Many companies registered with Companies House are small companies that started as a one-director company and remain so until the demise of either the director or the company itself.
In many cases directors have no understanding as to what being a director actually entails or what are the consequences of getting it wrong. Many directors look upon the company as being an extension of their self employment. The main point is that the company is a separate legal entity. It has its own rights and can take its own actions sometimes against its own directors.
One of the points to consider when starting a new business and choosing the trading medium is the appointment of directors, and the duties placed on them.
Appointment of a director
Companies Act 2006 Part 10 Chapter 1 defines the rule governing the appointment of a company director.
The requirements state that a person of at least 16 years of age may become a company director.
Persons who are currently disqualified from being a company officer or those who are un-discharged bankrupts are prohibited from being company directors.
It is only possible to appoint a corporate director if there is at least one other director that is a natural person.
Apart from the disqualification and bankruptcy provisions, in reality, Companies House will accept nominations for any persons the shareholders of a given company deem fit to act in that capacity.
There are three main elements to the directors’ duties:
- fiduciary duty – is a legal obligation from one party to act in the best interests of the other party. The courts have always regarded directors as being ‘fiduciaries’ and as a result the directors are required to act in good faith, in the best interests of the company and must not abuse the trust and confidence placed in them
- duty of skill and care – a director of a company must exercise reasonable care, skill and diligence. So directors with particular skills are expected to bring those skills for the benefit of the company
- statutory duties – are duties imposed by Companies Act as well as other relevant legislation. The Act ‘codifies’ long established common law principles by spelling them out in section 170-177. Duties stated in the Act include: duty to act within the company’s powers, duty to promote the success of the company, duty to exercise independent judgements, duty of skill, care and diligence, duty to avoid conflicts of interest, duty not to accept benefits from third parties and duties to declare interest in a proposed transaction or arrangements. The directors have other duties in areas such as health and safety, bribery law, employment law and tax, etc.
Implication of the breach of duty
Requirement to return any property wrongly taken from the company or to pay damages
Where the directors are held to be in breach, they can be required to return any property wrongly taken from the company or to pay damages to the company.
Under the Companies Act, any shareholder has the right to apply for permission to bring proceedings against a director in respect of any alleged negligence, breach of duty or breach of trust. The court will consider if the applicant was acting in good faith, whether the shareholders had authorised or ratified the breach being complained of and whether the conduct of the director concerned was consistent with the requirements set up in the Companies Act.
Director’s personal liability in respect of debts and losses of their company
Under a limited number of circumstances directors can be made personally liable for debts which they allow their company to run up. Some of the circumstances in which a director can be held personally liable are: wrongful trading, acting in breach of disqualification orders, involvement with phoenix companies, and making deceitful declarations to creditors of the company regarding the settlement of debts.
Disqualification and removal of directors
Under the provisions of the Companies Act 2006 a company may by ordinary resolution at a meeting remove a director before the expiration of their period of office.
Section 81 provides that the office of a director shall be vacated if:
- they cease to be a director by virtue of any provision of the Act or they become prohibited by law from being a director
- they become bankrupt or makes any arrangement or composition with their creditors generally
- they are, or may be, suffering from mental disorder and are either admitted to hospital under the Mental Health Act or an order is made by a court in matters concerning mental disorder
- they resign their office by notice to the company
- they shall for more than six consecutive months have been absent without permission of the directors from meetings of directors held during that period and the directors resolve that their office be vacated.
A court may make a disqualification order under the Company Directors Disqualification Act 1986 (CDDA 1986).
Examples of conduct which may lead to disqualification include:
- continuing to trade to the detriment of creditors at a time when the company was insolvent
- failure to keep proper accounting records
- failure to prepare and file accounts or make returns to Companies House
- failure to submit tax returns or pay over to the Crown tax or other money due
- failure to co-operate with the insolvency practitioner.
Disqualification proceedings are handled by the courts or the Insolvency Service. In some cases the director could also face criminal charges, fines, or be made personally liable for the company’s debts.
The effect of a disqualification
Unless the individual has permission from the courts it prevents them from:
- being a director of a company
- acting as receiver of a company’s property
- directly or indirectly being concerned or taking part in the promotion, formation or management of a company
- being a member of or being concerned or taking part in the promotion, formation or management of a limited liability partnership.
If a person contravenes the order, they are committing a criminal offence that makes them liable to a fine or a prison sentence of up to two years.
The Act applies not only to a person who has been formally appointed as a director but also to those people who have carried out the functions of a director and to shadow directors. A shadow director is a person in accordance with whose directions or instructions the directors of the company are accustomed to act. In order to be classified as a shadow director the person must effectively control the running of the company.
Setting up a company is now a cheap and easy process but there are governance laws that need to be understood. As the regulatory environment has become more and more onerous a newly appointed director needs to understand the full extent of the legislation and how it impacts on their responsibilities.
It is important that any director – whether of a big or small company – is familiar and complies with their duties. In particular, in small companies where family members are appointed just to make up numbers, they must ensure that they are aware that they cannot simply sit back and have no involvement in the company. All directors are jointly responsible for the company and the duties towards it. Ignorance is no defence and the consequences can be severe both for the company and personally.