CHAPTER 15 CONSTITUTION OF A COMPANY

CHAPTER 19 COMPANY DIRECTORS AND OTHER COMPANY OFFICERS

PART F MANAGEMENT, ADMINISTRATION AND REGULATION OF COMPANIES

INTRODUCTION

In this chapter we turn our attention to the appointment and removal, and the

powers and duties, of the directors.

The important principle to grasp is that the extent of directors' powers is

defined by the articles.

If shareholders do not approve of the directors' acts they must either remove

them under s 168 or alter the articles to regulate their future conduct.

However, they cannot simply take over the functions of the directors.

In essence, the directors act as agents of the company. This ties in with the

agency part of your law studies also discussed in connection with

partnerships. The different types of authority a director can have (implied and

actual) are important in this area.

We also consider the duties of directors under statute and remedies for the

breach of such duties.

Statute also imposes some duties on directors, specifically concerning

openness when transacting with the company.

Finally we look at the duties and powers of the company secretary and auditor.

Study guide

Intellectual level

F Management, administration and regulation of companies

1 Company directors

(a) Explain the role of directors in the operation of a company 2

(b) Discuss the ways in which directors are appointed, can lose their office or

be subject to a disqualification order

2

(c) Distinguish between the powers of the board of directors, the managing

director and individual directors to bind their company

2

(d) Explain the duties that directors owe to their companies 2

(e) Demonstrate an understanding of the way in which statute law has

attempted to control directors

2

2 Other company officers

(a) Discuss the appointment procedure relating to, and the duties and powers

of, a company secretary

2

(b) Discuss the appointment procedure relating to, and the duties and powers

of, company auditors

Exam guide

The relationship between members of a company and their directors could be examined in a knowledge

based or scenario question. The detailed rules regarding directors and other company officers are all

highly examinable.

1 The role of directors

Any person who occupies the position of director is treated as such, the test being one of function.

A director is a person who is responsible for the overall direction of the company's affairs. In company

law, director means any person occupying the position of director, by whatever name called.

Any person who occupies the position of director is treated as such. The test is one of function. The

directors' function is to take part in making decisions by attending meetings of the board of directors.

Anyone who does that is a director whatever they may be called.

A person who is given the title of director, such as 'sales director' or 'director of research', to give them

status in the company structure is not a director in company law. This is unless by virtue of their

appointment they are a member of the board of directors, or they carry out functions that would be

properly discharged only by a director.

1.1 De facto directors

A de facto director is anyone who is held out by a company as a director, performs the functions of a

director and who is treated by the board as a director although they have never been validly appointed.

1.2 Shadow directors 6/08

A person might seek to avoid the legal responsibilities of being a director by avoiding appointment as

such but using his power, say as a major shareholder, to manipulate the acknowledged board of directors.

In other words they seek the power and influence that come with the position of director, but without the

legal obligations it entails.

Company law seeks to prevent this abuse by extending several statutory rules to shadow directors.

Shadow directors are directors for legal purposes if the board of directors are accustomed to act in

accordance with their directions and instructions. This rule does not apply to professional advisers

merely acting in that capacity.

1.2.1 Shadow directors and de facto directors

Shadow directors differ from de facto directors because the public (and the authorities) are rarely aware

of their existence. Whereas a de facto director performs the everyday tasks that a director would

(dealing with suppliers and customers and being present at general meetings), the shadow director exerts

their influence away from the day-to-day running of the business .

1.3 Alternate directors

A director may, if the articles permit, appoint an alternate director to attend and vote for them at board

meetings which they are unable to attend. Such an alternate may be another director, in which case they

have the vote of the absentee as well as their own. More usually they are an outsider. Company articles

could make specific provisions for this situation.

1.4 Executive directors 6/08

An executive director is a director who performs a specific role in a company under a service contract

which requires a regular, possibly daily, involvement in management.

A director may also be an employee of his company. Since the company is also his employer there is a

potential conflict of interest which in principle a director is required to avoid.

To allow an individual to be both a director and employee the articles usually make express provision for

it, but prohibit the director from voting at a board meeting on the terms of their own employment.

Directors who have additional management duties as employees may be distinguished by special titles,

such as 'Finance Director'. However any such title does not affect their personal legal position. They

have two distinct positions as:

• A member of the board of directors; and

• A manager with management responsibilities as an employee

1.5 Non-executive directors 6/08

A non-executive director does not have a function to perform in a company's management but is involved

in its governance.

In listed companies, the UK Corporate Governance guidelines state that boards of directors are more

likely to be fully effective if they comprise both executive directors and strong, independent nonexecutive

directors. The main tasks of the NEDs are as follows:

• Contribute an independent view to the board's deliberations

• Help the board provide the company with effective leadership

• Ensure the continuing effectiveness of the executive directors and management

• Ensure high standards of financial probity on the part of the company

Non-executive and shadow directors are subject to the same duties as executive directors.

1.6 The Chief Executive Officer (Managing Director)

A Chief Executive Officer (also commonly known as a Managing Director ) is one of the directors of the

company appointed to carry out overall day-to-day management functions.

Boards of directors usually appoint one director to be Chief Executive Officer (this position is also

commonly known as Managing Director) . A Chief Executive Officer (CEO) or Managing Director (MD) has

a special position and has wider apparent powers than any director who is not appointed to that position.

The June 2008 exam included a question that required an explanation of three types of director.

1.7 Number of directors

Every company must have at least one director and for a public company the minimum is two. There is no

statutory maximum in the UK but the articles usually impose a limit. At least one director must be a

natural person, not a body corporate. A company may be a director. In that case the director company

sends an individual to attend board meetings as its representative.

1.8 The board of directors

Companies are run by the directors collectively, in a board of directors.

The board of directors is the elected representative of the shareholders acting collectively in the

management of a company's affairs.

One of the basic principles of company law is that the powers which are delegated to the directors under

the articles are given to them as a collective body. The board meeting is the proper place for the

exercise of the powers, unless they have been validly passed on, or 'sub-delegated', to committees or

individual directors.

2 Appointment of directors

The method of appointing directors, along with their rotation and co-option is controlled by the articles.

A director may be appointed expressly, in which case they are known as a de jure director.

Where a person acts as a director without actually being appointed as such (a de facto or shadow

director) they incur the obligations and have some of the powers of a proper director. In addition, a

shadow director is subject to many of the duties imposed on directors.

2.1 Appointment of first directors

The application for registration delivered to the Registrar to form a company includes particulars of the first

directors, with their consents. On the formation of the company those persons become the first directors.

2.2 Appointment of subsequent directors

Once a company has been formed further directors can be appointed, either to replace existing directors

or as additional directors.

Appointment of further directors is carried out as the articles provide. Most company articles allow for

the appointment of directors:

• By ordinary resolution of the shareholders, and

• By a decision of the directors.

However the articles do not have to follow these provisions and may impose different methods on the

company.

When the appointment of directors is proposed at a general meeting of a public company a separate

resolution should be proposed for the election of each director. However the rule may be waived if a

resolution to that effect is first carried without any vote being given against it.

2.3 Publicity

In addition to giving notice of the first directors, every company must within 14 days give notice to the

Registrar of any change among its directors. This includes any changes to the register of directors'

residential addresses.

2.4 Age limit

The minimum age limit for a director is 16 and, unless the articles provide otherwise, there is no upper

limit.

3 Remuneration of directors

Directors are entitled to fees and expenses as directors as per the articles, and emoluments (and

compensation for loss of office) as per their service contracts (which can be inspected by members).

Some details are published in the directors' remuneration report along with accounts.

Details of directors' remuneration is usually contained within their service contract. This is a contract

where the director agrees to personally perform services for the company.

3.1 Directors' expenses

Most articles state that directors are entitled to reimbursement of reasonable expenses incurred whilst

carrying out their duties or functions as directors.

In addition, most directors have written service contracts setting out their entitlement to emoluments and

expenses. Where service contracts guarantee employment for longer than two years then an ordinary

resolution must be passed by the members of the company that the contract is with.

3.2 Compensation for loss of office

Any director may receive non-contractual compensation for loss of office paid to him voluntarily. Any

such compensation is lawful only if approved by members of the company in general meeting after proper

disclosure has been made to all members, whether voting or not.

This only applies to uncovenanted payments; approval is not required where the company is contractually

bound to make the payment.

Compensation paid to directors for loss of office is distinguished from any payments made to directors

as employees. For example to settle claims arising from the premature termination of the service

agreements. These are contractual payments which do not require approval in general meeting.

3.3 Directors' remuneration report

Quoted companies are required to include a directors' remuneration report as part of their annual report,

part of which is subject to audit. The report must cover:

• The details of each individual directors' remuneration package

• The company's remuneration policy

• The role of the board and remuneration committee in deciding the remuneration of directors

Under s 421(3), it is the duty of the directors (including those who were a director in the preceding five

years) to provide any information about themselves that is necessary to produce this report.

Quoted companies are required to allow a vote by members on the directors' remuneration report. The

vote is purely advisory and does not mean the remuneration should change if the resolution is not passed.

A negative vote would be a strong signal to the directors that the members are unhappy with remuneration

levels.

Items not subject to audit

• Consideration by the directors (remuneration committee) of matters relating to directors'

remuneration

• Statement of company's policy on directors' remuneration

• Performance graph (share performance)

• Directors' service contracts (dates, unexpired length, compensation payable for early termination)

Items subject to audit

• Salary/fees payable to each director

• Bonuses paid/to be paid

• Expenses

• Compensation for loss of office paid

• Any benefits received

• Share options and long term incentive schemes – performance criteria and conditions

• Pensions

• Excess retirement benefits

• Compensation to past directors

• Sums paid to third parties in respect of a director's services

3.4 Inspection of directors' service agreements

A company must make available for inspection by members a copy or particulars of contracts of

employment between the company or a subsidiary with a director of the company. Such contracts must

cover all services that a director may provide, including services outside the role of a director, and those

made by a third party in respect of services that a director is contracted to perform.

Contracts must be retained for one year after expiry and must be available either at the registered office,

or any other location permitted by the Secretary of State.

Prescribed particulars of directors' emoluments must be given in the accounts and also particulars of any

compensation for loss of office and directors' pensions.

4 Vacation of office

A director may vacate office as director due to: resignation; not going for re-election; death; dissolution

of the company; removal; disqualification.

A director may leave office in the following ways.

• Resignation

• Not offering themselves for re-election when their term of office ends

• Death

• Dissolution of the company

• Being removed from office

• Being disqualified

A form should be filed with the Registrar whenever and however a director vacates office.

FAST FORWARD

4.1 Retirement and re-election of directors

The model articles for public companies provide the following rules for the retirement and re-election

of all directors ('rotation') at AGMs.

(a) At the first AGM of the company all directors shall retire.

(b) At every subsequent AGM any directors appointed by the other directors since the last AGM shall

retire.

(c) Directors who were not appointed or re-elected at one of the preceding two AGMs shall retire.

Directors who are retired by rotation are eligible to offer themselves for re-election. This mandatory

retirement of directors provides another control over their performance. Rather than having to go through

the process of seeking a resolution to remove a director, members have the opportunity every three years

to dispose of an underperforming director by simply not electing them .

4.2 Removal of directors

In addition to provisions in the articles for removal of directors, a director may be removed from office by

ordinary resolution at a meeting of which special notice to the company has been given by the person

proposing it: s 168.

On receipt of the special notice the company must send a copy to the director who may require that a

memorandum of reasonable length shall be issued to members. They also have the right to address the

meeting at which the resolution is considered.

The articles and the service contract of the director cannot override the statutory power. However, the

articles can permit dismissal without the statutory formalities being observed, for example dismissal by

a resolution of the board of directors.

The power to remove a director is limited in its effect in four ways.

RESTRICTIONS ON POWER TO REMOVE DIRECTORS

Shareholding

qualification to call a

meeting

In order to propose a resolution to remove a director, the shareholder(s) involved

must call a general meeting. To do this they must hold:

• Either, 10% of the paid up share capital

• Or, 10% of the voting rights where the company does not have shares

Shareholding to

request a resolution

Where a meeting is already convened, 100 members holding an average £100 of

share capital each may request a resolution to remove a director: s 338.

Weighted voting

rights

A director who is also a member may have weighted voting rights given to them

under the constitution for such an eventuality, so that they can automatically

defeat any motion to remove them as a director: Bushell v Faith 1970

Class right

agreement

It is possible to draft a shareholder agreement stating that a member holding

each class of share must be present at a general meeting to constitute quorum. If

so, a member holding shares of a certain class could prevent a director being

removed by not attending the meeting.

The courts have stressed that the s 168 power of members to remove directors is an important right, but

you should remember the ways in which members' intentions might be frustrated.

The dismissal of a director may also entail payment of a substantial sum to settle their claim for breach of

contract if they have a service contract. Under s 168(5), no resolution may deprive a removed director of

any compensation or damages related to their termination to which they are entitled to.

Southern Foundries (1926) Ltd v Shirlaw 1940

The facts: In 1933 S entered into a written agreement to serve the company as Managing Director for ten

years. In 1936 F Co gained control of the company and used their votes to alter its articles to confer on F

Co power to remove any director from office. In 1937 F Co exercised the power by removing S from his

directorship and thereby terminated his appointment as Managing Director (which he could only hold so

long as he was a director).

Decision: The alteration of the articles was not a breach of the service agreement but the exercise of the

power was a breach of the service agreement for which the company was liable.

QUESTION Resolution for removal of director

A company has three members who are also directors. Each holds 100 shares. Normally the shares carry

one vote each, but the articles state that on a resolution for a director's removal, the director to be

removed should have 3 votes per share. On a resolution for the removal of Jeremy, a director, Jeremy

casts 300 votes against the resolution and the other members cast 200 votes for the resolution. Has

Jeremy validly defeated the resolution?

ANSWER

Yes. This was confirmed in Bushell v Faith 1970.

5 Disqualification of directors

Directors may be required to vacate office because they have been disqualified on grounds dictated by the

articles. Directors may be disqualified from a wider range of company involvements under the Company

Directors Disqualification Act 1986 (CDDA).

A person cannot be appointed a director or continue in office if he is or becomes disqualified under the

articles or statutory rules.

The articles often embody the statutory grounds of disqualification and add some optional extra grounds.

Public company model articles provide that a director must vacate office if:

(a) They are disqualified by the Act or any rule of law.

(b) They become bankrupt or enter into an arrangement with creditors.

(c) They become of unsound mind.

(d) They resign by notice in writing.

(e) They are absent for a period of three consecutive months from board meetings held during that

period, without obtaining leave of absence and the other directors resolve that they shall on that

account vacate office.

Unless the court approves it, an undischarged bankrupt cannot act as a director nor be concerned directly

or indirectly in the management of a company. If they do continue to act, they become personally liable for

the company's relevant debts.

5.1 Disqualification under statute

The Company Directors Disqualification Act 1986 (CDDA 1986) provides that a court may formally

disqualify a person from being a director or in any way directly or indirectly being concerned or taking

part in the promotion, formation or management of a company: s1.

Therefore the terms of the disqualification order are very wide, and include acting as a consultant to a

company. The Act, despite its title, is not limited to the disqualification of people who have been directors.

Any person may be disqualified if they fall within the appropriate grounds.

In addition to the main grounds of disqualification, the articles may provide that a director shall

automatically vacate office if they are absent from board meetings (without obtaining the leave of the

board) for a specified period (three months is usual). The effect of this disqualification depends on the

words used.

• If the articles refer merely to 'absence' this includes involuntary absence due to illness.

• The words 'if they shall absent himself' restrict the disqualification to periods of voluntary absence.

The period of three months is reckoned to begin from the last meeting which the absent director did

attend. The normal procedure is that a director who foresees a period of absence, applies for leave of

absence at the last board meeting which they attend; the leave granted is duly minuted. They are not then

absent 'without leave' during the period.

If they fail to obtain leave but later offer a reasonable explanation the other directors may let the matter

drop by simply not resolving that they shall vacate office. The general intention of the rule is to impose a

sanction against slackness; a director has a duty to attend board meetings when they are able to do so.

QUESTION

Disqualification of directors

Which of the following are grounds provided for a director being compelled to leave office?

A Becoming bankrupt

B Entering into an arrangement with personal creditors

C Becoming of unsound mind

D Resigning by notice in writing

E Being absent from board meetings for six consecutive months without obtaining leave of absence

ANSWER

All of them.

QUESTION

Vacation of office

The articles of Robert Ltd provide that if a director should 'absent himself' for a period exceeding three

months from board meetings, the director shall automatically vacate office. Miles, a director, obtains a

twelve month leave of absence to go abroad. Whilst abroad, he contracts a rare illness; on his return he is

rushed to hospital and remains there for nine months. On the day of his release, there is a board meeting

which he does not attend, and he resolves not to attend board meetings again. After a further two months

he has a relapse and dies a fortnight later. At what point does he cease to be a director?

A After three months of his holiday

B After three months of hospitalisation

C At the point where he decides not to attend board meetings again

D When he dies

ANSWER

D The board can grant leave of absence, and 'absenting himself' does not include forced

hospitalisation. The period of three months begins on his release from hospital, and has not been

completed when he dies.

5.2 Grounds for disqualification of directors 6/09

Directors may be disqualified from acting as directors or being involved in the management of companies

in a number of circumstances. They must be disqualified if the company is insolvent, and the director is

found to be unfit to be concerned with management of a company.

Under the CDDA 1986 the court may make a disqualification order on any of the following grounds.

(a) Where a person is convicted of an indictable offence in connection with the promotion,

formation, management or liquidation of a company or with the receivership or management of

a company's property (s 2).

An indictable offence is an offence which may be tried at a Crown Court; it is therefore a serious

offence. It need not actually have been tried on indictment but if it was the maximum period for

which the court can disqualify is 15 years, compared with only 5 years if the offence was dealt with

summarily (at the Magistrates' Court).

(b) Where it appears that a person has been persistently in default in relation to provisions of

company legislation.

This legislation requires any return, account or other document to be filed with, delivered or sent or

notice of any matter to be given to the Registrar (s 3). Three defaults in five years are conclusive

evidence of persistent default.

The maximum period of disqualification under this section is five years.

(c) Where it appears that a person has been guilty of fraudulent trading. This means carrying on

business with intent to defraud creditors or for any fraudulent purpose whether or not the company

has been, or is in the course of being, wound-up.

The person does not actually have to have been convicted of fraudulent trading. The legislation also

applies to anyone who has otherwise been guilty, of any fraud in relation to the company or of any

breach of their duty as an officer (s 4).

The maximum period of disqualification under this section is 15 years.

(d) Where the Secretary of State acting on a report made by the inspectors or from information or

documents obtained under the Companies Act, applies to the court for an order believing it to

be expedient in the public interest.

If the court is satisfied that the person's conduct in relation to the company makes that person

unfit to be concerned in the management of a company, then it may make a disqualification order

(s 8). Again the maximum is 15 years.

(e) Where a director was involved in certain competition violations. Maximum – 15 years.

(f) Where a director of an insolvent company has participated in wrongful trading (s 10). Maximum

– 15 years.

The court must make an order where it is satisfied that the following apply:

(a) A person has been a director of a company which has at any time become insolvent (whether while

they were a director or subsequently).

(b) Their conduct as a director of that company makes them unfit to be concerned in the management

of a company. The courts may also take into account their conduct as a director of other companies,

whether or not these other companies are insolvent. Directors can be disqualified under this section

even if they take no active part in the running of the business.

In such cases the minimum period of disqualification is two years.

ILLUSTRATION

Offences for which directors have been disqualified include the following.

(a) Insider dealing: R v Goodman 1993

(b) Failure to keep proper accounting records: Re Firedart Ltd, Official Receiver v Fairall 1994

(c) Failure to read the company's accounts: Re Continental Assurance Co of London plc 1996

(d) Loans to another company for the purposes of purchasing its own shares with no grounds for

believing the money would be repaid: Re Continental Assurance Co of London plc 1996

(e) Loans to associated companies on uncommercial terms to the detriment of creditors:

Re Greymoat Ltd 1997

5.3 Disqualification periods

In Re Sevenoaks Stationers (Retail) Ltd 1991 the Court of Appeal laid down certain 'disqualification

brackets'. The appropriate period of disqualification which should be imposed was a minimum of two to

five years if the conduct was not very serious, six to ten years if the conduct was serious but did not

merit the maximum penalty, and over ten years only in particularly serious cases.

Disqualification as a director need not mean disqualification from all involvement in management: (Re

Griffiths 1997), and it may mean that the director can continue to act as an unpaid director (Re Barings

plc 1998), but only if the court gives leave to act.

5.3.1 Mitigation of disqualification

Examples of circumstances which have led the court to imposing a lower period of disqualification

include the following.

• Lack of dishonesty: Re Burnham Marketing Services Ltd 1993

• Loss of director's own money in the company: Re GSAR Realisations Ltd 1993

• Absence of personal gain, for example excessive remuneration: Re GSAR Realisations Ltd 1993

• Efforts to mitigate the situation: Re Burnham Marketing Services Ltd 1993

• Likelihood of re-offending: Re Grayan Building Services Ltd 1995

• Proceedings hanging over director for a long time: Re Aldermanbury Trust 1993

5.4 Procedures for disqualification

Company administrators, receivers and liquidators all have a statutory duty to report directors to the

Government where they believe the conditions for a disqualification order have been satisfied.

The Secretary of State then decides whether to apply to the court for an order, but if they do decide to

apply they must do so within two years of the date on which the company became insolvent.

5.5 Acting as a director whilst disqualified

Acting as a director whilst disqualified is a serious offence and where it is committed, directors are

personally liable for the debts of the company.

QUESTION Disqualification

In what circumstances may a court make a disqualification order against a director of a company?

ANSWER

The provisions for disqualification of directors are contained in the Company Directors Disqualification Act

1986. A court may, by order, disqualify a person from being a director, liquidator, administrator, receiver

or manager of a company, and from being concerned in the promotion or management of any company.

The order may be made in any one of the following circumstances.

(a) The director concerned is convicted of an indictable offence in connection with a company.

(b) The director concerned has been persistently in default in relation to company law requirements.

(c) The director concerned has been guilty of fraudulent trading.

(d) The Secretary of State applies for disqualification in the public interest.

(e) The director has been found to be in breach of certain aspects of competition law.

(f) The director has participated in wrongful trading in insolvency.

6 Powers of directors

The powers of the directors are defined by the articles.

The powers of the directors are defined by the articles. The directors are usually authorised 'to manage

the company's business' and 'to exercise all the powers of the company for any purpose connected with

the company's business'.

Therefore they may take any decision which is within the capacity of the company unless either the Act

or the articles themselves require that the decision shall be taken by the members in general meeting.

6.1 Restrictions on directors' powers

Directors' powers may be restricted by statute or by the articles. The directors have a duty to exercise

their powers in what they honestly believe to be the best interests of the company and for the purposes

for which the powers are given.

6.1.1 Statutory restrictions

Many transactions, such as an alteration of the articles or a reduction of capital, must by law be effected

by passing a special resolution. If the directors propose such changes they must secure the passing of

the appropriate resolution by shareholders in a general meeting.

6.1.2 Restrictions imposed by articles

As an example, the articles often set a maximum amount which the directors may borrow. If the directors

wish to exceed that limit, they should seek authority from a general meeting.

When the directors clearly have the necessary power, their decision may be challenged if they exercise the

power in the wrong way. They must exercise their powers:

• In what they honestly believe to be the interests of the company: Re Smith v Fawcett Ltd 1942

• For a proper purpose, being the purpose for which the power is given: Bamford v Bamford 1969.

We shall come back to these points when we consider directors' duties.

6.1.3 Members' control of directors

There is a division of power between the board of directors who manage the business and the members

who as owners take the major policy decisions at general meetings. How, then, do the owners seek to

'control' the people in charge of their property?

• The members appoint the directors and may remove them from office under s 168, or by other

means.

• The members can, by altering the articles (special resolution needed), re-allocate powers between

the board and the general meeting.

• Articles may allow the members to pass a special resolution ordering the directors to act (or

refrain from acting) in a particular way. Such special resolutions cannot invalidate anything the

directors have already done.

Remember that directors are not agents of the members. They cannot be instructed by the members in

general meeting as to how they should exercise their powers. The directors' powers are derived from the

company as a whole and are to be exercised by the directors as they think best in the interests of the

company.

6.1.4 Control by the law

Certain powers must be exercised 'for the proper purpose' and all powers must be exercised bona fide for

the benefit of the company. Failure by the directors to comply with these rules will result in the court

setting aside their powers unless the shareholders ratify the directors' actions by ordinary resolution

(50% majority).

7 Powers of the Chief Executive Officer (Managing

Director) 12/07

The CEO or MD has apparent authority to make business contracts on behalf of the company. Their

actual authority is whatever the board gives them.

In their dealings with outsiders the CEO or MD has apparent authority as agent of the company to make

business contracts. No other director, even if they work full time, has that apparent authority as a

director, though if they are employed as a manager they may have apparent authority at a slightly lower

level.

The CEO or MD's actual authority is whatever the board gives them.

Although appointment as CEO or MD has special status, it may be terminated just like that of any other

director (or employee); they then revert to the position of an ordinary director. Alternatively the company in

general meeting may remove them from their office of director and they immediately cease to be CEO or

MD since being a director is a necessary qualification for holding the post.

7.1 Agency and the CEO/MD

The directors are agents of the company, not the members. Where they have actual or usual authority

they can bind the company. In addition a director may have apparent authority by virtue of holding out.

Holding out is a basic rule of the law of agency. This means, if the principal (the company) holds out a

person as its authorised agent they are estopped from denying that they are its authorised agent. They are

bound by a contract entered into by them on the company's behalf.

Apparent authority is the authority which an agent appears to have to a third party. A contract made within

the scope of such authority will bind the principal even though the agent was not following their

instructions.

Therefore if the board of directors permits a director to behave as if he were a CEO or MD duly appointed

when in fact they are not, the company may be bound by their actions.

A CEO or MD has, by virtue of their position, apparent authority to make commercial contracts for the

company. Moreover if the board allows a director to enter into contracts, being aware of their dealings and

taking no steps to disown them, the company will usually be bound.

Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd 1964

The facts: A company carried on a business as property developers. The articles contained a power to

appoint a Managing Director but this was never done. One of the directors of the company, to the

knowledge but without the express authority of the remainder of the board, acted as if he were Managing

Director. He found a purchaser for an estate and also engaged a firm of architects to make a planning

application. The company later refused to pay the architect's fees on the grounds that the director had no

actual or apparent authority.

Decision: The company was liable since by its acquiescence it had represented that the director was a

Managing Director with the authority to enter into contracts that were normal commercial arrangements,

and which the board itself would have been able to enter.

Situations where the facts are similar to the Freeman & Lockyer case often occur in law exams so be

prepared to spot them.

In the Freeman & Lockyer case, Diplock L J laid down four conditions which must be satisfied in claiming

under the principle of holding out. The claimant must show that:

(a) A representation was made to them that the agent had the authority to enter on behalf of the

company into the contract of the kind sought to be enforced.

(b) Such representation was made by a person who had 'actual' authority to manage the business

of the company.

The board of directors would certainly have actual authority to manage the company. Some

commentators have also argued that the CEO/MD has actual or apparent authority to make

representations about the extent of the actual authority of other company agents. (However a third

party cannot rely on the representations a CEO/MD makes about their own actual authority).

(c) They were induced by the representation to enter into the contract; they had in fact relied on it.

(d) There must be nothing in the articles which would prevent the company from giving valid authority

to its agent to enter into the contract.

QUESTION  Directors' powers

Under the articles of association of Recycle Ltd the directors of the company need the consent of the

general meeting by ordinary resolution to borrow sums of money in excess of £50,000. The other articles

are all standard model articles.

Mary has been appointed Chief Executive Officer of the company and she holds 1% of the issued shares of

the company. Early in May 20X5 Mary entered into two transactions for the benefit of Recycle Ltd. First,

she arranged to borrow £100,000 from Conifer Bank Ltd, secured by a floating charge on the company's

assets. She had not sought the approval of the members as required by the articles. Secondly, she placed

a contract worth £10,000 with Saw Ltd to buy some agricultural machinery.

Advise the directors of Recycle Ltd whether they are bound by the agreements with Conifer Bank Ltd and

Saw Ltd.

ANSWER

The enforceability of the loan agreement and floating charge by Conifer Bank Ltd against Recycle Ltd is

determined by reference to s 40. The transaction is intra vires the company, but beyond the authority of

the Chief Executive Officer. Mary failed to obtain an ordinary resolution of the company as required by its

articles of association.

S 40 provides that, in favour of a person dealing in good faith with a company, the power of the board of

directors to bind the company or (importantly in this case) to authorise others to do so, shall be deemed

to be free of any limitation under the company's constitution.

There is no suggestion that Conifer Bank Ltd has not acted in good faith and it will be presumed that it has

in fact acted in good faith unless the contrary is proved by the company. The articles allow the board to

appoint a Chief Executive Officer. In that position, Mary has apparent authority as agent of the company to

make business contracts including the type of transaction entered into with Saw Ltd.

Under the Act, the restriction placed on her actual authority (by the article requiring an ordinary resolution)

shall be deemed not to exist in favour of the third party, Conifer Bank Ltd. The power of the board to

authorise Mary to bind the company is deemed to be free of any constitutional limitation.

In conclusion, Recycle Ltd will be bound to the contracts with both Conifer Bank Ltd and Saw Ltd.

8 Powers of an individual director

The position of any other individual director (not an MD) who is also an employee is that:

(a) They do not have the apparent authority to make general contracts which attaches to the position

of MD, but they have whatever apparent authority attaches to their management position.

(b) Removal from the office of director may be a breach of their service contract if that agreement

stipulates that they are to have the status of director as part of the conditions of employment.

9 Duties of directors 12/08, 6/09, 12/09, 6/10

The Companies Act 2006 sets out the seven principal duties of directors

The Company's Act 2006 sets out the principal duties that directors owe to their company. Many of these

duties developed over time through the operation of common law and equity, or are fiduciary duties

which have now been codified to make the law clearer and more accessible.

When deciding whether a duty has been broken, the courts will consider the Companies Act primarily. All

case law explained in this section applied before the 2006 Act and is included here to help you understand

the types of situation that arise and how the law will be interpreted and applied by the courts in the future.

Fiduciary duty is a duty imposed upon certain persons because of the position of trust and confidence in

which they stand in relation to another. The duty is more onerous than generally arises under a contractual

or tort relationship. It requires full disclosure of information held by the fiduciary, a strict duty to account

for any profits received as a result of the relationship, and a duty to avoid conflict of interest.

Broadly speaking directors must be honest and not allow their personal interests to conflict with their

duties as directors. The directors are said to hold a fiduciary position since they make contracts as

agents of the company and have control of its property.

The duties included in the Companies Act 2006 form a code of conduct for directors. They do not tell them

what to do but rather create a framework that sets out how they are expected to behave generally. This

code is important as it addresses situations where:

• A director may put their own interests ahead of the company's, and

• A director may be negligent and liable to an action in tort.

9.1 Who are the duties owed to?

Section 170 makes it clear that directors owe their duties to the company, not the members. This means

that the only company itself can take action against a director who breaches them. However, it is

possible for a member to bring a derivative claim against the director on behalf of the company.

The effect of the duties are cumulative, in other words, a director owes every duty to the company that

could apply in any given situation. The Act provides guidance for this. Where a director is offered a bribe

for instance they will be breaking the duty not to accept a benefit from a third party and they will also not

be promoting the company for the benefit of the members.

When deciding whether or not a director has breached a duty, the court should consider their actions in

the context of each individual duty in turn.

9.2 Who are the duties owed by?

Every person who is classed as a director under the Act owes the company a number of duties. Certain

aspects of the duties regarding conflicts of interest and accepting benefits from third parties also apply to

past directors. This is to prevent directors from exploiting a situation for their own benefit by simply

resigning. The courts are directed to apply duties to shadow directors where they would have been

applied to them previously under common law and equity.

Directors must at all times continue to act in accordance with all other laws; no authorisation is given by

the duties for a director to breach any other law or regulation.

9.3 The duties and the articles

The articles may provide more onerous regulations than the Act, but they may not reduce the level of

duty expected unless it is in the following circumstances:

• If a director has acted in accordance with the articles they cannot be in breach of the duty to

exercise independent judgement.

• Some conflicts of interest by independent directors are permissible by the articles.

• Directors will not be in breach of duty concerning conflicts of interest if they follow any provisions

in the articles for dealing with them as long as the provisions are lawful.

• The company may authorise anything that would otherwise be a breach of duty.

9.4 The duties of directors

The statutory duties owed by directors are to:

• Act within their powers

• Promote the success of the company

• Exercise independent judgement

• Exercise reasonable skill, care and diligence

• Avoid conflicts of interest

• Not to accept benefits from third parties

• Declare an interest in a proposed transaction or arrangement

We shall now consider the duties placed on directors by the Act. Where cases are mentioned it is to

demonstrate the previous common law or equitable principle that courts will follow when interpreting and

applying the Act.

9.4.1 Duty to act within powers (s 171) 6/10

The directors owe a duty to act in accordance with the company's constitution, and only to exercise

powers for the purposes for what they were conferred. They have a fiduciary duty to the company to

exercise their powers bona fide in what they honestly consider to be the interests of the company:

Re Smith v Fawcett Ltd 1942. This honest belief is effective even if, in fact, the interests of the company

were not served.

This duty is owed to the company and not generally to individual shareholders. The directors will not

generally be liable to the members if, for instance, they purchase shares without disclosing information

affecting the share price: Percival v Wright 1902.

In exercising the powers given to them by the articles the directors have a fiduciary duty not only to act

bona fide but also only to use their powers for a proper purpose. Bamford v Bamford 1969

The powers are restricted to the purposes for which they were given. If the directors infringe this rule by

exercising their powers for a collateral purpose the transaction will be invalid unless the company in

general meeting authorises it, or subsequently ratifies it.

Most of the directors' powers are found in the articles, so this duty means that the directors must not act

outside their power or the capacity of the company (in other words ultra vires).

If the irregular use of directors' powers is in the allotment of shares the votes attached to the new shares

may not be used in reaching a decision in general meeting to sanction it.

Howard Smith Ltd v Ampol Petroleum Ltd 1974

The facts: Shareholders who held 55% of the issued shares intended to reject a takeover bid for the

company. The directors honestly believed that it was in the company's interest that the bid should

succeed. The directors allotted new shares to a prospective bidder so that the shareholders opposed to the

bid would then have less than 50% of the enlarged capital and the bid would succeed.

Decision: The allotment was invalid. 'It must be unconstitutional for directors to use their fiduciary powers

over the shares in the company purely for the purpose of destroying an existing majority or creating a new

majority which did not previously exist'.

Any shareholder may apply to the court to declare that a transaction in breach of s 171 should be set

aside. However the practice of the courts is generally to remit the issue to the members in general

meeting to see if the members wish to confirm the transaction. If the majority approve what has been

done (or have authorised it in advance) that decision is treated as a proper case of majority control to

which the minority must normally submit.

Hogg v Cramphorn 1966

The facts: The directors of a company issued shares to trustees of a pension fund for employees to prevent a

takeover bid which they honestly thought would be bad for the company. The shares were paid for with

money belonging to the company provided from an employees' benevolent and pension fund account. The

shares carried 10 votes each and as a result the trustees and directors together had control of the company.

The directors had power to issue shares but not to attach more than one vote to each. A minority shareholder

brought the action on behalf of all the other shareholders.

Decision: If the directors act honestly in the best interests of the company, the company in general

meeting can ratify the use of their powers for an improper purpose, so the allotment of the shares would

be valid. But only one vote could be attached to each of the shares because that is what the articles

provided.

Bamford v Bamford 1969

The facts: The directors of Bamford Ltd allotted 500,000 unissued shares to a third party to thwart a

takeover bid. A month after the allotment a general meeting was called and an ordinary resolution was

passed ratifying the allotment. The holders of the newly-issued shares did not vote. The claimants

(minority shareholders) alleged that the allotment was not made for a proper purpose.

Decision: The ratification was valid and the allotment was good. There had been a breach of fiduciary duty

but the act had been validated by an ordinary resolution passed in general meeting.

These cases can be distinguished from the Howard Smith case (where the allotment was invalid) in that in

the Howard Smith case the original majority would not have sanctioned the use of directors' powers. In the

Bamford case the decision could have been sanctioned by a vote which excluded the new shareholders.

Ratification is not effective when it attempts to validate a transaction when

• It constitutes fraud on a minority.

• It involves misappropriation of assets.

• The transaction prejudices creditors' interests at a time when the company is insolvent.

Under s 239, any resolution which proposes to ratify the acts of a director which are negligent, in default

or in breach of duty or trust regarding the company must exclude the director or any members connected

with them from the vote.

Much of the case law in this area concerns the duty of directors to exercise their power to allot shares.

This is only one of the powers given to directors that are subject to this fiduciary duty. Others include:

• Power to borrow

• Power to give security

• Power to refuse to register a transfer of shares

• Power to call general meetings

• Power to circulate information to shareholders

9.4.2 Duty to promote the success of the company (s 172) 12/08

An overriding theme of the Companies Act 2006 is the principle that the purpose of the legal framework

surrounding companies should be to help companies do business. Their main purpose is to create wealth

for the shareholders.

This theme is evident in the duty of directors to promote the success of a company. During the

development of the Act, the independent Company Law Review recommended that company law should

consider the interests of those who companies are run for. It decided that the new Act should embrace the

principle of 'enlightened shareholder value'.

In essence, this principle means that the law should encourage longtermism and regard for all stakeholders

by directors and that stakeholder interests should be pursued in an enlightened and inclusive way.

To achieve this, a duty of directors to act in a way, which, in good faith, promotes the success of the

company for the benefit of the members as a whole, was created.

The requirements of this duty are difficult to define and possibly problematic to apply, so the Act provides

directors with a non-exhaustive list of issues to keep in mind.

When exercising this duty directors should consider:

• The consequences of decisions in the long term.

• The interests of their employees.

• The need to develop good relationships with customers and suppliers.

• The impact of the company on the local community and the environment.

• The desirability of maintaining high standards of business conduct and a good reputation.

• The need to act fairly as between all members of the company.

The list identifies areas of particular importance and modern day expectations of responsible business

behaviour. For example the interests of the company's employees and the impact of the company's

operations on the community and the environment.

The Act does not define what should be regarded as the success of a company. This is down to a

director's judgement in good faith. This is important as it ensures that business decisions are for the

directors rather than the courts.

No guidance is given for what the correct course of action would be where the various s172 duties are in

conflict. For example a decision to shut down an office may be in the long term best interests of the

company but it is certainly not in the interests of the employees affected, nor the local community in which

they live. Conflicts such as this are inevitable and could potentially leave directors open to breach of duty

claims by a wide range of stakeholders if they do not deal with them carefully.

This duty was the subject of a ten-mark question in December 2008. A full explanation of the duty was

required to score well.

9.4.3 Duty to exercise independent judgement (s 173)

This is a simple duty that states directors must exercise independent judgement. They should not

delegate their powers of decision-making or be swayed by the influence of others. Directors may

delegate their functions to others, but they must continue to make independent decisions.

This duty is not infringed by acting in accordance with any agreement by the company that restricts the

exercise of discretion by directors, or by acting in a way authorised by the company's constitution.

9.4.4 Duty to exercise reasonable skill, care and diligence (s 174)

Directors have a duty of care to show reasonable skill, care and diligence.

Section 174 provides that a director 'owes a duty to his company to exercise the same standard of ‘care,

skill and diligence that would be exercised by a reasonably diligent person with:

(a) The general knowledge, skill and experience that may reasonably be expected of a person

carrying out the functions carried out by the director in relation to the company; and

(b) The general knowledge, skill and experience that the director has.

There is therefore a reasonableness test consisting of two parts:

(a) An objective test

Did the director act in a manner reasonably expected of a person performing the same role?

A director, when carrying out his functions, must show such care as could reasonably be expected

from a competent person in that role. If a 'reasonable' director could be expected to act in a certain

way, it is no defence for a director to claim, for example, lack of expertise.

(b) A subjective test

Did the director act in accordance with the skill, knowledge and experience that they actually

have?

In the case of Re City Equitable Fire and Insurance Co Ltd 1925 it was held that a director is

expected to show the degree of skill which may reasonably be expected from a person of his

knowledge and experience. The standard set is personal to the person in each case. An accountant

who is a director of a mining company is not required to have the expertise of a mining engineer,

but they should show the expertise of an accountant.

The duty to be competent extends to non-executive directors, who may be liable if they fail in their duty.

Dorchester Finance Co Ltd v Stebbing 1977

The facts: Of all the company's three directors S, P and H, only S worked full-time. P and H signed blank

cheques at S's request who used them to make loans which became irrecoverable. The company sued all

three; P and H, who were experienced accountants, claimed that as non-executive directors they had no

liability.

Decision: All three were liable, P's and H's acts in signing blank cheques were negligent and did not show

the necessary objective or subjective skill and care.

In other words, the standard of care is an objective 'competent' standard, plus a higher 'personal'

standard of application. If the director actually had particular expertise that leads to a higher standard of

competence being reasonably expected.

The company may recover damages from its directors for loss caused by their negligence. However

something more than imprudence or want of care must be shown. It must be shown to be a case of gross

negligence. This was defined in Overend Gurney & Co v Gibb 1872 as conduct such that 'no men with any

degree of prudence, acting on their own behalf, would have entered into such a transaction as they entered

into'.

Therefore, in the absence of fraud it was difficult to control careless directors effectively. The statutory

provisions on disqualification of directors of insolvent companies and on liability for wrongful trading

therefore both set out how to judge a director's competence, and provide more effective enforcement.

The company by decision of its members in general meeting decides whether to sue the directors for their

negligence. Even if it is a case in which they could be liable the court has discretion under s 1157 to

relieve directors of liability if it appears to the court that:

• The directors acted honestly and reasonably.

• They ought, having regard to the circumstances of the case, fairly to be excused.

Re D' Jan of London Ltd 1993

The facts: D, a director of the company, signed an insurance proposal form without reading it. The form

was filled in by D's broker. An answer given to one of the questions on the form was incorrect and the

insurance company rightly repudiated liability for a fire at the company's premises in which stock worth

some £174,000 was lost. The company became insolvent and the liquidator brought this action under s

212 of the Insolvency Act 1986 alleging D was negligent.

Decision: In failing to read the form D was negligent. However, he had acted honestly and reasonably and

ought therefore to be partly relieved from liability by the court under s 727 of the Companies Act 1985,

(now s 1157 under the Companies Act 2006).

In the absence of fraud, bad faith or ultra vires the members may vote unanimously to forgive the

director's negligence, even if it is those negligent directors who control the voting and exercise such

forgiveness: Multinational Gas & Petrochemical Co v Multinational Gas and Petrochemical Services Ltd

1983. Where there is no fraud on the minority, a majority decision is sufficient: Pavlides v Jensen 1956.

9.4.5 Duty to avoid conflicts of interest (s 175) 6/09, 12/09

Directors have a duty to avoid circumstances where their personal interests conflict, or may possibly

conflict, with the company's interests. It may occur when a director makes personal use of information,

property or opportunities belonging to the company, whether or not the company was able to take

advantage of them at the time.

Therefore directors must be careful not to breach this duty when they enter into a contract with their

company or if they make a profit in the course of being a director.

This duty does not apply to a conflict of interest in relation to a transaction or arrangement with the

company, provided the director declared an interest.

As agents, directors have a duty to avoid a conflict of interest. In particular:

• The directors must retain their freedom of action and not fetter their discretion by agreeing to

vote as some other person may direct.

• The directors owe a fiduciary duty to avoid a conflict of duty and personal interest.

• The directors must not obtain any personal advantage from their position as directors without the

consent of the company for whatever gain or profit they have obtained.

The following cases are important in the area of conflict of interest.

Regal (Hastings) Ltd v Gulliver 1942

The facts: The company owned a cinema. It had the opportunity of acquiring two more cinemas through a

subsidiary to be formed with an issued capital of £5,000. However the company could not proceed with

this scheme since it only had £2,000 available for investment in the subsidiary.

The directors and their friends therefore subscribed £3,000 for shares of the new company to make up the

required £5,000. The chairman acquired his shares not for himself but as nominee of other persons. The

company's solicitor also subscribed for shares. The share capital of the two companies (which then

owned three cinemas) was sold at a price which yielded a profit of £2.80 per share of the new company in

which the directors had invested. The new controlling shareholder of the company caused it to sue the

directors to recover the profit which they had made.

Decision:

(a) The directors were accountable to the company for their profit since they had obtained it from an

opportunity which came to them as directors.

(b) It was immaterial that the company had lost nothing since it had been unable to make the

investment itself.

(c) The directors might have kept their profit if the company had agreed by resolution passed in

general meeting that they should do so. The directors might have used their votes to approve their

action since it was not fraudulent (there was no misappropriation of the company's property).

(d) The chairman was not accountable for the profit on his shares since he did not obtain it for himself.

The solicitor was not accountable for his profit since he was not a director and so was not subject

to the rule of accountability as a director for personal profits obtained in that capacity.

Industrial Development Consultants Ltd v Cooley 1972

The facts: C was Managing Director of the company which provided consultancy services to gas

companies. A gas company was unlikely to award a particular contract to the company but C realised that,

acting personally, he might be able to obtain it. He told the board of his company that he was ill and

persuaded them to release him from his service agreement. On ceasing to be a director of the company C

obtained the contract on his own behalf. The company sued him to recover the profits of the contract.

Decision: C was accountable to his old company for his profit.

Directors will not be liable for a breach of this duty if:

• The members of the company authorised their actions

• The situation cannot reasonably be regarded as likely to give rise to a conflict of interest

• The actions have been authorised by the other directors. This only applies if they are genuinely

independent from the transaction and:

– If the company is private - the articles do not restrict such authorisation, or

– If it is public - the articles expressly permit it.

• The company explicitly rejected the opportunity they took up: Peso Silver Mines v Cropper 1966.

9.4.6 Duty not to accept benefits from third parties (s 176) 6/10

This duty prohibits the acceptance of benefits (including bribes) from third parties conferred by reason of

them being director, or doing, (or omitting to do) something as a director. Where a director accepts a

benefit that may also create or potentially create a conflict of interest, they will also be in breach of their s

175 duty.

Unlike s 175, an act which would potentially be in breach of this duty cannot be authorised by the

directors, but members do have the right to authorise it.

Directors will not be in breach of this duty if the acceptance of the benefit cannot reasonably be regarded

as likely to give rise to a conflict of interest.

9.4.7 Duty to declare interest in proposed transaction or arrangement (s 177) 6/09

Directors are required to disclose to the other directors the nature and extent of any interest, direct or

indirect, that they have in relation to a proposed transaction or arrangement with the company. Even if

the director is not a party to the transaction, the duty may apply if they are aware, or ought reasonably to

be aware, of the interest. For example, the interest of another person in a contract with the company may

require disclosure under this duty if that other person's interest is a direct or indirect interest on the part

of the director.

Directors are required to disclose their interest in any transaction before the company enters into the

transaction. Disclosure can be made by:

• Written notice

• General notice

• Verbally at a board meeting

Disclosure to the members is not sufficient to discharge the duty. Directors must declare the nature and

extent of their interest to the other directors as well.

If the declaration becomes void or inaccurate, a further declaration should be made.

No declaration of interest is required if the director's interest in the transaction cannot reasonably be

regarded as likely to give rise to a conflict of interest.

9.5 Consequences of breach of duty 6/09, 6/10

Breach of duty comes under the civil law rather than criminal law and, as mentioned earlier, the company

itself must take up the action. This usually means the other directors starting proceedings.

Consequences for breach include:

• Damages payable to the company where it has suffered loss

• Restoration of company property

• Repayment of any profits made by the director

• Rescission of contract (where the director did not disclose an interest)

9.6 Declaration of an interest in an existing transaction or arrangement

(s 182) 6/09, 12/09

Directors have a statutory obligation to declare any direct or indirect interest in an existing transaction

entered into by the company. This obligation is almost identical to the duty to disclose an interest in a

proposed transaction or arrangement under s 177. However, this section is relevant to transactions or

arrangements that have already occurred.

A declaration under s 182 is not required if:

• It has already been disclosed as a proposed transaction under s 177

• The director is not aware of either

– The interest they have in the transaction, or

– The transaction itself

• The director's interest in the transaction cannot reasonably be regarded as likely to give rise to a

conflict of interest

• The other directors are aware (or reasonably should be aware) of the situation

• It concerns the director's service contract and it has been considered by a board meeting or

special board committee

Where a declaration is required it should be made as soon as reasonably practicable either:

• By written notice

• By general notice

• Verbally at a board meeting

If the declaration becomes void or inaccurate, a further declaration should be made.

9.7 Other controls over directors

The table below summarises other statutory controls over directors included in the Companies Act 2006.

CA06 Ref     CONTROL

188 Directors' service contracts lasting more than two years must be approved by the members.

190 Directors or any person connected to them may not acquire a non-cash asset from the

company without approval of the members. This does not apply where the asset's value is

less than £5,000, or less than 10% of the company's asset value. All sales of assets with a

value exceeding £100,000 must be approved.

197 Any loans given to directors, or guarantees provided as security for loans provided to

directors, must be approved by members if over £10,000 in value.

198 Expands section 197 to prevent unapproved quasi-loans to directors of over £10,000 in

value (PLCs only).

201 Expands section 197 to prevent unapproved credit transactions by the company for the

benefit of a director of over £15,000 in value (PLCs only).

204 Directors must seek approval of the members where the company loans them over £50,000

to meet expenditure required in the course of business.

217 Non-contractual payments to directors for loss of office must be approved by the members.

9.8 Examples of remedies against directors

Remedies against directors for breach of duties include accounting to the company for a personal gain,

indemnifying the company, and rescission of contracts made with the company.

The type of remedy varies with the breach of duty.

(a) The director may have to account for a personal gain: Regal (Hastings) Ltd v Gulliver 1942.

(b) They may have to indemnify the company against loss caused by their negligence such as an

unlawful transaction which they approved.

(c) If they contract with the company in a conflict of interest the contract may be rescinded by the

company. However under common law rules the company cannot both affirm the contract and

recover the director's profit: Burland v Earle 1902.

(d) The court may declare that a transaction is ultra vires or unlawful: Re Lee Behrens & Co 1932.

A company may, either by its articles or by passing a resolution in general meeting, authorise or ratify

the conduct of directors in breach of duty. There are some limits on the power of members in general

meeting to sanction a breach of duty by directors or to release them from their strict obligations.

(a) If the directors defraud the company and vote in general meeting to approve their own fraud, their

votes are invalid (Cook v Deeks 1916).

(b) If the directors allot shares to alter the balance of votes in a general meeting the votes attached to

those shares may not be cast to support a resolution approving the issue.

9.9 Directors' liability for acts of other directors

A director is not liable for acts of fellow directors. However if they become aware of serious breaches of

duty by other directors, they may have a duty to inform members of them or to take control of assets of

the company without having proper delegated authority to do so.

In such cases the director is liable for their own negligence in what they allow to happen and not directly

for the misconduct of the other directors.

9.10 Directors' personal liability

As a general rule a director has no personal liability for the debts of the company. But there are certain

exceptions.

• Personal liability may arise by lifting the veil of incorporation.

• A limited company may by its articles or by special resolution provide that its directors shall have

unlimited liability for its debts

• A director may be liable to the company's creditors in certain circumstances.

Can a director be held personally liable for negligent advice given by his company? The case below

shows that they can, but only when they assume responsibility in a personal capacity for advice given,

rather than simply giving advice in their capacity as a director.

Williams and Another v Natural Life Health Foods Ltd 1998

The facts: The director was sued personally by claimants who claimed they were misled by the company's

brochure. The director helped prepare the brochure, and the brochure described him as the source of the

company's expertise. The claimants did not however deal with the director but with other employees.

Decision: The House of Lords overruled the Court of Appeal, and ruled that the director was not personally

liable. In order to have been liable, there would have had to have been evidence that the director had

assumed personal responsibility. Merely acting as a director and advertising his earlier experience did not

amount to assumption of personal liability.

9.11 Fraudulent and wrongful trading

In cases of fraudulent or wrongful trading liquidators can apply to the court for an order that those

responsible (usually the directors) are liable to repay all or some specified part of the company's debts.

The liquidator should also report the facts to the Director of Public Prosecutions so that the DPP may

institute criminal proceedings.

10 The company secretary

Every public company must have a company secretary, who is one of the officers of a company and may

be a director. Private companies are not required to have a secretary.

Every public company must have a company secretary, who is one of the officers of a company and may

be a director. Private companies are not required to have a secretary. In this case the roles normally done

by the company secretary may be done by one of the directors, or an approved person. The secretary of

state may require a public company to appoint a secretary where it has failed to do so.

10.1 Appointment of a company secretary 6/10

To be appointed as a company secretary to a plc, the directors must ensure that the candidate should be

qualified (s 273) by virtue of:

• Employment as a plc's secretary for three out of the five years preceding appointment

• Membership of one of a list of qualifying bodies: the ACCA, CIMA, ICAEW, ICAS, ICAI or CIPFA

• Qualification as a solicitor, barrister or advocate within the UK

• Employment in a position or membership of a professional body that, in the opinion of the

directors, appears to qualify that person to act as company secretary

They should also have the 'necessary knowledge and experience' as deemed by the directors.

A sole director of a private company cannot also be the company secretary, but a company can have two

or more joint secretaries. A corporation can fulfil the role of company secretary. A register of secretaries

must be kept. Under UK Corporate Governance guidelines the appointment of the company secretary is a

matter for the board as a whole.

10.2 Duties of a company secretary 6/10

The specific duties of each company secretary are determined by the directors of the company. As a

company officer, the company secretary is responsible for ensuring that the company complies with its

statutory obligations. In particular, this means:

• Establishing and maintaining the company's statutory registers

• Filing accurate returns with the Registrar on time

• Organising and minuting company and board meetings

• Ensuring that accounting records meet statutory requirements

• Ensuring that annual accounts are prepared and filed in accordance with statutory requirements

• Monitoring statutory requirements of the company

• Signing company documents as may be required by law

Under UK Corporate Governance guidelines the company secretary should:

• Ensure good information flows within the board and its committees

• Facilitate induction of board members and assist with professional development

• Advise the chairman and the board on all governance issues

10.3 Powers and authority of a company secretary 6/10

The powers of the company secretary have historically been very limited. However, the common law

increasingly recognises that they may be able to act as agents to exercise apparent or ostensible

authority, therefore, they may enter the company into contracts connected with the administrative side of

the company.

Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd 1971

The facts: B, the secretary of a company, ordered cars from a car hire firm, representing that they were

required to meet the company's customers at London Airport. Instead he used the cars for his own

purposes. The bill was not paid, so the car hire firm claimed payment from B's company.

Decision: B's company was liable, for he had apparent authority to make contracts such as the present

one, which were concerned with the administrative side of its business. The decision recognises the

general nature of a company secretary's duties.

11 The company auditor

Every company (apart from certain small companies) must appoint appropriately qualified auditors. An

audit is a check on the stewardship of the directors.

Every company (except a dormant private company and certain small companies) must appoint auditors

for each financial year: s 475.

11.1 Appointment 12/07

The first auditors may be appointed by the directors, to hold office until the first general meeting at

which their appointment is considered.

Subsequent auditors may not take office until the previous auditor has ceased to hold office. They will

hold office until the end of the next financial period (private companies) or the next accounts meeting

(public companies) unless re-appointed.

APPOINTMENT OF AUDITORS

Members • Usually appoint an auditor in general meeting by ordinary resolution.

• Auditors hold office from 28 days after the meeting in which the accounts are laid until

the end of the corresponding period the next year. This is the case even if the auditors

are appointed at the meeting where the accounts are laid.

• May appoint in general meeting to fill a casual vacancy.

Directors • Appoint the first ever auditors. They hold office until the end of the first meeting at

which the accounts are considered.

• May appoint to fill a casual vacancy.

Secretary of

State

• May appoint auditors if members fail to.

• Company must notify Secretary of State within 28 days of the general meeting where

the accounts were laid.

11.1.1 Eligibility as auditor

Membership of a Recognised Supervisory Body is the main prerequisite for eligibility as an auditor. An

audit firm may be either a body corporate, a partnership or a sole practitioner.

The Act requires an auditor to hold an 'appropriate qualification'. A person holds an 'appropriate

qualification' if they:

• Have satisfied existing criteria for appointment as an auditor

• Hold a recognised qualification obtained in the UK

• Hold an approved overseas qualification

11.1.2 Ineligibility as auditor

Under the Companies Act 2006, a person may be ineligible on the grounds of 'lack of independence'.

A person is ineligible for appointment as a company auditor if they are:

• An officer or employee of the company being audited

• A partner or employee of such a person

• A partnership in which such a person is a partner

• Ineligible by virtue of the above for appointment as auditor of any parent or subsidiary undertaking

where there exists a connection of any description as may be specified in regulations laid down by

Secretary of State.

11.1.3 Effect of lack of independence or ineligibility

No person may act as auditor if they lack independence or become ineligible. If during their term of office

an auditor loses their independence or eligibility they must resign with immediate effect, and notify their

client of their resignation giving the reason.

A person continuing to act as auditor despite losing their independence or becoming ineligible is liable to

a fine. However it is a defence if they can prove they were not aware that they lost independence or

became ineligible.

The legislation does not disqualify the following from being an auditor of a limited company:

• A shareholder of the company

• A debtor or creditor of the company

• A close relative of an officer or employee of the company

However, the regulations of the accountancy bodies applying to their own members are stricter than

statute in this respect.

11.2 Reappointing an auditor of a private company

The rules on appointment make reference to a meeting where the accounts are laid. This is not always

relevant for private companies as under the Act they are not required to hold an AGM or lay the accounts

before the members. Therefore auditors of private companies are deemed automatically reappointed

unless one of the following circumstances apply.

• The auditor was appointed by the directors (most likely when the first auditor was appointed).

• The articles require formal reappointment.

• Members holding 5% of the voting rights serve notice that the auditor should not be reappointed

s 488.

• A resolution (written or otherwise) has been passed that prevents reappointment.

• The directors have resolved that auditors should not be appointed for the forthcoming year as

the company is likely to be exempt from audit.

11.3 Auditor remuneration

Whoever appoints the auditors has power to fix their remuneration for the period of their appointment. It

is usual when the auditors are appointed by the general meeting to leave it to the directors to fix their

remuneration (by agreement at a later stage). The auditors' remuneration must be disclosed in a note to

the accounts.

11.4 Exemption from audit

Certain companies are exempt from audit provided the following conditions are fulfilled.

(a) A company is totally exempt from the annual audit requirement in a financial year if its turnover for

that year is not more than £6.5 million, and its balance sheet total is not more than £3.26

million.

(b) The exemptions do not apply to public companies, banking or insurance companies or those

subject to a statute-based regulatory regime.

(c) The company is a non-commercial, non-profit making public sector body which is subject to audit

by a public sector auditor.

(d) Members holding 10% or more of the capital of any company can veto the exemption.

(e) Dormant companies which qualify for exemption from an audit as a dormant company.

11.5 Duties of auditors 12/07

The statutory duty of auditors is to report to the members whether the accounts give a true and fair view

and have been properly prepared in accordance with the Companies Act.

They must also:

• State whether or not the directors' report is consistent with the accounts.

• For quoted companies, report to the members on the auditable part of the directors'

remuneration report including whether or not it has been properly prepared in accordance with the

Act.

• Be signed by the auditor, stating their name, and date. Where the auditor is a firm, the senior

auditor must sign in their own name for, and on behalf, of the auditor.

To fulfil their statutory duties, the auditors must carry out such investigations as are necessary to form

an opinion as to whether:

(a) Proper accounting records have been kept and proper returns adequate for the audit have been

received from branches.

(b) The accounts are in agreement with the accounting records.

(c) The information in the directors' remuneration report is consistent with the accounts.

The auditors' report must be read before any general meeting at which the accounts are considered and

must be open to inspection by members. Auditors have to make disclosure of other services rendered to

the company and the remuneration received.

Where an auditor knowingly or recklessly causes their report to be materially misleading, false or

deceptive, they commit a criminal offence and may be liable to a fine: s 507.

11.6 Rights of auditors 12/07

The Companies Act provides statutory rights for auditors to enable them to carry out their duties.

The principal rights of auditors, excepting those dealing with resignation or removal, are set out in the

table below, and the following are notes on more detailed points.

Access to records A right of access at all times to the books, accounts and vouchers of the

company: S 499 (1)

Information and

explanations

A right to require from the company's officers, employees or any other

relevant person, such information and explanations as they think necessary

for the performance of their duties as auditors: S 499 (1)

Attendance at/notices of

general meetings

A right to attend any general meetings of the company and to receive all

notices of and communications relating to such meetings which any member

of the company is entitled to receive: s 502 (2)

Right to speak at general

meetings

A right to be heard at general meetings which they attend on any part of the

business that concerns them as auditors: s 502 (2)

Rights in relation to

written resolutions

A right to receive a copy of any written resolution proposed: s 502 (1)

If auditors have not received all the information and explanations they consider necessary, they should

state this fact in their audit report. The Act makes it an offence for a company's officer knowingly or

recklessly to make a statement in any form to an auditor which:

• Conveys or purports to convey any information or explanation required by the auditor and

• Is materially misleading, false or deceptive

The penalty is a maximum of two years' imprisonment, a fine or both.

11.7 Auditors' liability

Under s 532 any agreement between an auditor and a company that seeks to indemnify the auditor for

their own negligence, default, or breach of duty or trust is void. However under s 534, an agreement can

be made which limits the auditor's liability to the company. Such liability limitation agreements can

only stand for one financial year and must therefore be replaced annually.

Liability can only be limited to what is fair and reasonable having regard to the auditor's responsibilities,

their contractual obligations and the professional standards expected of them. Such agreements must be

approved by the members and publicly disclosed in the accounts or directors' report.

11.8 Termination of auditors' appointment

Auditors may leave office in the following ways: resignation; removal from office by an ordinary

resolution with special notice passed before the end of their term; failing to offer themselves for reelection;

and not being re-elected at the general meeting at which their term expires.

Departure of auditors from office can occur in the following ways.

(a) Auditors may resign their appointment by giving notice in writing to the company delivered to the

registered office.

(b) Auditors may decline reappointment.

(c) Auditors may be removed from office before the expiry of their appointment by the passing of an

ordinary resolution in general meeting. Special notice is required and members and auditors must

be notified. Private companies cannot remove an auditor by written resolution; a meeting must

be held.

(d) Auditors do not have to be reappointed when their term of office expires, although in most cases

they are. Special notice must be given of any resolution to appoint auditors who were not

appointed on the last occasion of the resolution, and the members and auditor must be notified.

Where a private company resolves to appoint a replacement auditor by written resolution, copies of the

resolution must be sent to the proposed and outgoing auditor. The outgoing auditor may circulate a

statement of reasonable length to the members if they notify the company within 14 days of receiving the

copy of the written resolution.

11.8.1 Resignation of auditors

However auditors leave office they must either: state there are no circumstances which should be brought

to members' and creditors' attention; or list those circumstances. Auditors who are resigning can also:

circulate a statement about their resignation to members; requisition a general meeting', or speak at a

general meeting.

PROCEDURES FOR RESIGNATION OF AUDITORS

Statement of circumstances Auditors must deposit a statement at the registered office with their

resignation stating:

• For quoted companies – the circumstances around their departure.

• For non-quoted public companies and all private companies – there are

no circumstances that the auditor believes should be brought to the

attention of the members or creditors.

• If there are such circumstances the statement should describe them.

• Statements should also be submitted to the appropriate audit authority.

Company action • The company must send notice of the resignation to the Registrar.

• The company must send a copy of the statement of circumstances to

every person entitled to receive a copy of the accounts.

Auditor rights If the auditors have deposited a statement of circumstances, they may:

• Circulate a statement of reasonable length to the members

• Requisition a general meeting to explain their reasons: s 518

• Attend and speak at any meeting where appointment of successors is to

be discussed.

If the auditors decline to seek reappointment at an AGM, they must nevertheless fulfil the requirements of

a statement of the circumstances just as if they had resigned. The reason for this provision is to prevent

auditors who are unhappy with the company's affairs keeping their suspicions secret. The statement must

be deposited not less than 14 days before the time allowed for next appointing auditors.

11.8.2 Removal of the auditor from office

PROCEDURES FOR REMOVAL FROM OFFICE

Auditor

representations

If a resolution is proposed either to:

• Remove the auditors before their term of office expires or

• Change the auditors when their term of office is complete the auditors have the

right to make representations of reasonable length to the company

Company action The company must:

• Notify members in the notice of the meeting of the representations

• Send a copy of the representations in the notice

• If it is not sent out, the auditors can require it is read at the meeting

Attendance at

meeting

Auditors removed before expiry of their office may:

• Attend the meeting at which their office would have expired

• Attend any meeting at which the appointment of their successors is discussed

Statement of

circumstances

If auditors are removed at a general meeting they must:

• Make a statement of circumstances for members and creditors

Remember: A statement of circumstances/no circumstances must be deposited however the auditors

leave office.

CHAPTER ROUNDUP

• Any person who occupies the position of director is treated as such, the test being one of function.

• The method of appointing directors, along with their rotation and co-option is controlled by the articles.

• Directors are entitled to fees and expenses as directors as per the articles, and emoluments (and

compensation for loss of office) as per their service contracts (which can be inspected by members).

Some details are published in the directors' remuneration report along with the accounts.

• A director may vacate office as director due to: resignation; not going for re-election; death; dissolution

of the company; removal; disqualification.

• Directors may be required to vacate office because they have been disqualified on grounds dictated by the

articles. Directors may be disqualified from a wider range of company involvements under the Company

Directors Disqualification Act 1986 (CDDA).

• Directors may be disqualified from acting as directors or being involved in the management of companies

in a number of circumstances. They must be disqualified if the company is insolvent, and the director is

found to be unfit to be concerned with management of a company.

• The powers of the directors are defined by the articles.

• Directors' powers may be restricted by statute or by the articles. The directors have a duty to exercise

their powers in what they honestly believe to be the best interests of the company and for the purposes

for which the powers are given.

• The CEO or MD has apparent authority to make business contracts on behalf of the company. Their

actual authority is whatever the board gives them.

• The Companies Act 2006 sets out the seven principal duties of directors.

• The statutory duties owed by directors are to:

– Act within their powers

– Promote the success of the company

– Exercise independent judgement

– Exercise reasonable skill, care and diligence

– Avoid conflicts of interest

– Not accept benefits from third parties

– Declare an interest in a proposed transaction or arrangement

• Every public company must have a company secretary, who is one of the officers of a company and may

be a director. Private companies are not required to have a secretary.

• Every company (apart from certain small companies) must appoint appropriately qualified auditors. An

audit is a check on the stewardship of the directors.

• The Companies Act provides statutory rights for auditors to enable them to carry out their duties.

• Auditors may leave office in the following ways: resignation; removal from office by an ordinary

resolution with special notice passed before the end of their term; failing to offer themselves for reelection;

and not being re-elected at the general meeting at which their term expires.

• However auditors leave office they must either: state there are no circumstances which should be brought to

members' and creditors' attention; or list those circumstances. Auditors who are resigning can also:

circulate a statement about their resignation to members; requisition a general meeting; or speak at a

general meeting.

QUICK QUIZ

1 A person who is held out by a company as a director and performs the duties of a director without actually

being validly appointed is a

A Shadow director

B De facto director

C Non-executive director

D Executive director

2 Fill in the blanks in the statements below.

Under model articles directors are authorised to m……………….. the b……………….. of the company,

and e……………….. the p………………..of the company.

3 Under which of the following grounds may a director be disqualified if he is guilty, and under which must

a director be disqualified?

A Conviction of an indictable offence in connection with a company

B Persistent default with the provisions of company legislation

C Wrongful trading

D Director of an insolvent company whose conduct makes him unfit to be concerned in the

management of the company

4 What is the extent of a Chief Executive Officer's actual authority?

5 What are the two principal ways by which members can control the activities of directors?

6 A public company must have two directors, a private company only needs one.

True

False

7 Describe the subjective test that directors must pass in order to meet their duty of care.

8 A private company with a sole director is not legally required to have a company secretary, but if it does,

the sole director cannot also be the company secretary.

True

False

9 State two reasons why a person would be ineligible to be an auditor under Companies Act 2006.

(1) ...........................................................................................................................................................

(2) ...........................................................................................................................................................

ANSWERS TO QUICK QUIZ

1 B. The description is of a de facto director.

2 Under model articles directors are authorised to manage the business of the company, and exercise all

the powers of the company.

3 A to C are grounds under which a director may be disqualified; D is grounds under which a director must

be disqualified.

4 The actual authority is whatever the board gives them.

5 Appointing and removing directors in general meeting

Reallocating powers by altering the articles

6 True. Private companies only need one director.

7 A director is expected to show the degree of skill, knowledge and expertise that he or she actually has in

order to meet the subjective test.

8 True. Sole directors cannot be company secretaries. Private companies are not legally required to have a

company secretary.

9 Any of:

(1) Is an officer/employee of the company being audited

(2) A partner or employee of a person in (1)

(3) A partnership in which (1) is a partner

(4) Ineligible by (1), (2) and (3) to be auditor of any of the entity's subsidiaries