Directors' Duties - What Constitutes Misconduct Part 1
This is Part 1 of a series of booklets considering the general question of Directors’ duties and responsibilities and in particular, what conduct can ultimately constitute a finding of “unfitness” and possible disqualification as acting as a director.
Unfitness is governed by section 6 of the Company Director Disqualification Act 1986 (“CDDA 1986”).
This series of booklets is intended to guide you through the general standard of behaviour expected by the Courts on either: (i) an objective basis – i.e. the standard expected of directors generally; and (ii) a subjective basis – i.e. the higher standard expected of directors having regard to their qualifications, skills and experience.
Although cases are always judged on their own individual facts, certain common threads can be determined from the various decisions made by the Courts when determining unfitness pursuant to Section 6 of the CDDA 1986.
1. Director Disqualification for incompetence
A director can be disqualified for incompetence.
When judging “competence”, a Court will look at a wide variety of factors when determining unfitness. These include:
- The type of business concerned;
- The size of the business;
- The experience or skills that the director holds himself/herself out to have;
- The actual experience and skills s/he has; and
- The allocated management responsibilities of that individual.
The Courts will always expect a director, regardless of his/her background, to meet a certain standard regardless of the industry s/he works within. If a director has the appropriate experience or other qualifications which demonstrates that expectations should be even higher than this minimum standard, then the Court will apply such expectations when determining whether their actions constituted unfitness.
A director has duties both to those who have direct interests in the company – shareholders, other directors, employees and creditors, and those who have indirect interests - government via policy concerns, potential customers in respect of advertising etc., the public generally in terms of who the goods and services are marketed.
A breach of any of these duties can lead to a finding of unfitness in disqualification proceedings.
2. Director Disqualification for inactivity or failure to act
If a director has remained completely inactive or has failed to act, this can in itself, constitute a finding of incompetence and lead to disqualification.
This category is often applicable to spouses of directors who are themselves appointed directors and then take no involvement whatsoever in the running of the business. If that company then later goes into liquidation, the likelihood is that the failure alone by the spouse to take any involvement and/or interest in the running of the company will be sufficient for a finding of unfitness.
The fact that someone agrees to be a director of the company, and even may be a signatory to a bank account, is in itself a breach of their duties as they are acting as a conduit for misbehaviour to occur without insisting on having any supervisory or other control over the company’s affairs.
Such inactivity is no defence to a disqualification claim.
b. Newly or rapidly appointed employees
Another danger is in circumstances where the director controlling the business promotes an employee to the position of director. This can often occur with relatively new, sometime graduate, recruits who may be ambitious and eager to obtain an early promotion. Often that person can be in “awe” of the main controller of the business or “dazzled” by a strong personality and take little if any part in the management of the company, or alternatively they could be overconfident about their own abilities without truly understanding the nature of the responsibilities they are taking on.
c. Lateral hires when trading gets tough
It is not uncommon for an experienced individual, when times are getting tougher, to recruit in an individual and quickly promote them to director, whilst at the same time resigning their own position and allowing this new individual to be seen to be controlling the company (and being disqualified as a director and potentially being subject to litigation proceedings when things go wrong). There is no such thing as a “free lunch”.
Once you are a director you take up the entire responsibility for the company’s corporate governance, its duties to all creditors (including Her Majesty’s Revenue & Customs) and the approach to marketing and sales taken by the company and its employees.
3. The concept of individual and collective responsibility when considering disqualification pursuant to the Company Director Disqualification Act 1986
The management of a company is vested in its directors. The running of the company can only be conducted through its directors.
Directors have (both collectively and individually), a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them to properly discharge their duties as directors.
In larger companies this requires detailed reporting structures and management processes to ensure that at every level there is accountability which goes up through the chain of command.
In assessing the question of unfit conduct, when faced with a disqualification claim, the Court will look at the size and type of the business and the experience of the person, his/her role in the business and duties and responsibilities assigned to that person. Therefore, whilst the role of director is universal, the Court will consider the actual roles and responsibilities of each individual director as well as their overall corporate governance responsibilities.
4. The duty on a director to keep informed and to supervise
There is a duty on a director to inform himself/herself of the affairs of a company and engage with co-directors in supervising and adhering to those duties.
If a director fails to monitor, supervise or keep himself/herself informed about the company, then this lack of knowledge can be no excuse in disqualification proceedings and any finding of unfitness (see our comments above).
A lack of control can be evidenced by a number of things such as:-
- Failing to hold board meetings;
- Not issuing appropriate instructions to employees;
- Not implementing appropriate reporting mechanisms where direct supervision is not possible.
- Leaving important corporate matters to external bodies – for example expecting accountants to deal with all tax matters and accounts without any degree of involvement or review by directors (which is a direct contravention of Section 173 of the Companies Act 2006).
- Not making adequate enquiries as to the company’s financial position by reviewing management information or checking ledgers;
- Not regularly monitoring adherence to statutory duties, including the requirement to deal with all PAYE/Vat and corporation tax returns, filing accounts and other returns to Companies House, adherence to anti-money laundering regulations, professional regulatory requirements and any fraudulent matters.
- Not ensuring that a company’s creditors are treated in an identical fashion.
It is vital that all directors take an active part in a company’s management and in the interests of all parties and ensure that they ensure all parts of the company are operating in a manner that complies with the legal framework.
Any failure to do this cannot be justified unless there are unusual circumstances, for example fraud by an employee, illness, fraud by an external party and reliance on wrong advice (although this presents a difficult bar to meet where no negligence proceedings have been brought).
The privilege of limited liability is bestowed to directors and their shareholders, via the company, on the basis of the responsibilities that directors bear to ensure that they act in accordance with their duties. A breach of such duties can lead to disqualification proceedings (which would lead to their inability to act for a company in the future) and personal liability for the losses incurred (despite the assumed “limited” liability of the company).
5. Delegation by directors of responsibilities to others
We are often asked what happens when a director delegates responsibilities to others in the company of a similar standing or level. Does this absolve the director if things later go wrong due to mistakes made by the other person to whom the task was delegated?
As an act, delegation is permitted and indeed necessary in the smooth running of larger organisations. A person cannot be expected to do everything in a medium to large sized company.
The courts are however clear on this point. Whilst directors can delegate functions to other people in the management chain, such delegation does not absolve a person from a duty to supervise the discharge of the delegated function. Indeed, the responsibility, should things go wrong, rests not just with the director who delegated the task. It rests with the entire board of directors if there is one.
When delegating a function, role or task, a director should:
- Consider whether the person to whom the task or function is delegated has the appropriate skills and experience to carry out this task.
- Ensure that the correct systems, individuals (e.g. mid-management) and structure is in place to ensure that adequate supervision of this individual is performed;
- If necessary, depending on the seriousness and financial risk to the company, obtain the board’s approval of the tasks being delegated and who to;
- Ensure that there is a concise record of who is doing what and the reporting procedures. Quite commonly, this type of record is a combination of the employment contract, staff manual and regular appraisals.
However, it is important to realise that at all times the directors do have to have some trust in the employees of the company, as any failures by them are ultimately the directors’ responsibilities.
IN ORDER TO FIND OUT MORE ABOUT THIS SUBJECT AND THE ANSWERS TO THE QUESTIONS LISTED BELOW, DOWNLOAD OUR HANDY TIPS BOOKLET HERE.
ALTERNATIVELY, CONTACT THE DISQUALIFICATION TEAM ON 020 7841 0390
6. Can a director be disqualified under section 6 of the CDDA 1986 for matters which preceded his/her appointment?
7. Does it matter in director disqualification proceedings if the director hasn’t drawn any remuneration from the company?
8. Can I be disqualified as a director for my role as a shareholder or a non-executive director?
9. What can a director do if unable to remedy improper or inappropriate running of a company? What are his/her director responsibilities?
10. Director Disqualification: “Phoenix” companies and reusing a company’s name
11. Director Disqualification for repeatedly failing companies
12. Director Disqualification Continuation of a failed business model
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