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Directors and their Responsibilities

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Directors

Definition of director

The directors of a company are the people who manage the company, take business decisions and make business contracts on the company’s behalf.   The Companies Act 2006 defines a director as any person occupying the position of a director, by whatever name called.  In practice, it is necessary to examine the function of the individual, the constitution of the company and the terms of any contract between the company and the individual to decide whether he is occupying the position of director.

On the other hand, the shareholders are the members of a company who partly finance the business by buying shares in it.  The directors can also be shareholders, but this is not necessarily the case.  The rights and duties of shareholders and directors are distinct and should not be confused.  Directors attend and vote at Board meetings.  Shareholders attend and vote at annual general meetings (AGMs) and extraordinary general meetings (EGMs). The allocation of control of the company between the directors and the shareholders is governed by the company’s constitution; that is the memorandum and articles of association.

Every private company must have at least one director, although it is common for a company’s articles of association to specify a minimum number of two.  Where a company has only one director, that individual cannot also be the company secretary.  Otherwise, subject to the provisions of the articles, a company can generally appoint as many directors as it chooses.

This factsheet deals with private limited companies only. If you require advice for a public limited company you should speak to your legal advisor.

Types of director

Directors of the company should be formally registered as directors at Companies House.  Sometimes, senior employees are given titles which include the word ‘director’, for example ‘director of information technology’, when they are not in fact directors of the company.  In these circumstances, care must be taken in holding these employees out as directors to third parties when this is not legally the case.  This is because the third party would be entitled to assume the senior employee has the powers of a director.  The company would then be bound by the actions of the senior employee that may exceed his or her powers, but which are within a director’s powers, for example entering into a supply contract.

There are a number of different types of director.  A company may have some or all of the following:

The Chairman is a member of the Board who is usually elected to that position by the Board.  He or she can be either an executive or a non-executive director.

The Managing Director is an executive director with authority to deal with all areas of the business.

Executive Directors are members of the board with authority to carry out certain day-to-day functions, such as entering into contracts and managing staff.  Executive directors may also be employees of the company.

Non-Executive Directors attend and vote at Board meetings but they have no executive powers regarding the day-to-day running of the company.  They will not be employees of the company.

An Alternate Director attends Board Meetings as a stand in (a proxy) for another director and votes on his or her behalf when that director is going to be absent, provided the company’s articles permit this.

Shadow directors

Briefly, shadow directors are individuals in accordance with whose directions and instructions the directors of the company are ‘accustomed to act’.  In effect, they give directions to the Board as a whole.  However, an individual is not deemed to be a shadow director just because the Board acts on his professional advice e.g. an accountant or solicitor.

Appointment, removal and retirement of directors

The appointment of a new director or the departure of an existing director must be notified to Companies House on Form 288 within 14 days of the appointment/departure taking effect.  Failure to comply with this renders the company and the directors liable to a fine.  The Register of Directors will also need to be altered.

Appointment and retirement

Subject to a number of statutory provisions, the appointment and retirement of directors is governed by the company’s articles.  Therefore, before considering appointing a new director, the articles must be examined.  Bear in mind an individual cannot be appointed a director of a company if he is an undischarged bankrupt (unless the court has given him leave to act), nor can he be appointed if he has been disqualified by the court from holding a directorship.

The retirement of directors by rotation is governed by the company’s articles but, generally, all directors must retire at the first AGM and at each subsequent AGM one-third of the directors who are subject to retirement by rotation must retire.  For these purposes, usually the Managing Director and directors holding executive office are ignored.

Removal

Although the articles also govern removal of a director, a director can always be removed by the shareholders passing an ordinary resolution.  Neither the articles of association nor the director’s contract of employment can prevent this.  An ordinary resolution requires 51% of the shareholders’ votes and those proposing the resolution must hold 5% of the total voting rights in the company.

To comply with this procedure, the shareholders must give the company ‘special notice’.  This is a formal notice, which must be left at the company’s registered office at least 28 days before the EGM takes place.  When the company receives a special notice of an intended resolution to remove a director, it must immediately send a copy of it to the director.  The director has the opportunity to respond.

Once the notice has been received, the Board should have a meeting in which they agree to call an EGM within either 14 or 21 days and notice of the EGM must then be given to all the shareholders.  It is at this EGM that the vote to remove the director is made by the shareholders.

The director who is being asked to leave could resign voluntarily.  If he or she wishes to remain he or she is entitled to attend the EGM and be heard on the resolution at the meeting or they can make a written statement, which should be sent to the members or read out at the EGM in his defence.

Sometimes, the articles give directors who are also shareholders special voting rights to prevent them from being removed.  These are, in effect, ‘weighted voting’ rights.  What they do is multiply the director’s votes or shares by a multiplier of two or three or more and thus prevent the 51% majority necessary for the ordinary resolution to remove them from being passed.

Note that a director may also be an employee of the company.  If this is the case, their rights and duties as a director are separate and distinct from their rights and duties as an employee. For further information, see the section on terminating a director below.

It should be noted that previously the model articles (which were replicated in many directors’ service agreements) provided for a director's appointment to be terminated where, by reason of that person’s mental health, that person is prevented from personally exercising any powers or rights which that person would otherwise have.

However, this provision has been removed from the model articles and therefore should not be relied upon in service agreements. In any event caution should be exercised when seeking to remove a director due to ill health or mental health issues to prevent any claim arising under the Equality Act 2010.

Disqualification of directors

Directors can be disqualified by the court for a variety of reasons and once disqualified they cannot participate in the management of that or any other company.  If a disqualified director does so act, they commit a criminal offence.  A disqualified director is still able to trade as a sole trader or in partnership.  The minimum period of disqualification is two years and the maximum period 15 years.  Grounds for disqualification include persistent failure to produce and file company accounts at Companies House, being responsible for the company’s insolvency, being found guilty of wrongful or fraudulent trading or bankruptcy.  The investigation is carried out by the Insolvency Service.

Powers and duties of directors

The directors are responsible for the management of the company and their powers are set out in the company’s memorandum and articles.

Directors’ duties are defined by the company’s articles, their contracts of employment and by the Companies Act 2006.  These duties are owed individually.  Where several directors are liable for a default, they are jointly and severally liable.  Directors owe their duties to the company and not, as a general rule, to its shareholders.  This means any action against the directors must be brought by the company itself.  However, where the directors themselves control the majority of shares in the company and they will not permit an action to be brought in the company’s name, the courts will permit minority shareholders to bring an action in the company’s name in limited circumstances. However, in employment tribunal claims involving discrimination against employees, a director may find himself or herself being sued personally alongside the company.

The main duties are as follows:

Duty of skill and care

A director must carry out their work with the skill and care of a person with their knowledge, qualifications and experience.  The more experienced a director, the more that can be expected from them.  A director is not liable for the acts of co-directors solely by virtue of their position, but they will be if they participate in the act.

Fiduciary duties

A director owes fiduciary duties to the company.  There are three main fiduciary duties:

  1. Not to act in conflict of interest and to act bona fide in the best interests of the company.  This means they must not put themselves in a position where the interests of the company conflict with either their personal interests or their duties to a third party, at any rate without disclosing the potential conflict.  An example of a conflict would be to be involved with a known competitor.
  2. Not to make a secret profit.  Directors cannot make a secret profit out of their position without first getting the approval of the company.  An example of a secret profit would be where the director receives a personal commission for awarding one of the company’s contracts to a particular contractor.  A director has a statutory duty to disclose their interests in company contracts to the other directors at a Board meeting.  This includes the director’s contract of employment.
  3. To exercise the powers they have been given by the memorandum and articles of association and not to exceed or abuse those powers.

Where directors act in breach of fiduciary duty, they are liable to compensate the company for loss resulting from their defaults.  In addition, they are liable to account to the company for any profit made from the breach – the company does not need to prove loss in this case as liability is strict.

Statutory duties

Statutory duties include such matters as filing the company accounts and annual return and preparing a Directors’ Report.

Many of the core fiduciary duties of directors have now been codified in sections 171 to 177 of the Companies Act 2006 as general directors’ duties.  The seven general statutory duties of directors are: 

  • To act within the company’s constitution and only exercise powers for a proper purpose.
  • To act in good faith to promote the success of the company.
  • To exercise independent judgment.
  • To exercise reasonable skill, care and diligence.
  • To avoid conflicts of interest.
  • Not to accept benefits from third parties.
  • To declare any interest in a proposed or existing transaction or arrangement with the company.

Liability of directors

The general rule is that directors cannot be made personally liable for the company’s debts because their liability is limited.  However, there are a number of circumstances in which the director can be personally liable.  These include where the director:

  1. Provides a personal guarantee to a creditor for a loan.
  2. Commits wrongful trading.
  3. Commits fraudulent trading.
  4. Acts outside the powers given by the articles of association.
  5. Continues to act as a director when subject to a disqualification order.

In addition, there are a large number of offences which a director can commit relating to non-compliance with the requirements of the Companies Act 2006 and concerning malpractice before and during the company’s liquidation.

In cases of discrimination against employees, a director could be held personally liable for financial awards (such as injury to feelings) if he or she was a "prime mover" in the act or campaign of discrimination. This can occur where the act of discrimination occurs when the director is exercising the authority of the company, or it can occur where the director is acting as an agent when he or she is held to be aiding the company in discriminatory practices.

Is the director an employee?

In law, directors are office holders. The rights and duties of an office are defined by that office and it exists independently of the person who fills it.  This contrasts with the rights and duties of an employee which are defined by a contract of employment.  Not all directors are also employees of the company.  Directors who have employment contracts, express or implied, will be employees.  If an individual is a director and he or she does not have an employment contract, then he or she will not be an employee even though he or she may carry out a wide range of activities.  Such activities could be done in their capacity as an office holder rather than as an employee.  For a director to be an employee, there has to be an extra legal arrangement between the two parties, which involves obligations on both sides. 

It is important to note that an employment contract does not have to be written, it may be implied or verbally agreed.  If a director has a written ‘service agreement’, then they will be an employee of the company.  The service agreement will constitute their contract of employment.  That agreement will typically set out the rights and duties of the parties and include a provision as to what notice is to be given and received to terminate the employment relationship.

In the event of a dispute, the Employment Tribunal will have to decide whether or not there is a employment relationship, taking into account a number of factors.  Amongst these might be whether or not the director is required to turn up at work at a certain time and work a set number of hours rather than being free to come and go as they choose and whether they are paid a salary rather than just dividends and expenses.

Where a director is also an employee, their directorship and their rights in respect of that directorship are quite separate from their rights as an employee.

Directors as employees

An executive director who is also an employee has two roles: one as a senior employee and the other as an officer (director) of the company.  As an employee, the director will be bound by the provisions of their contract of employment or service agreement and also by the implied terms in an employment relationship.  These include the implied terms of mutual trust and confidence, to act in good faith and not to disclose confidential information. 

As stated above, a director also owes statutory and fiduciary duties to the company.  These are obligations which ordinary employees do not owe.

A director’s contract of employment or service agreement will generally have to be approved by the Board.  In awarding a service agreement, the Board members must act in the interests of the company.  Directors can award themselves service agreements for a fixed term up to two years without the consent of the shareholders.  Fixed-term contracts for periods exceeding two years require shareholders’ approval by ordinary resolution of the company in general meeting.  Approval is not required by the members of a company which is either a non-UK company or a wholly owned subsidiary. Copies of all directors’ service agreements (or, where the contracts are not in writing, memoranda of their terms), must be kept at the company’s registered office, where they are open to inspection by the members. This contrasts with an ordinary employee’s contract of employment, which is kept on the personnel file and is confidential. Further, the service agreement/memoranda must be kept for a period of at least one year from the date of termination or expiry of the agreement.  This obligation applies regardless of the length of any service contract and whether or not it is terminable within 12 months.

Directors’ fees are governed by the articles of association.  The salaries of directors who are also employees will be in accordance with the terms of their contracts of employment or service agreements.

Terminating an employee director

It must first be established if the company is allowed to terminate both the employment relationship and the directorship.  Remember that the employment relationship and the directorship are separate and different considerations and provisions apply.

Terminating the employment relationship

As with all employees, if the director has the required service to bring a claim for unfair dismissal, the company must have a fair reason for dismissal and must act fairly to avoid a claim of unfair dismissal.  There are six potentially fair reasons for dismissal and in all cases a fair procedure must be followed.  If the employee director has been made redundant, he or she is entitled to a statutory redundancy payment if employed for two years or more.

To avoid a wrongful dismissal claim, the employee should receive the relevant period of notice provided for in his or her contract or pay in lieu of notice.  Directors who are employees are generally given long notice periods, for example six months, a year or even longer.  Alternatively, they may be employed on fixed-term contracts with no provisions enabling early termination.  In this case, the employee should receive a sum equivalent to the salary and benefits he or she would have received during the unexpired period of the fixed-term contract.

Terminating the directorship

As set out in the section on appointment, removal and retirement of directors (see above), the directorship may be terminated by ordinary resolution of the company with special notice or in accordance with the company’s articles of association.  Payments made to a director for loss of office must be disclosed and approved by the shareholders in advance. 

If a director is validly removed from the Board, the removal takes effect notwithstanding that their contract of employment or service agreement may not have been properly terminated.  Indeed, unless dismissed from employment, he or she will simply continue to be employed as an ordinary employee.  Conversely, dismissal from the company’s employment does not automatically entail removal from the Board; the proper procedures must still be followed.

That said, where a director is removed by the Board, it is common for him or her also to lose his or her employment in the company since the two usually go together.  As discussed above, this may expose the company to a claim for unfair or wrongful dismissal.  There is nothing to preclude an individual remaining as a non-executive director if their employment is terminated.

Finally, the company’s articles may also require the director to transfer their shareholding upon the termination of either their employment or their directorship so the provisions should be checked.

This document has been created by, or on behalf of ESP Ltd, as a general document and as a guide in relation to its subject matter and has not been bespoke drafted for you or the specific circumstances in which you are looking to use it. Prior to using this document and undertaking any HR process you must consult your organisation’s own policies and procedures to ensure that you do not do anything in conflict with your own policies and procedures.  If in any doubt as to how to use this document or, if you require any legal advice, please feel free to contact ESP Ltd on 0333 006 2929 and our legal team will be more than happy to assist.  ESP Ltd will not be liable in any way for any actions undertaken by you or your use of this document unless we have been consulted regarding your use of this document as legal advisor to your business or have bespoke drafted any documentation in response to a specific support request.