4.1 Directors' Duties and Powers

Why governance is examined

Independent OpenExamPrep material for SQE1 Functioning Legal Knowledge 1 (FLK1) Business Law and Practice treats company decision-making as a working system, not a list of labels. In England and Wales a private or unlisted public company is run day to day by its directors, while members (shareholders) retain the power to change the constitution, appoint and remove directors, and approve transactions that statute or the articles put beyond the board. Exam questions typically give you a small company, a tense board, and a member who is being squeezed. Your job is to name the correct duty, the correct decision-maker, the correct majority, the correct notice or filing step, and — if the majority will not budge — the correct minority remedy.

The general duties in Companies Act 2006 (CA 2006) ss.171–177 are owed to the company (s.170). They rest on older common-law and equitable rules and are interpreted in the same way. A former director remains bound by the conflict duty (s.175) as regards property, information or opportunity learned while in office, and by the no-benefits duty (s.176) as regards things done or omitted before leaving. Shadow directors are bound to the extent the corresponding common-law rules would have bound them. More than one duty can apply to the same facts (s.179). Breach of the fiduciary duties (everything except s.174) attracts the usual equitable toolkit: account of profits, rescission, and restoration of company property. Breach of s.174 is treated as a common-law duty of care.

The general duties in working order

Section 171 requires a director to act in accordance with the company's constitution and to exercise powers only for the purposes for which they were conferred. Using a share-allotment power to dilute a dissenting member, or using a borrowing power to entrench the board, is a purpose problem even if the articles appear to allow the act.

Section 172 is the duty SQE1 candidates must be able to recite with precision. A director must act in the way the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. In doing so the director must have regard (among other matters) to: the likely long-term consequences of the decision; the interests of employees; the need to foster business relationships with suppliers, customers and others; the impact of operations on the community and the environment; the desirability of maintaining a reputation for high standards of business conduct; and the need to act fairly as between members. The list is mandatory but not exclusive. The duty is subjective good faith — the court asks what this director honestly thought — but a director who never considered the factors at all is in a weak position. Section 172(3) states that the duty has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors. The Supreme Court in BTI 2014 LLC v Sequana confirmed the content of that overlay: when insolvency is imminent or probable, directors must consider creditors' interests; when insolvent liquidation or administration is inevitable, creditors' interests become paramount. That is functioning knowledge, not a citation exercise: if the company is on the brink, a decision that strips value to members while trade creditors go unpaid is a s.172 problem as well as a later wrongful-trading problem.

Section 173 requires independent judgment. A director may follow a shareholders' agreement or a constitutional restriction that lawfully fetters future discretion, but may not simply vote as a majority shareholder instructs if that abandons independent judgment.

Section 174 is the dual care, skill and diligence standard: the care that would be exercised by a reasonably diligent person with the knowledge, skill and experience reasonably expected of a person carrying out that director's functions (objective), and the knowledge, skill and experience that this director actually has (subjective). A qualified finance director is judged more strictly on the accounts than a non-executive without that background; neither may ignore obvious insolvency warning signs.

Section 175 is the duty to avoid conflicts of interest, especially exploitation of company property, information or opportunity — and it is immaterial that the company could not itself take the opportunity. The duty does not apply to a conflict arising from a transaction with the company (that is s.177 / s.182 territory). It is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict, or if the matter is authorised by the directors. Private-company boards may authorise unless the constitution forbids it; public-company boards may authorise only if the constitution allows it. Interested directors do not count for quorum or vote. Members can also authorise.

Section 176 forbids accepting a benefit from a third party conferred because the person is a director or does (or does not do) something as director, unless acceptance cannot reasonably be regarded as likely to give rise to a conflict. A supplier's personal hospitality that is intended to influence a contract award is the classic illustration.

Section 177 requires a director who is directly or indirectly interested in a proposed transaction or arrangement with the company to declare the nature and extent of that interest to the other directors before the company enters into it. Declaration can be at a board meeting or by written or general notice. No declaration is needed if the other directors already know, if the interest cannot reasonably be regarded as likely to conflict, or if it concerns terms of a service contract that a board or committee will consider. Interests in existing transactions are declared under s.182.

Some transactions still need member approval even if the board has declared and authorised: substantial property transactions (s.190), loans and quasi-loans to directors (s.197 and following), and long-term service contracts. Compliance with the general duties does not remove a Chapter 4 approval requirement (s.180).