Tuesday, 24 February 2015

Director Responsibilities and Duties - Part 1

This is the first of a series of articles considering the general question of Directors’ duties and responsibilities. Such duties are vital for directors to understand as failure to adhere to them can ultimately constitute a finding of “unfitness” and possible disqualification as acting as a director. This can have an enormous impact on a person’s livelihood and as such director duties are something to be clearly understood.
Unfitness is governed by section 6 of the Company Director Disqualification Act 1986 (“CDDA 1986”).
This series of articles 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.
This article deals with those common threads.
1. Disqualification for incompetence
A director can be disqualified for incompetence.
When judging the question of competence, a Court take in to account a wide variety of factors when determining the question of unfitness. These include:-
  1. The type of business concerned;
  2. The size of the business;
  3. The experience or skills that the director holds himself / herself out to have;
  4. The actual experience and skills s/he has; and
  5. The allocated management responsibilities of that individual.
The Courts will always expect a director to meet a certain standard, regardless of both his/her background and 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 (eg accounting skills), then the Court will apply such expectations when determining whether their actions constituted unfitness.
A director has duties both to those who have direct and indirect interests in the company. Those with direct interests include
  1. Shareholders;
  2. Other directors;
  3. Employees; and
  4. Creditors,
Those who have indirect interests include:
  1. Government via policy concerns;
  2. Potential customers in respect of advertising etc;
  3. 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 being commenced by the Secretary of State for Business Innovation & Skills.
2. 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 can lead to disqualification.
a. Spouses
This category is often applicable to spouses of directors who are themselvesappointed directors and then take little or no involvement whatsoever in the running of the business. If that company then later goes into liquidation / administration, 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 may for example even be a signatory to a bank account, is in itself a breach of duty as that person is effectively 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 although it may help in terms of mitigation and thus reducing any period of disqualification.
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. The person may enjoy the title of director but understand little if anything of the responsibilities which come with it. Often that person takes little if anypart in the management of the company. Alternatively they can often 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 or the writing is on the wall, to recruit in an individual and quickly promote them to director, whilst at the same time resigning their own position. Effectively they are putting that other person in the firing line for any disqualification proceedings by allowing this new individual to be seen to be controlling the company
There is no such thing as a free lunch.
It should be remembered that 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
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 sized companies this often requires detailed reporting structures and management processes to ensure that at every level there is accountability which goes up through the chain of command. This however is not always the case in smaller to mid-sized companies.
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 still consider the actual roles and responsibilities of each individual director as well as their overall corporate governance responsibilities. For example, the day to day role of a finance director compared to a sales director can be very different.
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 is 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).
In situations where directors fall out for personal reasons, it can be hard to ensure that proper adherence to one’s directorial duties are carried out. However, every effort must be made, even in difficult circumstances. If it is still not possible, then a director must tender his/her resignation and make it clear the reasons why.
5. Delegation 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 thdirector if things later go wrong due to mistakes made by the other person to whom the task wasdelegated?
The quick answer to this question is no.
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 medium to large sized company. It simply isn’t possible.
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 personfrom a duty to supervise the discharge of the delegated function.
Furthermore, 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. This is strongly advisedto do in such circumstances;
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, even in smaller businesses, it is vital that a proper paper trail is in place in the event something later goes wrong and questions are asked as to why a particular decision was made.
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.
6. Can a director be disqualified for matters which preceded his/her appointment?
The quick answer is no.
Ordinarily a director cannot be disqualified for failing to remedy previous inadequacies in the company before s/he became a director.
However, the answer does come with an important caveat. If it is the case that a newdirector comes in to “see out” the company, cover up for previous directors mistakes or extract what value is left in a companyall of these actions are indeed worthy of criticism.
Additionally, a director’s conduct will be assessed where s/he is appointed and does little or nothing to protect creditors from a deteriorating situation which preceded his/her
Appointment or where s/he could have done something to prevent a pre-existing situation from getting worse. An example of this could be where there are outstanding tax returns from previous periods and a director does not bring them up to date or act to deal with this liability.
Even if appointed for all the right reasons, a new director can quickly get in to trouble if they do not take control. A proper understanding of their role pre appointment (especially if the company is in difficulty) is vitally important.
7. Does it matter if the director hasn’t drawn any remuneration from the company?
The answer is No.
A director can’t avoid his/her responsibilities on the basis that s/he didn’t earn anythingfrom the business.
However the converse is true. The higher the level of remuneration by a director, the more the Court will expect that person to have been involved in running of the business – quite often we see the main interest represented by a shareholder who distances himself from any interest in a company but is paid the most.
8. Can a person be disqualified for his/her role as a shareholder or non-executive director?
The disqualification regime applies to all directors.
A director is not precisely defined in legislation but refers to all individuals who hold the position of director by whatever name called (section 250 Companies Act 2006). This includes:
De Facto Directors – directors who are held out as directors or perform functions which could only be carried out by a director, but who are not formally recorded as director in the Company’s statutory records and at Companies House;
Shadow Directors – those individuals who whilst not openly acting as a director may instruct the company’s directors in the performance of their duties and the direction of the company. This is defined by Section 251 Companies Act 2006;
Corporate Directors – i.e. companies who sit on the board of directors and are appointed as such;
Directors of corporate directors;
Non-executive directors – whose responsibilities in respect of the management and direction of the company, including its financial affairs, are no different to that of appointed De Jure directors. Non-Executive directors need to be especially careful. Often they take appointments later in life as a means of earning money, but with little daily involvement in a company. They are often appointed due to a particular expertise (eg an accountant). If things go wrong, it is not excuse to say that they only had limited involvement in the company. The same rules apply and the situation is even worse if they had a particular expertise required by that company;
If shareholders act in any of the above ways it will be extremely difficult to distance themselves from any allegations of unfitness as a director in director disqualification proceedings. As such, all individuals involved in the management of a company must be aware of what their role is and whether it is conduct that could only be performed by a director.
Non-Executive directors
As stated above, the general rule is that non-executive directors who fail to take part in the management of the affairs of the company can also be disqualified for unfitnessA non-executive director, as any other conventional director (see our comments above), can be disqualified for incompetence or any other finding of unfitness.
As a rule of thumb, non-executive directors in larger organisations are likely to be at less risk than those attached to smaller organisations. In larger organisations, non-executive directors are invited to attend board meetings and receive regular (and often better prepared) management information. However, there is still a duty on the non-executive director to ensure that the information before him at a board meeting is accurate and that directors act properly in determining how to deal with any issues which may give cause for concern.
9. What can a director do if unable to remedy improper or inappropriate running of a company?
If a director discovers something untoward going in the company but cannot compel his co-directors to fix it, what should that person do?
Conventionally a director should raise these issues at a board meeting and ensure there is a minute of this meeting to record his concerns and suggestions to remedy the situation (it may also be advisable to keep a personal record of the minute).
If a majority of directors are unwilling to follow such suggestions or do not propose similar remedial action, or if the remaining directors refuse to attend the meeting, then there are very few alternatives available.
If the director is also a shareholder s/he may be able to take derivative action against the fellow directors or force the company to take the necessary steps proposed. However, if this is not possible, then the only alternative is for that director to resign.
However, for director disqualification claims, a previous director can still be subject to these proceedings and therefore throughout that directors involvement in the company s/he should always ensure that any such improper acts or behaviour are dealt with quickly and that there are thorough records of his//her attempts to mitigate the effects of such actions on others or remedy the situation.
A detailed paper trail is vital in such circumstances.
Equally, simply resigning may not be enough to avoid criticism as that director is effectively leaving the company vulnerable to the will of the previous directors and therefore a decision has to be made as to whether there is a need to convene a shareholders meeting (if that director is a shareholder), report such concerns to government or regulatory authorities or to otherwise consider whistle blowing.
However, the answer when faced with the above situation is to try and remedy things and if this is not possible, to resign. To simply state I did what I could is no defence to a claim of unfitness.
10. Disqualification: Phoenix companies and reusing a company’s name
The Insolvency Act 1986 set about adopting a procedure to prevent individuals as directors from repeatedly allowing companies to fail and immediately recommencing trading in the same name. These were and often continue to be referred to as Phoenix Companies.
A Phoenix Company may be used to prefer favoured creditors, mislead creditors and the public into believing the same business is continuing to trade (even though it has entered into liquidation) or enabling the continued provision of credit to pay for that director’s lifestyle.
Under current legislation (section 216 of the Insolvency Act 1986) this is prohibited and is both a criminal offence (which a liquidator is legally required to report to governmental authorities and which can attach a director disqualification order) and a civil offence (where the director can be pursued for losses incurred by creditors of the Phoenix Company.
The breach of this legislation is quite commonly a basis for director disqualification proceedings and it is usually a difficult issue for an individual without legal knowledge to deal with. However there are statutory exceptions to the rule (which perhaps should be considered when it is intended to continue trading in the old company name) which can be relied on to rebut any allegations of unfitness.
11. Repeatedly failing companies
The courts do not treat all directors equally in circumstances where they have had a series of previous company failures. They make a distinction is often made between“honest and “bad” Phoenix Companies.
An “honest” Phoenix Company is where a failure has happened through no fault of the management and the business had to be rescued by a successor company in the interests of the public and the creditors
A “bad Phoenix company is characterised by intentionally dishonest or grossly negligent behaviour and where the management are simply looking after their own interests through several continuously traded companies which repeatedly fail one after the other.
There are current proposals by the Secretary of State (published in July 2013) which include a provision that directors should be disqualified on the automatic basis of repeatedly failing companies, regardless as to whether it was an “honest” or “bad” Phoenix Company. This will have important effects on directors of a company where they have had a previous failure, as it may be a case of 2 (or three) strikes and you’reout. It remains to be seen if these proposals find themselves on to the statute book in April 2015.
12. Continuation by a director of a failed business model
A director can be disqualified if the successor company’s business is just a mere continuation of a failed business model with no real prospects of success.
In order to defend such an allegation, a director must show that the successor business had a different business model to the old company.
For example, aFWJ, we successfully acted for an individual who established 3 successive bagel chain companies in 4 years, each of which failed owing over £1 million to HMRC. However, we successfully demonstrated that each company had a very different modus operandi with genuine prospects of success at the outset of each company. The Secretary of State later discontinued proceedings and paid our client’s costs in full.
Should you require assistance with any concerns which relate to Director Duties, possible misconduct, concerns about Director Disqualification proceedings or your personal risk generally as a director, then please contact Francis Wilks Jones and we will be more than happy to discuss your concerns on an initial free no obligation basis.
Each case we deal with is unique to the individual concerned. Our team of experts can provide you with the tailored expert advice you need.
Call us now on 0207 841 0390 for your free consultation.