Director’s Duties & liability

A director’s principal role is to run and direct the day-to-day business and strategy of the company, to make all key decisions and to safeguard the success of its business.  Directors must promote their company’s success and must not act in a way which conflicts with this obligation and favours the actions which promote their own personal interest.  Broadly speaking a director must always act in the best interest of the company and not prioritise themselves or the shareholders ahead of the company in the decision making.

Shareholders are the owners of the company.  They have legal rights linked to the protection of their interest in the company as well as certain rights to vote on key decisions.

The incorporated company is the ‘body corporate’ the legal vehicle which conducts business, owned by the shareholders and run by the directors.  The company can trade, enter contracts, assume liabilities and do business with other parties.

But what are the specific duties a director owes?  How and when does a director have personal liability for company obligations and liabilities?  What is “piercing the corporate veil” and does this apply to directors?

This is a subject which every company director should be familiar with, both in terms of understanding their duties and how to avoid personal liability should the company fail, or other circumstances arise which lead to an investigation into the affairs of the company.

What are the Companies Act 2006 duties?

Sections 171 to 177 of the Companies Act 2006 (CA 2006) set out seven core general directors’ duties which are as follows:

• To act within their powers (s.171);

• To promote the success of the company (s.172);

• To exercise independent judgment (s.173);

• To exercise reasonable care, skill and diligence (s.174);

• To avoid conflicts of interest (s.175);

• Not to accept benefits from third parties (s.176); and

• To declare any interest in a proposed transaction or arrangement with the company (s.177).

In the most part, the general duties will come into force upon taking up office and end upon resignation as director.  However, the duties contained in s.175 and s.176 continue to apply after the director has resigned their office.

Can a director be exempt from the general duties?

No. Section 232 CA 2006 makes it clear that any provision that purports to exempt a director of a company (to any extent) from any liability that would otherwise attach to the director in connection with any negligence, default, breach of duty or breach of trust in relation to the company is void.

Who owes the general duties?

These general duties are owed to the company by (1) directors who are registered at Companies House and properly appointed to the board (known as de jure directors), (2) by persons who act as a director but who have not been appointed to the board (known as de facto directors); and (3) by  ‘shadow’ directors (persons in accordance with whose directions or instructions the directors of a company are accustomed to act).

Aside from the company being able to enforce these general duties, it is also worth noting that shareholders are able to instigate ‘derivative’ proceedings against directors (on the company’s behalf) under s.260 CA 2006, for alleged breach of a director’s duty to promote the success of the company under s.172 CA 2006 and in particular in relation to actual or proposed acts or omission involving negligence, default, breach of duty and breach of trust by a director, former director, of shadow director.

What other duties and obligations apply to directors?

Aside from the statutory general duties, directors owe a number of other duties for and on behalf of the company they represent, including the following:

·         Directors owe fiduciary duties to the company.  This concept broadly encompasses the obligation to act in its best interest, to safeguard its assets, to act with integrity and confidentiality and not to make a profit as director, unless authorised by the company's constitution.  In essence, directors occupy a trustee-like position with regard to the company’s assets.

·         In some instances, directors are also employees and will therefore owe specific employment-related obligations to the company as their employer.

·         A company’s articles of association may also set out separate bespoke specific duties and obligations which apply to directors.

·         Under s.441 CA 2006 directors are under a duty to deliver accounts.

·         Directors may enter into direct legal relationships with third parties on behalf of or in connection with company business such a personal guarantee agreements.

·         Directors can also be personally prosecuted in certain circumstances for breaches of health and safety law and GDPR for example.

·         In the context of the insolvency of the company, a company director will be subject to other obligations and duties including cooperating with the insolvency practitioner during their investigations and the discharge of their office.

·         As a pre-cursor to insolvency, the way a director manages a company which is in potential financial distress will also come under scrutiny.  Where an insolvency practitioner finds that a director falls short of their duties, they may be subject to personal claims for wrongful trading, misfeasance, breach of fiduciary duty and fraudulent trading.  These claims may result in the director personally contributing to the insolvency and lead to disqualification proceedings.

What is piercing the corporate veil and does it apply to directors?

The doctrine of “piercing the corporate veil" means establishing personal liability for a liability which would ordinarily rest with the company and, thereby, going beyond the usual protection offered by a shareholder’s limited liability and the separate legal entity of the company.

This typically arises in cases where a company's separate legal personality is being abused for the purpose of some impropriety.

 The case of Petrodel Resources Ltd v Prest [2013] UKSC 34, established that the Court may, in certain situations, lift and pierce the corporate veil where a person was under an existing legal obligation or liability or subject to an existing legal restriction which they deliberately evaded or whose enforcement they deliberately frustrated by interposing a company under his control.

It therefore only applies generally to shareholders but could, of course, also affect those directors who are shareholders.

Recent Trends: Increased Scrutiny of Directors

The legal and regulatory environment for directors continues to evolve and several key trends are becoming increasingly apparent.

Greater Focus on Director Conduct During Economic Uncertainty

Economic and political insecurity has led to persistently challenging trading conditions, rising borrowing costs and ongoing economic pressures for businesses.  These have in turn increased scrutiny of directors' decision-making; be that by the shareholders or other stakeholders.

Increased Emphasis on Creditor Interests & risk of insolvency

Businesses experiencing financial difficulties are more likely to face investigation by insolvency practitioners and regulators, particularly where governance records are incomplete or decision-making processes are poorly documented.

Directors who focus solely on shareholder outcomes and priorities when insolvency is looming, will likely face criticism and potential claims around the conduct of the business.  Directors must always act in the best interests of the company itself and consider  the best way to proceed as well as creditor interests shoudl  insolvency risks increase.

Governance and Accountability Under the Microscope

Regulators, lenders and investors increasingly expect businesses to demonstrate robust governance processes.  This is also the case as a company prepares to be sold. Due diligence around past conduct and any potential issues as well as good record keeping is increasingly becoming a key focus point for potential buyers.  Poor governance will result in purchase prices being depreciated and or sales falling through.  Sellers (who may also be directors) will often have to give personal legally binding warranties to provide comfort to a buyer.

Board minutes, management accounts, risk assessments and decision-making records, evidence of professional advice from lawyers and accountants are becoming increasingly important evidence in defending claims and investigations.

Continued Enforcement Action

The Insolvency Service continues to pursue directors whose conduct falls below expected standards, particularly in cases involving misuse of company funds, failure to maintain adequate records and misconduct during insolvency.

ESG and Corporate Responsibility

Environmental, social and governance (ESG) issues are increasingly influencing stakeholder expectations and business decision-making.

While not always creating direct liability, failures in governance and risk management can have significant reputational and commercial consequences.

Commercial Litigation Top Tips for Directors

From a commercial litigation perspective, prevention is invariably more cost-effective than cure.  Directors can reduce their exposure by adopting some practical measures:

1. Document Key Decisions

Well-maintained board minutes and management records, evidence of advice can provide crucial evidence if decisions are later challenged.

2. Manage Conflicts of Interests Properly

Identify, declare and document actual or potential conflicts at the earliest opportunity. Stand down from decisions which may create a conflict.  Consider external advice on tricky issues to guide the board more broadly.

3. Monitor Financial Health

Ensure decisions are supported by accurate financial information and seek professional advice promptly where concerns arise.  Directors should always take independent advice from accountants, bankers and even insolvency professionals if the company is experiencing financial distress.

 Companies should not continue to take on liabilities it knows that it cannot meet in the context of financial pressure or balance-sheet insolvency.  Should directors proceed to support such action in that circumstance, their conduct could be subject to investigation and wrongful trading claims brought.

4. Use Written Agreements

Many commercial disputes arise from informal, self-drafted documents, AI-drafted documents or verbal arrangements.  The rise of the availability of AI tools has led to an increased use and reliance on AI produced documents which are not fit for purpose.

Clear professionally drafted contracts prepared by a solicitor will reduce uncertainty and provide valuable protection.  They afford the business with a fit-for-purpose vehicle to do business.

When the time comes to sell the business, having legal relationships properly documented is absolutely key.

5. Review Personal Guarantees

Understand the extent of and liability created by any personal commitments provided to lenders, landlords or suppliers.  Sometimes these are provided early on in a business’ life and not properly reviewed or updated as time goes on and the company grows.  Personal liabilities of directors who have provided PGs should be monitored regularly.

6. Seek Early Legal Advice

Many disputes can be resolved commercially if addressed early. Delayed action will simply increase costs and limit options.  Sometimes the idea of instructing solicitors can seem daunting, but often it will be the best decision made when disputes are in their early stages and there is a much higher chance of early and amicable resolution if tackled early with the right legal support.

7. Review D&O Insurance

Regularly assess whether existing director an officer insurance cover remains appropriate for the size, complexity and risk profile of the business.

Conclusion

Directorship brings significant legal responsibility alongside the opportunity to lead and grow a business.

Whilst the corporate structure provides valuable protection, directors who fail to understand and comply with their duties can face substantial personal exposure. Strong governance, proactive risk management and timely professional advice remain the most effective tools for protecting both the company and those entrusted with its management.

For advice on directors' duties, shareholder disputes, director claims, insolvency-related litigation or wider business governance issues, please contact Forbes Solicitors' Commercial Litigation team.