Duties and Liabilities of directors under the UK Company Act 2006

1.      Duty to act within powers

CA 2006 s. 171 requires directors to act according to the constitution of the company. Company’s constitution has been defined under section 17 of the CA 2006 as it includes company’s articles and any shareholders resolution and agreements. Moreover this section requires directors not to extend the power given to them even if they act on the interest of the company especially when those powers were given for special purpose. This was formulated by Lord Greene in the case of Smith and Fawcett [1942] also known as “proper purpose doctrine”.  Proper purpose doctrine has been applied in relation to the issue of shares since this may affect the voting power of shareholders. Directors can issue share in order to increase capital however share allotment for any other purpose will be improper use of power as shown in the case of Hogg V Cramphorn [1967] where directors issued share for the purpose of forestalling takeover bid and remain in power. This has been criticised due to the fact that it shows that directors have no right to defeat takeover bid by issuing shares. Moreover In the case of Whitehouse v Carlton hotel Pty [1987] it was pointed out that favouring one shareholder or group of shareholder by allotting shares to them is not function of the directors and therefore is improper use of power. However section 171 of the CA2006 is against Section 172 as pointed out in the case of Extrasure travel insurance ltd v scattergood [2002] where directors transferred £200000 to the parent company to help it to pay debts; On one hand, it was argued that directors were acting in good faith and on the other hand it was argued that directors were using their power for an improper purpose, the directors were guilty of abuse of power even though they were working in company’s interest. It is argued that these two parts of s.171 should be separated since the first one is about good faith and the second is about collateral purpose and hence different duties as held in the case of Bishopsgate investment management ltd V Maxwell [1993].Therefore directors should not only act on the best interest of the company but also act within the scope of the power given to them.

2.      Duty to run the company for the benefit of shareholders

 CA 2006 s. 172 requires directors to promote success of the company by acting in a good faith in a way which they consider to promote the success of the company. Therefore directors should have regards to relationship between company and its stakeholders, company employee’s interest, long term effect of any decision and the impact of the operation of the company on the environment and community as whole. The first part of this section of the CA 2006 is about subjective test as judged in the case of Regentcrest Plc V Cohen [2001]. On the other hand, the test even though is subjective, but it has got some limits. In the case of Hutton V West Cork Rly Co [1993] it has been shown that the directors can act perfectly for the interest of the company and yet irrationally. Moreover this section requires directors not only to act for the interest of the company but also to promote success of the firm for the benefit of all members. In the case of Mutual Life insurance Co of New York V Rank organisation ltd [1985] where directors issued share to ordinary shareholders expect those who are in North America. The court decided that directors acted in the best interest of the company and fairly between those different shareholders since the exclusion of those shareholders in North America did not affect their shares or their rights. CA 2006 s 172 (3) requires directors not only to act for the best interest of shareholders but also creditors as endorsed in the case of West Mercia Safetywear Ltd V Dodd [1988] where director arranged to repay £4000 the debt to its parent company while he knew that the company was insolvent, therefore the court of appeal decided that the director acted with disregard of the general creditors interest. However this section 172 has been criticised by Dignam, A & Lowry, J (2009) that sometimes is difficult to act for the best interest of the shareholders and at the same time to act in the best interest of creditors, therefore this section needs substitution of creditors since creditors are already protected by the Insolvency Act 1986.

3.      Duty to exercise independent judgment

CA 2006 s. 173 requires directors to exercise independent judgement. This section is not going against other sections but trying to give directors power to make decision for the best interest of the company without necessarily following the instruction of the shareholders. This section operates to prevent the directors of the company when contracting third parties as decided  in the case of Fulham Football Club Ltd V Cabra Estates Plc [1994] where four directors of the club decided to enter in to contract with Cabra who was their landlord to support planning application for the future development of the club’s grounds. In return for this Cabra paid substantial fee to the club. The directors argued to act unlawful on their powers for the interest of the company however the court of appeal rejected the argument by arguing that even though the directors have the duty to act for the interest of the company, this does not limit them from entering into contracts which can benefit the company in future. Therefore once the board can establish that it is acting in the interest of the company to enter in any agreement, duty will not be broken. Moreover, the time of negotiation is the time for directors to make decision and not during performance of the contract as decided in the case of Thorby V Goldberg [1964]. Therefore if at the time directors made their decision they thought they were acting in the best interest of the company, therefore the contract should be entered and carried into effect. However this section has been criticised by raising doubts on the extent to which directors of the company can depend on other board members with specialist expertise in relation to the matter to be decided by the board or other directors (Dignam, A & Lowry, J (2009)).

4.      Duty of care, skill and diligence

CA 2006 s. 174 requires directors to posses’ skills, knowledge and experience which will help them to carry out the functions of the director. This is because directorship is among very important post in the company which involves important responsibilities, and therefore it is supposed not to be accepted without consideration of the future effects of the position and company’s obligations. Sometimes companies appoint directors due to their social standings. For example in the case of  Re Cardiff Saving Bank, Marquis of Bute [1892] where marquis was appointed president of the bank when six month old. In the case of Re Forest of Dean Coal Mining Co [1878], it was formulated that, since directors are businessman, it is not expected to see them devoting much time and attention to the company or attending many board meeting but they are bound to use their knowledge fairly and reasonable diligence in managing the company. This section had some criticism on how diligence can be measured in different companies. This sometimes leads to directors rely much on professional advisers rather than shareholders and hence incur high cost as shown in the case of Re Bradcrown Ltd, Official Receiver V Ireland [2000].

5.      Duty of conflict of interest

 CA 2006 s 175 requires directors to avoid any situations which may result or may have direct or indirect interest which go against the company’s interest as judged in the case of Regal (Hastings) Ltd V Gulliver [1942]. This section was formulated by Lord Herschell in the case of Bray V ford [1896] and it applies to the misuse of any company’s property, opportunity or information. This section requires directors to account for any profit made due to conflict of interest as applied in the case of Chan V Zacharia [1984]. Section 175 (2) is about corporate opportunity where directors benefit themselves from an opportunity which belongs to the company. This was applied in the case of Cook V Deeks [1916] where directors used their powers to exclude company’s interest by incorporating another company to overtake the company on the tender on table. Another part of this section is about post-resignation breach of duty. This is when director decided to resign in order to start a new business which will be competing with company as shown in Foster Bryant Surveying Ltd V Bryant [2007]. However there will be no breach of duty if the company started is not competing with the one director resigned as judged in the case of Balston Ltd V Headline Filters Ltd [1990]. Directors can avoid any liability regarding breach of this duty by authorisation of other directors of the company if it is a public company. Moreover directors are not required to be interested in any transaction which the company was part of it. For example in the case of Aberdeen Railway Co. V Blaikie Bros [1854] where Blaikie was director of both companies and therefore fix high price of chairs for claimant in order to benefit himself. This section has been criticised due to the fact that it allows directors of the public company to authorise breach of duty, this may result to directors favouring each other. To some extent this section goes against section 172 as judged in the case of Regal (Hastings) Ltd V Gulliver [1942] since directors argued to be acting for company’s interest, however they were liable under section 175.

6.      Liabilities

Section 178 of the company Act shows that effects of the breach of duty by directors are the same as they would apply when the common law rule applied. In case directors breach their duties (section 171-177) they will be liable for any damages or compensation if the company suffer loss. Moreover they will be required to account for any profit made as judged in the case of Regal (Hastings) Ltd V Gulliver [1942]; return company’s property and the contract entered by them without disclosing their interest will be cancelled. Judges always use the word constructive trust as means for fashioning remedy for profit made due to the use of the company’s property for example in the case of JJ Harrison (properties) Ltd V Harrison [2002] where the director bought the land from the company for £8400 and few years later sold part of it for £110,300 and the remaining for £122,500. The director resigned and he was liable as constructive trustee. Moreover those who assist directors in breach of duty will be liable as well as shown in the case of Barnes V Addy [1874]. Moreover, directors can misapply the funds of the company to other person who is stranger for the benefit of both. The third party will become constructive trustee as shown in the case of Belmont Finance Corp V Williams Furniture Ltd [1980].