Advising a prospective company director

Increasingly clients are reluctant to take on directorships fearing the repercussions of business failure in the current prolonged recession.

This raises the difficult issue of advising clients who are offered directorships in businesses in which they may presently be involved where they do not have all the underlying financial information to enable them to make an informed decision as to whether or not to accept the appointment.

A useful place to start is by discussing with the client their underlying fiduciary obligations as a director; this is nothing new, as there has been a common law fiduciary duty towards a company they manage for many years before sections 171-177 of the Companies Act 2006 came into play.

However, the Act sets out to codify with greater precision what those duties are and the consequences for a director who falls short in meeting its obligations. This makes it easier for the practitioner to identify with the prospective appointee any potential levels of exposure.

In essence the duty of good faith is an obligation at all times to act in the best interests of the company, which means that the director must neither make a profit nor receive a benefit at the expense of the company (so even without the Bribery Act coming into force there are certain banned activities!).

It is equally important to remember that both the old common law and equitable duties which existed before the commencement of the 2006 Act still apply and have been effectively incorporated into the general requirement of a director to act in good faith by section 170.

It should not be too difficult to point out to a client that if he act honestly and thinks before taking any steps on behalf of the company, he should not have any real problems in complying with the statutory duties imposed under sections 171-177, but it is worth running through with a prospective appointee the following headline issues:

• Act within the constitutional powers of the company '“ which can readily be checked by referring to the articles of association and enquiring as to whether there is a shareholders agreement in place.
• Promote the success of the company '“ what on the face of it may appear self-evident may make it prudent for the prospective appointee to be recommended to ask for copies of business plans and current accounts and forecasts.
• Execute judgement, care and diligence '“ perhaps this means acting a level higher than 'the man on the Clapham omnibus' but if the client does not seem to understand these concepts you should probably be advising him against taking the appointment; naivety will not be an excuse if something goes wrong.
• Avoid conflicts of interest '“ this certainly does need to be explained in some detail and it is all too common to find directors suggesting that their companies enter into business arrangements with other entities in which they have an interest without necessarily being absolutely open about those relationships.
• Do not to accept benefits from third parties at the expense of or to the detriment of the company. Again one needs to stress to a client that they need to think about any action they take while acting as a director to see whether this test is satisfied.
• You have a duty to declare an interest in a transaction or arrangement. I suspect that this is regularly flouted and it is worth stressing to a prospective appointee as a potential problem if at a future date such a transaction is ever challenged where proper disclosure was not made at the time.

However, it is also useful to mention that if something does go wrong all is not lost, and to point out that under section 1,157 the director can apply to the Companies Court for relief against the consequences of failure to adhere to the fiduciary duties owed to the company.

In the recent case of Towers v Premier Waste Management Ltd [2011] EWCA Civ 923, the Court of Appeal considered the duties that a director owes to his company and the circumstances where relief might be granted under section 1,157.

The director had taken a loan of equipment from a customer of the company free of charge, but he had not disclosed this benefit and it had not been approved by the company.

The Court of Appeal held that the director had acted in breach of his duty to the company and had put himself in a position where a conflict of interest arose. It held that the requirement to avoid a conflict of interest extended to not making a secret profit.

Consequently the director failed to convince the Court of Appeal that section 1,157 applied to relieve the director of the consequences of his failure to observe his statutory duties towards the company.

This is a clear illustration that a prospective director must recognise that they need to think before they act once they take up their new appointment.