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What are the legal duties of company directors?

Sep 11, 2023 | Uncategorised

If you’re the director of a limited company, what are your legal duties?

The basic principle is that day-to-day operations are your domain. But as a director, you’re bound by certain legal obligations and duties too.

These are outlined in the Companies Act 2006, a piece of legislation that became law under Tony Blair’s Labour government. It had the primary aim of stopping directors from abusing their power over shareholders, staff and other parties.

Whatever your position is within a limited company, it’s important to know where you stand. In this article, we break down the legal duties of company directors and look at what happens if the company goes into liquidation.

What is the role of a company director?

The basic structure of a limited company is simple. It’s owned by shareholders, who appoint directors. The law states that you must have at least one director.

The director’s job is to manage the business. This is a comprehensive role that covers everything from business strategy to accounting, from employee wellbeing to statutory obligations. A director is like a cop, a priest, an accountant and a visionary all in one. Or, at least, the good ones are.

What is the Companies Act 2006?

The Companies Act 2006 is a piece of legislation that sets out how companies in the UK are to be managed, run and financed. It replaced the Companies Act 1985 and has been implemented in stages – the most recent one being the amendments that were made in 2009.

The act provides both public and private companies with common corporate laws. Company directors are legally obliged to meet the standards that it sets out.

COVID-19 brought about some changes to the act – but these have largely been dropped.

Why was the act introduced?

The overriding aim of the act was to stop directors in the UK from abusing their powers by modernising and simplifying corporate law. Along the way, it strove to simplify administrative processes and improve shareholder rights.

On top of this were political concerns. The act aimed to bring Northern Ireland’s laws in line with the rest of Great Britain’s and (at the time) to synthesise EU directives and UK law.

What are a director’s responsibilities according to the Companies Act 2006?

The act lays out seven responsibilities for directors of public and private companies.

1. To act within their powers as company director

This involves following the company’s constitution – the legal document put together when the company is registered – and the articles of association.

2. To promote the success of the company for the benefit of its members as a whole

This duty encompasses all of the director’s actions – not just those carried out at board level. Directors are legally obliged to consider the long-term consequences of their actions and how these will serve their employees, stakeholders, and even the environment.

3. To exercise independent judgement

4. To exercise reasonable care, skill and diligence

5. To avoid conflicts of interest

This aims to stop directors from exploiting their positions for private gain.

6. To not accept benefits from third parties

Third-party gifts and benefits are only permissible when approved by the company’s members – or when their receipt can be proven not to give rise to a conflict of interest.

7. To declare interesting proposed arrangements or transactions with the company

What else does the act do?

To make these seven principles a reality, the act includes a range of measures. With its 1,300 sections, the act is the longest ever passed, so these are just some of its most important points.

It simplifies the incorporation process and gives new rights to indirect investors. It offers guidance on updating articles of association and codifies directors’ legal duties. It encourages companies to go digital, wherever possible.

It also aims to strip away some red tape for private companies – in particular, removing the need for an in-house secretary or annual general meetings.

Why is Section 172 important?

Section 172 is an amendment to the act that has caused some controversy. It stipulates how a director should act when “promoting its success” – in other words, how a director should act to benefit their shareholders.

When promoting their company, directors are now legally bound to

  • consider the long-term consequences of their decisions
  • foster relationships with suppliers, customers and other stakeholders
  • take into account their environmental impact
  • maintain a good reputation for business conduct
  • and act fairly to all company members

This isn’t loose guidance, either. Directors now have to submit an S172 report each year, alongside their accounts, that outlines how all this is being achieved.

What are the most important amendments?

Some amendments have been made to the legal duties of public company directors.

For instance, if the company is listed on the London Stock Exchange then its annual accounts and reports must factor in environmental and social issues. It must also hold an annual meeting and submit accounts in a timely fashion – within six months of the end of the financial year.

The act has also been amended to encourage greater transparency in financial reports – for instance, it must disclose any major acquisitions that have been made.

In private companies, company directors have full authority to allocate shares and can financially assist anyone who buys their shares. They can also now reduce their share capital without applying for a court order.

What other legislation applies to company directors?

The Insolvency Act 1986 covers what happens if a business becomes insolvent. A director’s legal duties change in the event of liquidation.

When the company is insolvent, its director no longer reports to its shareholders but turns their attention to creditors.

The director has to ensure that trading stops immediately – if it continues, they could be held personally responsible and even disqualified for “wrongful trading”.

No matter what the director contributed to the company at the start, they’re not guaranteed any assets or company money on liquidation.

Do you need guidance relating to the legal duties of company directors? Get in touch with our expert team of corporate solicitors for a free consultation

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