Companies Act 2006 – CHAPTER 2

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GENERAL DUTIES OF DIRECTORS

Sections 170 to 181: General comments

298. The general duties form a code of conduct, which sets out how directors are expected
to behave; it does not tell them in terms what to do. More particularly, the duties address:

• the possibility that a director may put his own or other interests ahead of those of the
company;

• the possibility that he may be negligent.

299. The duties are derived from equitable and common law rules, and are not at the
moment written down in statute.

300. The Law Commission and the Scottish Law Commission recommended that there
should be a statutory statement of a director’s main fiduciary duties and his duty of care and
skill in their joint report Company Directors: Regulating Conflicts of Interests and
Formulating a Statement of Duties. The CLR’s main recommendations in respect of
directors’ general duties are summarised in chapter 3 of the Final Report.

301. The CLR recommended that there should be a statutory statement of directors’
general duties, and that this should, with two exceptions, described in the next paragraph, be
a codification of the current law. In particular they wanted:

• to provide greater clarity on what is expected of directors and make the law more
accessible. In particular, they sought to address the key question “in whose interests
should companies be run?” in a way which reflects modern business needs and wider
expectations of responsible business behaviour;

• to make development of the law in this area more predictable (but without hindering
development of the law by the courts);

• to correct what the CLR saw as defects in the present duties relating to conflicts of
interest.

The Government has accepted these recommendations.

302. There are two areas, both relating to the regulation of conflicts of interest, where the
statutory statement departs from the current law:

• under section 175, transactions or arrangements with the company do not have to be
authorised by either the members or by the board; instead interests in transactions or
arrangements with the company must be declared under section 177 (in the case of
proposed transactions) or under section 182 (in the case of existing transactions)
unless an exception applies under those sections;

• section 175 also permits board authorisation of most conflicts of interest arising from
third party dealings by the director (e.g. personal exploitation of corporate resources
and opportunities). Such authorisation is effective only if the conflicted directors have
not participated in the taking of the decision or if the decision would have been valid
even without the participation of the conflicted directors. Board authorisation of
conflicts of interest will be the default position for private companies, but public
companies will need to make provision in their constitutions to permit this. Board
authorisation is not permitted in respect of the acceptance of benefits from third
parties (section 176).

303. Both reforms implement recommendations of the CLR, which noted that the basic
principles in the current law relating to directors’ conflicts of interest are very strict:

• they noted that in practice most companies permit a director to have an interest in a
proposed transaction or arrangement with the company, provided that the interest is
disclosed to his fellow directors. The statutory statement therefore reflects the current
position in most companies;

• they also took the view that the current strict rule relating to conflicts of interest in
respect of personal exploitation of corporate opportunities fettered entrepreneurial and
business start-up activity by existing company directors. The statutory statement
therefore provides for board authorisation of such conflicts.

304. These reforms are modified for charitable companies in England and Wales and
Northern Ireland by section 181.

Codification of common law rules and equitable principles

305. Codification is not a matter of transposing wording taken from judgments into
legislative propositions. Judgments are, of necessity, directed at particular cases. Even when
they appear to state general principles, they will rarely be exhaustive. They will be the
application of (perhaps unstated) general principles to particular facts. In the company law
field, the principles being applied will frequently be taken from other areas, in particular
trusts and agency. It is important that these connections are not lost and that company law
may continue to reflect developments elsewhere. Frequently the courts may formulate the
same idea in different ways. In contrast legislation is formal. It is not easy to reconcile these
two approaches but the draft sections seek to balance precision against the need for continued
flexibility and development. In particular:

• subsection (3) of section 170 provides that the statutory duties are based on, and have
effect in place of, certain common law rules and equitable principles;

• subsection (4) of section 170 provides that the general duties should be interpreted and
applied in the same way as common law rules and equitable principles. The courts
should interpret and develop the general duties in a way that reflects the nature of the
rules and principles they replace;

• subsection (4) of section 170 also provides when interpreting and applying the
statutory duties, regard should be had to the common law rules and equitable
principles which the general duties replace; thus developments in the law of trusts and
agency should be reflected in the interpretation and application of the duties;

• section 178 provides that the civil consequences of breach (or threatened breach) of
the statutory duties are the same as would apply if the corresponding common law
rule or equitable principle applied. It also makes clear that the statutory duties are to
be regarded as fiduciary, with the exception of the duty to exercise reasonable care
skill and diligence which is not under the present law regarded as a fiduciary duty.

306. The statutory duties do not cover all the duties that a director may owe to the
company. Many duties are imposed elsewhere in legislation, such as the duty to file accounts
and reports with the registrar of companies (section 441). Other duties remain uncodified,
such as any duty to consider the interests of creditors in times of threatened insolvency.

Duties owed to the company

307. Section 170(1) makes it clear that, as in the existing law, the general duties are owed
by a director to the company. It follows that, as now, only the company can enforce them.
Part 11 (derivative claims and actions by members) describes the mechanism whereby
members may be able to enforce the duties on behalf of the company.

Who are the duties owed by?

308. The duties are owed by every person who is a director of a company (as defined in
section 250). They are therefore owed by a de facto director in the same way and to the same
extent that they are owed by a properly appointed director.

309. Certain aspects of the duty to avoid conflicts of interest and the duty not to accept
benefits from third parties continue to apply even when a person ceases to be a director; this
is necessary to ensure that a director cannot, for example, exploit an opportunity of which he
became aware while managing the company’s business without the necessary consent simply
by resigning his position as director. The closing words of section 170(2) provide that these
duties apply to a former director subject to any necessary adaptations. This is to reflect the
fact that a former director is not in the same legal position as an actual director.

310. The statutory duties apply to shadow directors where, and to the extent that, the
common law rules or equitable principles which they replace so apply (section 170(5)). This
means that where a common law rule or equitable principle applies to a shadow director, the
statutory duty replacing that common law rule or equitable principle will apply to the shadow director (in place of that rule or principle). Where the rule or principle does not apply to a
shadow director, the statutory duty replacing that rule or principle will not apply either.

The relationship between the duties

311. Many of the general duties will frequently overlap. Taking a bribe from a third party
would, for example, clearly fall within the duty not to accept benefits from third parties
(section 176) but could also, depending on the facts, be characterised as a failure to promote
the success of the company for the benefit of its members (section 172) or as an aspect of
failing to exercise independent judgment (section 173).

312. The effect of the duties is cumulative, so that it is necessary to comply with every
duty that applies in any given case. This principle is stated in section 179. One exception
relates to the duty to avoid conflicts of interest (section 175). This particular duty does not
apply to a conflict of interest arising in relation to a transaction or arrangement with the
company. In such cases the duty to declare interests in proposed transactions or arrangements
(section 177) or the requirement to declare interests in existing transactions or arrangements
(section 182) will apply instead. Section 181 modifies these provisions for charitable
companies in England and Wales and Northern Ireland.

313. The cumulative effect of the duties means that where more than one duty applies, the
director must comply with each applicable duty, and the duties must be read in this context.
So, for example, the duty to promote the success of the company will not authorise the
director to breach his duty to act within his powers, even if he considers that it would be most
likely to promote the success of the company.

314. As well as complying with all the duties, the directors must continue to comply with
all other applicable laws. The duties do not require or authorise a director to breach any other
prohibition or requirement imposed on him by law.

Relationship between the duties and the company’s constitution

315. Under section 171 a director must act in accordance with the company’s constitution.

316. Companies may, through their articles, go further than the statutory duties by placing
more onerous requirements on their directors (e.g. by requiring shareholder authorisation of
the remuneration of the directors). The articles may not dilute the duties except to the extent
that this is permitted by the following sections:

• section 173 provides that a director will not be in breach of the duty to exercise
independent judgment if he has acted in a way that is authorised by the constitution;

• section 175 permits authorisation of some conflicts of interest by independent
directors, subject to the constitution;

• subsection (4)(a) of section 180 preserves any rule of law enabling the company to
give authority for anything that would otherwise be a breach of duty;

• subsection (4)(b) of section 180 provides that a director will not be in breach of duty if
he acts in accordance with any provisions in the company’s articles for dealing with
conflicts of interest;

• section 232 places restrictions on the provisions that may be included in the
company’s articles. But nothing in that section prevents companies from including in
their articles any such provisions as are currently lawful for dealing with conflicts of
interest.

317. The company’s constitution may also set out the purposes of the company, especially
in the case of an altruistic company which has purposes other than the benefit of the
company’s members. It is very important that directors understand the purposes of the
company, so that they are able to comply with their duty to promote the success of the
company in section 172.

Relationship between the duties and the detailed rules requiring member approval of
conflicts of interest

318. Under the provisions in Chapter 4 of this Part, the directors must sometimes obtain
prior shareholder approval for the following types of transaction involving a director (or, in
some cases, a person connected to a director): long-term service contracts; substantial
property transactions; loans, quasi-loans and credit transactions; and payments for loss of
office.

319. Section 180 provides that:

• compliance with the general duties does not remove the need for member approval of
such transactions (subsection (3));

• (subject to the exception set out in the bullet point below) the general duties apply
even if the transaction also falls within Chapter 4 (because it is a long-term service
contract, substantial property transaction, loan, quasi-loan, credit transaction or
payment for loss of office). So, for example, the directors should only approve a loan
to a director if they consider that it would promote the success of the company. This is
so, even if the loan does not require the approval of members under Chapter 4 because
it falls within a relevant exception, such as the exception for expenditure on company
business in section 204;

• if the transaction falls within Chapter 4 (because it is a long-term service contract,
substantial property transaction, loan, quasi-loan, credit transaction or payment for
loss of office) and approval of the members is obtained to the transaction in
accordance with that Chapter, or an exception applies, so that approval is not
necessary under that Chapter, then the director does not need to comply with the duty
to avoid conflicts of interest (section 175) or the duty not to accept benefits from third
parties (section 176) in respect of that transaction. All other applicable duties will still
apply. For example, a director would not be acting in breach of the duty to avoid
conflicts of interests if he failed to obtain authorisation from the directors or the
members for a loan from the company in respect of legal defence costs. Section 181
modifies this provision for charitable companies in England and Wales and Northern
Ireland.

Relationship between the duties and the general law

320. Section 180(5) provides that the general duties have effect notwithstanding any
enactment or rule of law except where there is an express or implied exception to this rule.
For example, section 247 provides that directors may make provision for employees on the
cessation or transfer of a company’s business even if this would otherwise constitute a breach
of the general duty to promote the success of the company.

Consequences of breach

321. Section 178 preserves the existing civil consequences of breach (or threatened breach)
of any of the general duties. The remedies for breach of the general duties will be exactly the
same as those that are currently available following a breach of the equitable principles and
common law rules that the general duties replace.

322. Subsection (2) of that section makes it clear that the duties are enforceable in the same
way as any other fiduciary duty owed to a company by its directors (except for the duty to
exercise reasonable care, skill and diligence, which is not considered to be a fiduciary duty).
In the case of fiduciary duties the consequences of breach may include:

• damages or compensation where the company has suffered loss;

• restoration of the company’s property;

• an account of profits made by the director; and

• rescission of a contract where the director failed to disclose an interest.

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