Directors fiduciary duties

Directors fiduciary duties

Directors fiduciary duties

Directors Fiduciary Duties – More Than Meets The Eye

When starting a new business through a company structure, budding entrepreneurs often overlook the issue of directors’ fiduciary duties. In their rush to launch their ‘great’ business ideas, entrepreneurs tend miss the fact that a directorship imposes serious legal duties and obligations and ignoring then can result in some dire consequences.

The Legal Framework

The Companies Act 2006 (“Act”) codified common law directors’ fiduciary duties as follows:

(a)  Act Within Powers – A director must act within the powers conferred by the constitution of the company and only for the purposes they are conferred. (Section 171)

(b) Promote Success Of The Company – a director must act in good faith and in the best interests of the company at all times taking into consideration potential consequences of decisions on third parties and the community, maintain high business standards and act fairly between shareholders. (Section 172).  This includes a duty to disclose one’s own wrongdoing (Item Software (UK) Ltd v Fassihi [2004]).

(c) Exercise Independent Judgment – the director should not be influenced by other persons or the interests of other persons. (Section 173)

(d) Exercise Reasonable Care, Skill And Diligence – directors must act to the standard of a reasonably diligent person with the general knowledge, skill and experience of a person carrying out the functions of a director. (Section 174)

(e) Avoid Conflicts Of Interest –  unless authorised by the Board, a director must avoid any situation where a conflict of interest could arise with the best interest of the company. (section 175)

(f) No Benefits From 3rd Parties – a director must not accept any benefit from a 3rd Party that is given due to him/her being a director of the company. (Section 176)

(g) Declare A Personal Interest – a director must declare a personal interest of any kind in any transaction or arrangement to be undertaken by the company. (Section 177)

Section 170 (1) expressly provides that the duties are owed to the company not to the shareholders.  The importance here is that the interests of the company must prevail over the interests of shareholder at all times.

There are several secondary statues that impose additional duties on directors such as the Income Tax Act, Corporate  Manslaughter  and  Corporate  Homicide  Act  2007, Fraud Act 2010, Bribery Act 2010 and others.

There are many different aspects to directors’ duties, but only the fiduciary aspect will be considered.  A close examination of each of the duties will indicate that each of them  has  a fiduciary element to it. So, what is a fiduciary duty?

Fiduciary Duty

A fiduciary duty arises where a person (“Fiduciary”)  acts on behalf of or represents another person in some legal relationship or capacity which is such that it requires the Fiduciary to act with prudence, trust, honesty and in the best interest of the other person.  The breach of a fiduciary duty is a serious matter  and can  result in personal liability and civil and/or criminal penalty. Examples of where a fiduciary duty exists, include lawyer/client, accountant/client, bank/client, trustee/beneficiary, agent/principal.

The underlying foundations of directors’ fiduciary duties and its fiduciary aspects are twofold:

(a)  the success of the company; and

(b)  absolute loyalty (Philip Towers v Premier Waste Management Ltd [2011]).

The fiduciary duty is pervasive and can show up in unexpected ways and in circumstances where one could think there is no duty, or it has lapsed. For example, where a company rejects an investment proposal and subsequently a director take up the opportunity for personal gain. A fiduciary duty may exist in such circumstances even though the company rejected the opportunity and suffered no loss (Crown Dilmun v Sutton [2004]). The fact is that the director came in possession of the information in his/her capacity as a director.

Also, where Company A invests in Company B and nominates Mr X (an employee) as a director of Company B with instructions to represent and protect the interests of Company A. Company B receives an offer to participate in a business opportunity. Mr X consults Company A and is instructed to reject the opportunity. Irrespective of the fact that Mr. X is following his/her employer’s instructions, it is likely that the duty  under Section 173 to exercise independent judgment has been breached. The eventual outcome of the opportunity is not a relevant factor. In Fulham Football Club v Cabra Estates [1994), the Court of Appeal held that directors must exercise unfettered discretion.

The courts take a dim view of breaches of duty, particularly where there is a fiduciary duty involved.  In Philip Towers v Premier Waste Management Ltd [2011], a director received undisclosed benefits. The Court of Appeal held that the director’s argument that the breach was a minor one and that the company did not incur a loss were irrelevant – the fact was that the duty had been breached.

How Can Directors Protect Themselves?

So, what can directors do to protect themselves? These is no ironclad answer, but there are a number of options to minimise liability.

(a) Education – all directors should educate themselves on their duties. They should have a clear understanding of their legal obligations and the kinds of conduct that can result in a breach of duty.

(b) Declaration of Interests – personal interests, direct or indirect, in Company matters should be declared – irrespective of its nature or size (Philip Towers v Premier Waste Management Ltd [2011]). If in any doubt, make a declaration.

(c) Board Minutes – minutes of board meetings should be detailed and accurate and should fully document the basis on which decisions are reached. Any declarations of interests and/or the Board authorisation for any purpose should be fully documented. If anything goes wrong in future, Board minutes will be reviewed and are often relied upon in litigation and prosecutions.

(d) Ratification

A breach of duty can be ratified by shareholders either in advance or retroactively provided that no third party interests are involved and there is no criminal activity. However, Section 239 of the Act prohibits shareholders from voting on  a resolution to ratify their own breaches acting as directors and directors cannot ratify their own acts (Goldtrail Travel Ltd (in liquidation) v Aydin [2014]).

(e) Pre-Emptive Application

Section 1157 of the Act allows a director to make a pre-emptive application to the court for relief provided that the director has acted honestly and reasonably (Cullen Investments Ltd v Brown [2017]).

(f) Company Indemnity

It is possible for a company to indemnify its directors against personal liability provided that the indemnity does not relate to:

(i)  a breach of a duty owed to the company;

(ii) any kind of criminal conduct; and

(iii) any costs and expenses for a criminal defence or in civil cases brought by the company and judgment goes against the director.

(g) Insurance

A company or the director himself/herself can take an insurance policy to cover director’s liability for breach of duties.

(h)  Take Professional Advice

If there is any doubt, the director should take appropriate advice from a professional.

One Man Companies

Many companies are one man entities. That is to say that there is only 1 director, who also owns 100% of the company. Many consider that in such  situations they are the company and they are only responsible to themselves. Nothing could be further from the truth. Companies are distinct legal entities separate from their owners – they have a life of their own, albeit an artificial one. The director still owes the duties described earlier. Some of the duties are not just to the company but also extend to third parties such as lenders, creditors, suppliers, customers, agents, distributors and employees and the community.

Post Directorship Duties

A resigning director should also be aware that his/her duties to the company do not cease with their resignation. Directors continue to be under a general duty not to use any of the non-public information they have acquired as directors (CMS Dolphin Ltd v Simonet [2001]).

Conclusion

Directors’ fiduciary duties are of immense importance because they form the central foundation for Corporate Governance and directors ignore them at their own peril. The courts have clearly demonstrated that they will take a narrow view when interpreting  the statutory provisions and common law. Directors have an evident self-interest in education and informing themselves of what is expected of them. Ownership of the company does not give them absolution in this respect.

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