insolvency practitioner. In this situation there is a danger that the board itself could be subject to criticism – and a claim for a personal contribution to company funds made against individual board members – if they are found not to have acted when they ought reasonably to have done, for example to recover company property and thereby minimise the loss to creditors. For this reason pre-insolvency advice should always be sought when the question of director action fails to be considered.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.