Walking the tightrope – balancing duties against the risks of breach

Blog | Company Secretarial
Published: 26th January 2022
Area: Corporate & Commercial

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Corporate governance is under increasing public and legislative scrutiny and reporting obligations.  This looks set to continue, most recently with the introduction by the FCA of reporting obligations (for UK premium listed companies) against the recommendations of the Task Force on Climate-related Financial Disclosures.

With this in mind, it’s worth NEDs reminding themselves of their corporate governance obligations, and their particular duties.  NEDs sit on the board without daily management or operational responsibilities.  Their role is to challenge, question and hold the executive directors to account and bring independence to decision-making.  However, contrary to what some may say - they’re still subject to the same duties and liabilities as the executive directors - in law, there is no distinction between NEDs and executive directors.

So what are those duties, and how do NEDs navigate them?

The key is to be aware of and alive to them, and keep them in mind when undertaking your role as a NED.  Those are a mixture of directors’ duties codified by the Companies Act 2006; specific duties imposed by other regulations in specific scenarios; and a more general common law fiduciary duty.

The duties

The general duties under the Companies Act are to:
  • Act within powers - i.e. the company’s constitution. It’s important to read and be alive to the company’s articles. You’d be surprised how many directors don’t/ aren’t

  • Promote the success of the company. All companies (other than exempt small companies) must prepare a strategic report to help the members /shareholders assess how the board has performed this duty

  • Exercise independent judgement.  This can be critical if you’re a director appointed by a specific sector of the members/investor(s)

  • Exercise reasonable care, skill and diligence

  • Avoid conflicts of interest

  • Not accept benefits from third parties

  • Declare an interest in a proposed transaction or arrangement

There are also statutory obligations such as keeping the statutory books up to date and ensuring returns are filed, and obligations arising under others laws including:
  • Certain duties on insolvency, and liabilities such as for wrongful trading or knowingly allowing the company to defraud creditors knowing there was no reasonable prospect of them being paid

  • Health and safety regulations

  • Environmental legislation

  • Competition and securities law

The duty to promote the success of the company is worth considering, as this is where conflicts can arise (particularly if a NED represents one sector of the membership). A director is required to act in the way they consider, in good faith, will be most likely to promote the success of the company for the benefit of its members as a whole (not just for their appointing faction). They must have regard to the following (amongst others):

  • The likely long term consequences of any decision

  • The interests of employees

  • The need to foster business relationships with suppliers, customers and others

  • The impact of operations on the community and environment (see more about this here)

  • The desirability of maintaining a reputation for high standards of conduct

  • Acting fairly between members of the company

And all this requires skill

A director must exercise the care, skill and diligence that would be exercised by a reasonably diligent person with both

(A) the objective general knowledge, skill and experience that may reasonably be expected of a person carrying out their functions,  and

(B) the subjective general knowledge, skill and experience that the director actually has.  As a minimum they must show the objective knowledge, skill and experience required, but where they have specialist knowledge they’re subject to a higher subjective standard.

NEDs should make sure that in accepting office they are not accepting responsibilities that they will not fulfil - delegation is no defence for breach of duty.

How to manage those duties and associated risks

The law acknowledges that directors are not guarantors of a company’s success, they are in control of an entrepreneurial venture that requires a necessary degree of commercial risk.  They’re not liable for mere errors of judgement or ordinary commercial misjudgement.

The court may excuse directors if they act honestly and reasonably, but will only do so if they ought fairly to be excused.  Holding regular board and management meetings/reviews, and keeping clear and timely minutes of them, are in practice the best way to manage this risk.  Those minutes will act as evidence of the steps taken to manage the obligations, and of why it was commercially reasonable to make the decisions you did at the time you did if they are later challenged.

Under the Companies Act, a company may not generally exempt a director from, or indemnify them against, liability for any negligence, default, breach of duty or breach of trust.  However, a company can provide a qualifying third party indemnity provision such that it may:

  • Indemnify a director for proceedings brought by third parties (covering legal costs and the amount of any judgment, except for the legal costs for the unsuccessful defence of criminal proceedings, fines imposed in criminal proceedings and penalties imposed by regulatory bodies such as the FCA

  • Pay a director’s defence costs incurred in civil proceedings brought by the company itself or costs incurred in an application for relief of liability by the director under the Companies Act 2006, provided the director repays the costs if they are unsuccessful; and

indemnify a director acting as a trustee of an occupational pension scheme against liability incurred in connection with the company’s activities as trustee of the scheme, provided the indemnity does not cover any liability for fines imposed in criminal proceedings, penalties payable to regulatory authorities or any liability incurred in unsuccessfully defending criminal proceedings.

It is worth considering whether such indemnities are in place and, if not, whether to implement them. The above are subject to disclosure in the director's report.

The Companies Act does not prevent a company from maintaining directors and officers insurance for its directors, against liability in connection with any negligence, default, breach of duty or breach of trust by them.  Even though a company is primarily subject to limited liability, we would always recommend that a director ensures the company has taken out adequate directors and officers insurance to cover their potential personal exposure.

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