Directors run companies - they make the big decisions, sign contracts, and steer the business. But with great power comes great responsibility! The law imposes strict duties on directors to prevent them from abusing their position. Get this topic right, and you'll understand one of the most frequently tested areas in SQE1 Business Law.
There are 7 statutory duties in sections 171-177 of the Companies Act 2006. Think of them as the 'Seven Commandments' for directors. Learn these section numbers - they come up constantly in exams!
Before diving into duties, let's clarify who we're talking about. A 'director' includes anyone occupying the position of director, BY WHATEVER NAME CALLED (s.250 CA 2006). This is crucial - you can't escape duties just by calling yourself something else!
Shadow directors are tricky! Someone is a shadow director if the board is 'accustomed to act' on their directions. But professional advisors (lawyers, accountants) giving advice in their professional capacity are NOT shadow directors. Watch for exam questions trying to catch you out on this distinction.
Here's a fundamental point that trips up many students: directors owe their duties to THE COMPANY, not to individual shareholders (s.170 CA 2006). The company is a separate legal person (remember Salomon!), and it's the company that can sue directors for breach. Shareholders generally cannot sue directors directly - though there are exceptions we'll cover later.
The general duties specified in sections 171 to 177 are owed by a director of a company to the company.
| Section | Duty | Key Point |
|---|---|---|
| s.171 | Act within powers | Follow constitution, use powers for proper purpose |
| s.172 | Promote success | Act in good faith for benefit of members as a whole |
| s.173 | Independent judgment | Don't delegate decision-making inappropriately |
| s.174 | Reasonable care, skill, diligence | Objective + subjective test |
| s.175 | Avoid conflicts of interest | No undisclosed conflicts |
| s.176 | Not accept benefits from third parties | No bribes or secret commissions |
| s.177 | Declare interest in transactions | Disclose any personal interest |
Remember the duties with PIRATES: Powers (s.171), Interest declaration (s.177), Reasonable care (s.174), Avoid conflicts (s.175), Third party benefits (s.176), Exercise independent judgment (s.173), Success of company (s.172). Not in section order, but memorable!
Section 171 has two parts: (1) act in accordance with the company's constitution, and (2) only exercise powers for the purposes for which they were conferred. In plain English: follow the rulebook, and don't misuse your powers.
A director must: (a) act in accordance with the company's constitution, and (b) only exercise powers for the purposes for which they are conferred.
[1974] AC 821
Directors issued new shares, which had the effect of diluting the majority shareholder's stake. The primary purpose was to defeat a takeover bid, not to raise capital.
The share issue was invalid. Even though the directors honestly believed they were acting in the company's best interests, the power to issue shares exists to raise capital, not to manipulate control.
Powers must be exercised for their PROPER PURPOSE. Even good faith doesn't save you if you use a power for the wrong reason. Courts look at the SUBSTANTIAL purpose, not just any incidental purpose.
Section 172 is often called the most important duty. Directors 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 members as a whole. Notice: it's about what the DIRECTOR believes - a subjective test. But they must also 'have regard to' various stakeholder interests.
A director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to: (a) long-term consequences; (b) employee interests; (c) supplier/customer relationships; (d) community and environment; (e) maintaining reputation; (f) acting fairly between members.
This approach is called 'enlightened shareholder value'. Directors must primarily focus on shareholders (members), but must CONSIDER other stakeholders too. It's not that employees or the environment come first - they're factors to consider when pursuing shareholder benefit. Think of it as: 'Shareholders are the destination, but consider these factors on the journey.'
When a company is insolvent or near-insolvent, s.172 is modified. Directors must then consider creditors' interests, potentially putting them ABOVE shareholders. This is because in insolvency, it's creditors' money at risk, not shareholders'. Watch for exam scenarios involving struggling companies!
Directors must exercise their own judgment - they can't just blindly follow what others tell them. This doesn't mean ignoring advice (that would be foolish!), but means ultimately making your own decision. You can't say 'the lawyer told me to' as a complete defence.
A director must exercise independent judgment. This duty is not infringed by acting in accordance with an agreement entered into by the company or in a way authorised by the company's constitution.
What about 'nominee directors' appointed by investors to represent their interests? They still owe duties to the company, not their nominator. They can consider the nominator's views, but must ultimately decide what's best for the company. A nominee who just votes however their appointer instructs is breaching s.173.
Section 174 uses a dual objective/subjective test. Directors must show the care, skill, and diligence of a reasonably diligent person with: (1) the general knowledge, skill, and experience that may REASONABLY BE EXPECTED of someone in that role (objective), AND (2) the actual knowledge, skill, and experience that THIS PARTICULAR director has (subjective).
A director must exercise reasonable care, skill and diligence - the care, skill and diligence that 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 same functions, and (b) the general knowledge, skill and experience that the director has.
The objective test sets a FLOOR - you can't fall below minimum competence by claiming ignorance. The subjective test raises the bar for experts - a qualified accountant who becomes finance director is held to higher standards than a non-accountant in the same role. You're judged by whichever standard is HIGHER.
[1994] 1 BCLC 561
A director signed an insurance proposal form without reading it properly. The form contained incorrect information, and when the company made a claim, the insurer refused to pay.
The director breached his duty of care. A reasonably diligent director would have read the form before signing it.
Directors must pay attention to what they're signing. You can't blindly sign documents without reading them, even if you trust the person who prepared them.
Directors must avoid situations where they have, or could have, a direct or indirect interest that conflicts with the company's interests. This applies especially to exploiting property, information, or opportunities - even if the company couldn't have used them itself!
A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. This applies in particular to the exploitation of any property, information or opportunity.
Here's the good news: conflicts CAN be authorised! For private companies, the board can authorise conflicts unless the articles prohibit it. For public companies, the articles must EXPRESSLY permit board authorisation. The conflicted director cannot count towards the quorum or vote on the authorisation.
[2003] EWCA Civ 424
Two directors discovered a property for sale next to the company's existing property. Without telling the board, they bought it personally through their own company. The company had a policy of not acquiring new properties.
The directors breached their duty. Even though the company had decided not to expand, the opportunity came to them AS DIRECTORS, so they should have disclosed it to the board.
If you learn of an opportunity in your capacity as director, you must disclose it - even if you think the company won't want it. It's not for you to decide unilaterally.
Directors must not accept benefits from third parties that are given because of their position as director. Think: bribes, kickbacks, secret commissions. The duty is NOT breached if accepting the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest - so normal corporate hospitality is usually fine.
A director must not accept a benefit from a third party conferred by reason of being a director, or doing (or not doing) anything as director. A 'third party' means anyone other than the company or its subsidiaries.
Unlike s.175 conflicts, s.176 benefits CANNOT be authorised by the board. The only 'authorisation' is that benefits that won't cause conflicts aren't caught in the first place. So if a supplier gives a director an expensive gift to secure a contract, that's a breach - full stop.
If a director has any interest (direct or indirect) in a proposed transaction or arrangement with the company, they must declare the nature and extent of that interest to the other directors. This must be done BEFORE the transaction is entered into. For existing transactions, there's a separate disclosure requirement under s.182.
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.
Section 178 CA 2006 says the consequences of breach are 'the same as would apply if the corresponding common law rule or equitable principle applied'. In practice, this means the full range of remedies is available: damages, account of profits, rescission of contracts, injunctions, and more.
| Remedy | What It Does | When Used |
|---|---|---|
| Damages/Compensation | Money to compensate company for loss | When company suffers financial loss |
| Account of Profits | Director hands over profits made from breach | When director gained from breach |
| Rescission | Undo the transaction | When contract made in breach |
| Injunction | Court order to stop or require action | To prevent ongoing/future breach |
| Restoration of Property | Return company property | When director took company assets |
Usually, only the COMPANY can sue for breach of directors' duties (since duties are owed to the company). But what if the directors who breached ARE the majority controlling the company? They'll never vote to sue themselves! This is where derivative claims come in - shareholders can sue on the company's behalf in certain circumstances under s.260-264 CA 2006.
Under s.239 CA 2006, shareholders can RATIFY (approve after the fact) conduct by a director that amounts to breach of duty. If ratified, the breach is effectively forgiven. BUT: the director who breached (and any connected persons) cannot vote in favour of ratification. Only 'disinterested' shareholders can approve it.
Ratification of conduct by a director amounting to negligence, default, breach of duty, or breach of trust requires an ordinary resolution. The votes of the director (if a member) and any connected persons must be disregarded.
Even if a director has breached their duty, the court may grant relief under s.1157 CA 2006 if the director acted honestly and reasonably, and it appears fair to excuse them. This is discretionary - the court considers all circumstances. It's a safety valve for directors who made honest mistakes.
Companies generally CANNOT indemnify directors against liability for breach of duty (s.232). However, they CAN purchase Directors & Officers (D&O) insurance, and they CAN indemnify against third party claims (but not against the company itself or criminal fines). Most companies maintain D&O insurance as standard.
| Section | Duty | Can Be Authorised? |
|---|---|---|
| s.171 | Act within powers | No - constitutional limits apply |
| s.172 | Promote success | No - fundamental duty |
| s.173 | Independent judgment | Yes - by constitution/agreement |
| s.174 | Care, skill, diligence | No - but relief possible under s.1157 |
| s.175 | Avoid conflicts | Yes - by board (private) or articles (public) |
| s.176 | No third party benefits | No - unless no conflict arises |
| s.177 | Declare interests | Disclosure satisfies the duty |
In exam scenarios: (1) Identify which duty/duties are potentially breached, (2) Consider if any authorisation/ratification applies, (3) Consider remedies available. The most tested duties are s.172 (success), s.174 (care/skill), and s.175 (conflicts). Know Howard Smith for proper purpose, Bhullar for conflicts, and Re D'Jan for care.
171-177 = The Seven Duties. 170 = To whom owed. 178 = Consequences. 239 = Ratification. 1157 = Court relief. These section numbers are gold in the exam - drop them in your answers!