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Law for Business

Knowhow - guidance - precedents

13 APR 2015

Ten things every director needs to know – Part 10

Ten things every director needs to know – Part 10
You cannot be a sleeping director.

This is the last in a series of articles in which we explore the role of a director from various angles, some of them slightly unconventional.  Each article identifies a fact of which directors need to be aware – whether concerning their duties, their relationship with other key players or their responsibilities under the Companies Act 2006 – and uses it as a starting-point to illuminate a particular aspect of their role.

This article considers whether, in the light of the statutory duty imposed on directors to exercise due care and skill, a director may choose to be a so-called “sleeping director”, who plays no role whatsoever in his company’s affairs.

The duty of care - overview

For the most part, the statutory duties imposed on directors by Part 10 of the Companies Act 2006 seek to ensure that a director is loyal to his company.  This aim is reflected most clearly in section 172, which requires a director to act in such a way as to promote the company’s success, but it also forms the basis of the duty to avoid conflicts of interest (section 175) and the duty to exercise powers only for a proper purpose (section 171(b)), for example.  The duties based on loyalty – which are sometimes referred to as fiduciary duties – are, however, supplemented by a duty of care, which is designed to ensure that a director is not only guided by a desire to promote his company’s interests, but also meets a minimum standard of competence.

The competence duty is contained in section 174, which requires a director to exercise the care, skill and diligence that would be exercised by a reasonably diligent person who possesses:

• the knowledge, skill and experience that a director in his position would be expected to possess; and
• any additional knowledge, skill and experience that he in fact possesses.

Thus, under section 174, a director’s conduct is measured against an objective minimum standard of competence and, if he happens to have any extra knowledge, skill or experience, against a higher subjective standard of competence.

The duty of care – the objective minimum standard
The precise objective minimum standard to which a director must adhere will depend upon his role within the company and, indeed, the nature and size of the company itself.  A non-executive director of an SME will not be expected to have the same level of knowledge, skill and experience as an executive director of a major listed company.  Broadly, however, every director will, amongst other things, be expected to understand his company’s business and its financial position, attend board meetings and apply his mind to the issues under discussion, read papers before he signs them and challenge his fellow board members where appropriate.

The duty of care – a higher subjective standard?
If a director has any knowledge, skill or experience which a director in his position would not normally possess, he will be expected to apply it in his conduct of the company’s affairs.

Take the case of a director of a manufacturing company in the Northeast who has worked in manufacturing in that part of the country for thirty years.  If he is invited to purchase a rival business, he will need to comply with his duty of care when deciding whether to proceed with the acquisition.  In order to comply with the objective minimum standard, he will need to carry out due diligence on the target and may also need to seek legal and financial advice on the potential advantages and risks of the transaction.  Given that he has thirty years’ experience of the workings of the local market, he will also need to comply with a higher, subjective standard of care.  If, for example, the combined business will be likely to suffer as a result of the preference amongst customers in that market for dealing with small companies which are able to offer a more personalised service, someone with his experience of local conditions would be expected to give that fact due weight in his decision-making process.

The effect of the incorporation into the duty of a subjective element is that directors who carry out the same function in the same company will nevertheless be subject to different standards of competence if some of them have special skills or experience.

Sleeping directors
A shareholder does not owe his company any duties, and as such is, on the whole, perfectly within his rights to refuse to play any part in its life.  He can refuse to read any shareholders’ written resolutions which are sent to him, refuse to attend any general meetings and even refuse to respond to requests from the directors to discuss the company’s long-term future.  As a part owner of the company, it is his prerogative to refuse to take any interest whatsoever in its affairs.

By contrast, a director who adopts a similarly hands-off approach will be in breach of his duty of care.  A director who accepts a seat on the board but then fails to attend board meetings, makes no effort to learn about the company’s business and allows his fellow directors to run the business as they please cannot be said to be exercising care, skill and diligence.  Even if he does not possess any particular skills which would raise the standard of competence expected of him, he will fall short of the objective minimum standard which all directors must attain.

The position was summed up neatly by the Court of Appeal in Re Westmid Packing Services Ltd (1998):

“ … the collegiate or collective responsibility of the board of directors of a company is of fundamental importance to corporate governance under English company law.  That collegiate or collective responsibility must however be based on individual responsibility.  Each individual director owes duties to the company to inform himself about its affairs and to join with his co-directors in supervising and controlling them.
A proper degree  of delegation and division of responsibility is of course permissible, and often necessary, but not a total abrogation of responsibility.”

Directors generally
What is the impact of the duty of care on directors who, unlike sleeping directors, wish to participate in their company’s life?

In the first place, it is worth making the point that the duty does not prevent a director from acting in a non-executive capacity.  Non-executive directors - whose function is primarily to oversee the activities of the executive directors, thus carrying out a supervisory role on the board - are a vital part of the governance structure of large companies (see, for example, the description of their role in Section A.4 of the UK Corporate Governance Code (September 2014)), and can play an important role in the smallest companies, too.

The key to complying with section 174 is to have the skills needed in order to run a company and to apply those skills wholeheartedly to the task of managing the company’s affairs (or, in the case of non-executive directors, the task of overseeing the activities of the other board members).  A director who cannot devote much time to the company, such that he regularly misses board meetings, runs the risk of breaching the minimum objective standard.  So, too, does a director who, with the best will in the world, and even with the benefit of expert advice, finds that he simply cannot grasp the meaning of business documents.  As far as the subjective standard is concerned, a director needs to ensure that he brings to bear upon his role any special knowledge or experience he may have, whether in the form of a deep understanding of the sector in which the company operates or in the form of professional expertise in matters such as law or accounting.

The big picture
Directors are central to the life of their company, and with power comes responsibility.  A director whose conduct is not satisfactory faces a variety of possible sanctions.  Most obviously, perhaps, he may be removed from office by the shareholders, but he may also face court proceedings, in the form, for example, of a wrongful trading claim under the Insolvency Act 1986 or disqualification proceedings under the Company Directors Disqualification Act 1986.

The statutory statement of directors’ duties forms part of this wider scheme of measures which are designed to hold to account directors whose behaviour is not of a suitably high standard.  The duty of care acts as an important supplement to the fiduciary duties, giving the statutory statement real teeth, and as such must be taken seriously.  A director must be loyal, certainly, but he must also apply himself to his functions within the company diligently and conscientiously.
Director's Guide to Duties, A

Director's Guide to Duties, A

The role of the company director, written in a question answer format, for the layperson.

International Corporate Procedures

International Corporate Procedures

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