Duties of directors of local authority companies under CA 2006

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Directors’ duties under CA 2006 | Who are the duties owed by? | Duties owed to the
company | Duration of the duties | Cumulative duties | Relationship between the duties
and the company’s constitution | Duties | Consent, approval and authorisation by members
| Consequences of breach | Relief from liability | Managing roles in local authorities and
companies

Produced in partnership with Clare Hardy of Geldards LLP

This Practice Note is one of a series covering local authority (LA) companies. This Practice Note
covers the duties owed by the directors of an LA company to the company, as well as to the LA
highlighting when those dual responsibilities may conflict.

For more information on LA companies, see Practice Note: Local authority companies.

Directors’ duties under CA 2006

Chapter 2 of Part 10 of the Companies Act 2006 (CA 2006) codified certain long-standing
common law and equitable duties of directors. In summary, the seven general duties under CA
2006 are:
• to act within their powers
• to promote the success of the company
• to exercise independent judgment
• to exercise reasonable care, skill and diligence
• to avoid conflicts of interest
• not to accept benefits from third parties
• to declare an interest in a proposed transaction or arrangement

Who are the duties owed by?

The general duties apply to all the directors of a company. ‘Director’ is defined to include any
person occupying the position of director, by whatever name called, which includes de facto
directors.

The general duties apply to shadow directors where and to the extent that they are capable of
 Duties of directors of local authority companies under CA 2006

so applying. According to the explanatory notes to the legislation, the starting point for shadow
directors is that the general duties apply, unless they are not capable of applying.

CA 2006 makes no distinction between executive and non-executive directors.

Duties owed to the company

The duties are owed to the company. With limited exceptions, only the company will be able to
enforce them. Directors do not, by virtue of the office of director, owe fiduciary duties to the
company's shareholders or creditors, although in certain circumstances shareholders may be
able to bring a derivative action on the company's behalf.

Duration of the duties

In general, a director's duties to the company will start when they became a director; but after
resignation, they will not continue to owe the general duties to the company. However, CA 2006
provides that certain aspects of the duty to avoid conflicts of interest and the duty not to accept
benefits from third parties continue to apply after a person ceases to be a director.

The duty to avoid conflicts of interest will continue to apply as regards the exploitation of any
property, information or opportunity of which they became aware at a time when they were a
director.

The duty not to accept benefits from third parties will continue to apply as regards things done or
omitted by them before they ceased to be a director.

A director also continues to owe duties of confidence to the company following their resignation.

Cumulative duties

Where more than one duty applies in a given case, the directors must comply with each
applicable duty. For example, the duty to promote the success of the company will not authorise
directors to breach their duty to act within their powers, even if they consider that action would
be most likely to promote the success of the company. The general duties also do not require or
authorise a director to breach any other law.

Relationship between the duties and the company’s constitution

Companies may, through their articles, go further than the statutory duties by placing more
onerous requirements on their directors (for example by requiring shareholder authorisation of
the remuneration of the directors). However, the articles may not dilute the duties except to the
extent permitted by specific sections.

Duties

Duty to act within powers

Under CA 2006, s 171, a director of a company must:

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• act in accordance with the company's constitution, and

• only exercise powers for the purposes for which they are conferred

A company’s constitution is widely defined for these purposes to include:

• the company’s articles of association
• decisions taken in accordance with the articles and other decisions taken by the
members or a class of them if they can be regarded as decisions of the company
• any resolutions and agreements affecting a company’s constitution

The Supreme Court made the following comments in relation to this duty in the case of Eclairs
Group Ltd and Glengary Overseas Ltd v JKX Oil and Gas plc:
‘The principle has nothing to do with fraud. […] The important point for present purposes is that the proper purpose rule is
not concerned with excess of power by doing an act which is beyond the scope of the instrument creating it as a matter of
construction or implication. It is concerned with abuse of power, by doing acts which are within its scope but done for an
improper reason. It follows that the test is necessarily subjective. “Where the question is one of abuse of powers,” said
Viscount Finlay in Hindle v John Cotton Ltd (1919) 56 Sc LR 625, 630, “the state of mind of those who acted, and the
motive on which they acted, are all important”.’
Can conduct which would otherwise breach this duty be authorised?

CA 2006, s 180 preserves any rule of law enabling the company to give authority for anything
that would otherwise be a breach of duty. Under equity, breaches of fiduciary duty could be
authorised in advance by ordinary resolution following full and frank disclosure of all material
facts, although the company could not authorise acts which are unlawful.

That means that conduct which is not in accordance with the company’s constitution (eg
entering into a transaction which falls outside the company’s objects) cannot be authorised; and
conduct which is in accordance with the company’s constitution but may potentially be for an
improper (but lawful) purpose (eg issuing shares to a director’s associates) can be authorised.
There are, however, rights of action which a minority shareholder who has been unfairly
prejudiced by such conduct may have.
Duty to promote the success of the company

A director must act in the way they consider, in good faith, would be most likely to promote the
success of the company for the benefit of its members as a whole. In so doing, the director must
have regard (among other matters) to:
• the likely consequences of any decision in the long term
• the interests of the company's employees
• the need to foster the company's business relationships with suppliers, customers and
others
• the impact of the company's operations on the community and the environment
• the desirability of the company maintaining a reputation for high standards of business
conduct
• the need to act fairly as between the members of the company

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The duty is subject to any enactment or rule of law requiring directors in certain circumstances
to consider or act in the interests of the creditors of the company.

It should be noted that:

• the duty applies to all decisions made by a director, not merely formal decisions made by
the whole board
• the obligation to have regard to the listed factors is clearly subordinate to the overarching
duty to promote the success of the company for the benefit of its members as a whole.
However, the obligation to have regard to at least the listed factors, in carrying out the
overarching duty, is mandatory
• the list of factors is non-exhaustive. Directors should have regard to other matters
relevant to the duty to promote the success of the company

In having regard to the listed factors, the duty to exercise reasonable care, skill and diligence will
apply. In some cases, to satisfy the duty, it may be necessary to seek expert advice, for
example in relation to the impact on the community or environment.

CA 2006, s 172 has been the subject of a great deal of comment and debate. Concerns have
included:
• the uncertain meaning of the term ‘success’. The government has stated that
‘success’ in this context will usually mean ‘long-term increase in value’ for commercial
companies, and that what will promote the success of the company, and what constitutes
such success, will be for the director's good faith judgment—its view was that this would
ensure that business decisions on, for example strategy and tactics, are for the directors,
and are not subject to decision by the courts, provided the directors were acting in good
faith
• whether the test is subjective or objective. In Re Southern Counties Fresh Foods Ltd,
the court confirmed that the test under (at least the first limb of) CA 2006, s 172(1)
remains subjective in nature (that is, one looks at whether the director honestly believed
that they acted in a way most likely to promote the company’s success). Nevertheless, a
court may be more likely to be persuaded that a decision was not taken in good faith
where it was not a decision that a reasonable and intelligent director could have
concluded would promote the success of the company

The subjective test will only apply where there is evidence of actual consideration of the
best interests of the company. Where there is no such evidence, the proper test is
objective, namely whether an intelligent and honest person in the position of a director of
the company concerned could, in the circumstances, have reasonably believed that the
transaction was for the benefit of the company
• whether the distinction between a company as a corporate entity and its members
will be maintained. The fiduciary duty to act in the best interests of the company was
traditionally interpreted by identifying the company with its shareholders, both present
and future and requiring directors to balance short-term and long-term interests. It is not
clear that this will be the case under CA 2006, s 172. The drafting of the section could
mean that the interests of the company's present members take precedence

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• how, or if, directors should document their compliance with the section. Some
commentators have been of the view that directors would be in a much better position
where, if litigation later arises, they can provide records, such as minutes of discussions,
to prove that they paid due regard to the factors listed in CA 2006, s 172(1). However,
the prevailing view appears to be that it will be sufficient for the minutes to state that the
directors have taken the factors into account in carrying out their duty. If any factor is
particularly relevant, whether or not in the specified list, the minutes should reflect points
made during discussions (subject to company policies on record-keeping), but otherwise
the discussion of each factor need not be minuted. For significant or potentially
controversial decisions, briefing papers prepared by management should address each
listed factor, unless clearly irrelevant, along with other relevant matters

Concern has been expressed that directors may be exposed to risk if the board minutes
deal with CA 2006, s 172 matters inconsistently, for example by sometimes stating that
the matters were taken into account, sometimes discussing each factor individually, and
sometimes not referring to them at all. Such inconsistency could be construed as an
indicator of whether, and to what extent, the board took CA 2006, s 172 matters into
account
• interests of creditors. As noted, the duty in CA 2006, s 172 is subject to any enactment
or rule of law requiring directors in certain circumstances to consider or act in the
interests of the creditors of the company. Accordingly, the duty is displaced when the
company is insolvent, and may be modified by an obligation to have regard to the
interests of creditors as the company nears insolvency; according to the explanatory
notes to CA 2006, the section has been drafted to leave case law to develop in the area

In GHLM Trading Ltd v Maroo, the court held that the duty in CA 2006, s 172 was indeed
modified when the company was of doubtful solvency or on the verge of insolvency. It
further held that, where creditors' interests are relevant, it will be a director's duty to have
regard to the interests of the creditors as a class. If a director acts to advance the
interests of a particular creditor, without believing the action to be in the interests of
creditors as a class, the director would commit a breach of duty

The precise point at which the duty arises remains unclear. In Hellard (Liquidators of HLC
Environmental Projects Ltd) v Carvalho, the judge commented as follows:
‘It is clear that established, definite insolvency before the transaction or dealing in question is not a pre-requisite
for a duty to consider the interests of creditors to arise. The underlying principle is that directors are not free to
take action which puts at real (as opposed to remote) risk the creditors' prospects of being paid, without first
having considered their interests rather than those of the company and its shareholders. If, on the other hand, a
company is going to be able to pay its creditors in any event, ex hypothesis there need be no such constraint on
the directors. Exactly when the risk to creditors' interests becomes real for these purposes will ultimately have to
be judged on a case by case basis.’

Can conduct which would otherwise breach this duty be authorised?

As noted above, CA 2006, s 180(4)(a) allows breaches of this duty to be authorised in advance
by ordinary resolution following full and frank disclosure of all material facts, although the
company could not authorise acts which were unlawful.

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That means that conduct which is potentially not going to promote the success of the company
can be authorised, provided that:
• the company is solvent at the time of the conduct (because duties are owed to the
creditors in the case of an insolvent company)
• the conduct is lawful

There are, however, rights of action which a minority shareholder who has been unfairly
prejudiced by such conduct may have.
Duty to exercise independent judgment

CA 2006, s 173 codified the principle of law under which directors must exercise their powers
independently, without subordinating their powers to the will of others, whether by delegation or
otherwise (unless authorised by or under the constitution to do so).

The section provides that a director must exercise independent judgment. For example, a
director could not agree with a third person (such as their appointing shareholder) to vote at
board meetings in any particular way, even if voting in that way would not otherwise have
breached their duties to the company.

Can conduct which would otherwise breach this duty be authorised?

The duty will not be infringed by a director acting in accordance with an agreement entered into
by the company that restricts the future exercise of the directors' discretion or in a way
authorised by the company's constitution. For example, the company’s articles of association
may provide that a director is entitled to take account of the wishes and interests of a specific
shareholder(s).

Further, CA 2006, s 180(4)(a) allows breaches of this duty to be authorised in advance by

ordinary resolution of the shareholders following full and frank disclosure of all material facts,
although the company could not authorise acts which were unlawful.

That means that conduct which may amount to a failure to exercise independent judgment can
be authorised. There are, however, rights of action which a minority shareholder who has been
unfairly prejudiced by such conduct may have.

The government has said that this duty will not prevent directors relying on advice, as long as
the directors exercise their own judgment in deciding whether or not to follow the advice.
Duty to take reasonable care, skill and diligence

A director must exercise the care, skill and diligence which would be exercised by a reasonably
diligent person with both:
• 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
(the objective test), and
• the general knowledge, skill and experience that the director actually has (the subjective
test)

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Therefore, at a minimum, a director must display the knowledge, skill and experience set out in
the objective test, but where a director has specialist knowledge, the higher subjective standard
must be met. In applying the test, regard must be had to the functions of the particular director,
including their specific responsibilities and the circumstances of the company.

It follows that a person should not take on a directorship, unless they are sufficiently qualified or
experienced to be able to fulfil the functions that they might reasonably be expected to carry out.
A particularly highly qualified or experienced director will be obliged to exercise a high level of
skill and expertise.

A director will also be required to exercise their duties diligently, keep themselves informed
about the company's affairs and join with their co-directors in supervising and controlling them.
This will not prevent a director from relying on the experience and expertise of their colleagues
or, generally, prevent sensible delegation or division of tasks, provided that the director does not
attempt to abrogate all responsibility.

Can conduct which would otherwise breach this duty be authorised?

In principle, conduct which may amount to a breach of this duty could be authorised in advance
by ordinary resolution of the shareholders following full and frank disclosure of all material facts.
However, it would be very usual for such conduct to be authorised by any shareholder, because
it goes to the heart of what is expected from a director. Furthermore, approval of such conduct
would be very unhelpful if ever proceedings were brought against a director under the Company
Directors Disqualification Act 1986 (CDDA 1986).
Duty to not accept benefits from third parties

Directors must not accept any benefit (including a bribe) from a third party which is conferred
because of his or her being a director or doing or not doing anything as a director. ‘Benefit’ is not
defined. The government stated, during the parliamentary debates, that it intended the ordinary
dictionary meaning of the word, and noted that the Oxford English Dictionary defined it as a
favourable or helpful factor, circumstance, advantage or profit.

The duty will not be infringed if the acceptance of the benefit cannot reasonably be regarded as
likely to give rise to a conflict of interest.

Benefits conferred by the company, its holding company or subsidiaries, and benefits received
from a person who provides the director's services to the company, are excluded.

The duty will continue to apply after a person ceases to be a director in relation to things done or
omitted by them before they ceased to be a director.
Can conduct which would otherwise breach this duty be authorised?

Unlike CA 2006, s 175, board authorisation is not permitted in respect of the acceptance of
benefits from third parties, but any previous ability of the members of a company to authorise
the acceptance of benefits that would otherwise be a breach of this duty is preserved by CA
2006, s 180(4), and the company's articles may contain provisions for dealing with conflicts.
Companies often provide in their constitutions that where directors accept benefits under a
specified value, they will not be in breach of their duty to the company, for example to ensure

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that the acceptance of a certain level of corporate hospitality will not cause a director to breach
CA 2006, s 176.

Furthermore, breaches of this duty can be authorised by ordinary resolution of the shareholders,
although it is rare for shareholders to approve such breaches where appropriate ‘safe harbours’
are set out in their articles of association.
Duty to declare interest in proposed transaction or arrangement with the company

Directors must declare to the other directors the nature and extent of any interest, direct or
indirect, in a proposed transaction or arrangement with the company. The director need not be a
party to the transaction for the duty to apply. An interest of another person in a contract with the
company may require the director to make a disclosure under this duty, if the other person's
interest amounts to a direct or indirect interest on the part of the director. It would therefore be
prudent for directors to do some due diligence into the interests of their connected persons.

The declaration must be made before the company enters into the transaction or arrangement.

The declaration may be made at a meeting of the directors, or by notice in writing in accordance
with CA 2006, s 184 (notice in writing) or CA 2006, s 185 (general notice).

Where a declaration of interest proves to be, or becomes inaccurate or incomplete, a further

declaration must be made, if the company has not yet entered into the transaction or
arrangement when the director becomes, or should reasonably have been, aware of the
inaccuracy or incompleteness.

No declaration will be required:

• where the director is not aware of his or her interest or where the director is not aware of
the transaction or arrangement, but directors will be treated as being aware of matters of
which they ought reasonably to be aware, or
• if the interest cannot reasonably be regarded as likely to give rise to a conflict of interest,
if the other directors are already aware of it, or if it concerns the terms of the director's
service contract which have been (or are to be) considered at a board meeting or board
committee

Can conduct which would otherwise breach this duty be authorised?

As noted above, CA 2006, s 180(4)(a) permits breaches of this duty to be authorised in advance
by ordinary resolution of the shareholders following full and frank disclosure of all material facts.
However, it would be very unusual for such a breach to be authorised because shareholders
would expect any such interests to be declared as part of good governance.

Consent, approval and authorisation by members

Where the duty to avoid conflicts of interest or the duty to declare an interest in a proposed
transaction or arrangement is complied with by authorisation by or disclosure to the directors,
the transaction or arrangement is not liable to be set aside by any common law rule or equitable
principle requiring the consent or approval of the shareholders. This is without prejudice to any
enactment, or provision of the company's constitution, requiring such consent or approval.

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Compliance with the duty to avoid conflicts of interest and the duty not to accept benefits from
third parties is not necessary where CA 2006, Pt 10 (Chapter 4) (transactions requiring approval
of the members) applies and either approval is given under Chapter 4, or Chapter 4 specifies
that approval is not needed. CA 2006, Pt 10 (Chapter 4) sets out specific rules regarding
approval of (and in some cases prohibitions on) certain transactions between companies and
their directors and such directors’ associates, eg long service contracts, substantial property
transactions, loans and payments for loss of office. All other applicable duties set out in Chapter
4 continue to apply.

Compliance with the general duties does not remove the need for approval under applicable
provisions of CA 2006, Pt 10 (Chapter 4) in the case of certain transactions with a director (or in
some cases, with a connected person), such as long service contracts, substantial property
transactions, loans and payments for loss of office.

CA 2006, s 180(4) preserves any rule of law enabling the company to give authority for anything
that would otherwise be a breach of duty. Under equity, breaches of fiduciary duty could be
authorised in advance by ordinary resolution following full and frank disclosure of all material
facts, although the company could not authorise acts which were unlawful. For example, if the
shareholders, with full knowledge of the relevant facts, authorise, or informally acquiesce in, a
conflict of interest within the meaning of CA 2006, s 175, the conduct will not be a breach of the
section.

A director will not be in breach of the general duties if they act in accordance with any provisions
in the company’s articles for dealing with conflicts of interest.

Subject to these exceptions, CA 2006, s 180(5) provides that the general duties have effect
notwithstanding any enactment or rule of law, except where there is an express or implied
exception to this rule.

Consequences of breach

Action by the company

As noted above, the codified duties are owed to the company and only the company will be able
to enforce them, although in certain circumstances shareholders may be able to bring a
derivative action on the company's behalf. In addition, a liquidator or administrator of a company
will be able to bring actions in the company’s name after they have been appointed.
Remedies

The consequences of a breach or threatened breach of the duties are the same as for breach of
the corresponding common law or equitable principles, and with the exception of the duty to
exercise reasonable care, skill and diligence), the statutory duties are enforceable in the same
way as other fiduciary duties owed by directors to their company.

The remedy for a breach of the duty of care, skill and diligence is usually damages. Remedies
for breaches of other fiduciary duties include:
• an injunction

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• setting aside of the transaction, restitution and account of profits

• restoration of company property held by the director, and/or
• damages

A breach of duty may also be grounds for the termination of an executive director's service
contract, or for disqualification as a director under CDDA 1986.
Unfair prejudice actions

Where a company's affairs are being or have been conducted in a manner that is unfairly
prejudicial to the interests of members generally or of some part of its members, those members
may bring a claim by applying to the court by petition for an order. In practice, this right of action
will only apply where a minority shareholder is being treated in an unfair manner by the majority
shareholders and/or the directors, therefore it is unlikely to be of relevance in the case of wholly-
owned subsidiaries of an LA.

Relief from liability

Ratification

CA 2006, s 239 regulates the decisions of a company to ratify (in the sense of condone, forgive)
conduct by a director amounting to negligence, default, breach of duty or breach of trust in
relation to the company.

The section largely preserved the previous common law on ratification of acts of directors, but in
a significant change, provides that any decision by a company to ratify conduct by a director
amounting to negligence, default, breach of duty or breach of trust in relation to the company
must be taken by members without reliance on the votes in favour by the director or any
connected person.
Power of court to grant relief

Where proceedings for negligence, default, breach of duty or breach of trust are brought against
a director, the court may relieve them from liability if it considers both that:
• they have acted honestly and reasonably, and
• considering all the circumstances of the case, they ought fairly to be excused

A director may also apply to the court for relief where they have reason to expect that a claim
may be made against them.
Indemnity and insurance

A company will not be able to exempt a director from any liability for negligence, default, breach
of duty or breach of trust in relation to the company.

The company may, however, indemnify the director against defence costs, or costs incurred in
an application for relief, provided that the director repays the costs if they are unsuccessful.

A company is able to purchase insurance for its directors, and those of an associated company,

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against any liability attaching to them in connection with any negligence, default, breach of duty
or breach of trust by them in relation to the company of which they are a director.

Managing roles in local authorities and companies

Members and officers who take on roles in LA companies will need to be able to balance those
roles with their roles in their LAs. It is important for them to be clear about the role that they are
fulfilling at any time, as their exercise of powers and any obligations they have and any
constraints on their actions will differ according to the capacity in which they are acting.

Members and officers who take on roles in LA companies will need to consider their obligations
under the relevant codes of conduct of their LAs.

Members and officers who are involved in an LA’s decision-making will need to consider the
implications that taking on a role in an LA company might have on their ability to participate in
decision making. For example, there will be potential for conflicts of interest to arise if authorities
take decisions relating to companies on which their members and officers have interests. The
individuals involved should ensure that they are avoid getting into situations where they could
have conflicts of interests. Local authorities can help to avoid difficulties for decision makers, by
ensuring that there is separation of functions. Persons who are involved in managing a company
should not be involved in taking decisions on behalf of the LA about the company.

There could also be a risk of decisions being affected or appearing to be affected by

predetermination if members and officers are involved in decisions relating to companies in
which they have roles. If a decision maker gives too much focus on aspects of a decision that
are of particular interest to a company, they might not take account of all relevant matters and
so might not make a reasonable decision. If a decision maker has given an indication of how
they think that a decision might affect a company and their view-on that, this might lead to a
perception that they have predetermined the decision. The LA needs to address these risks by
ensuring that decision makers have all information relevant to a decision and know the
importance of considering it and by ensuring that the records of decisions and reasons for them
clearly show that decision makers considered everything relevant when they made their
decision.

Members and officers also need to be clear about the context in which they receive information
and the consequences this will have for their access to and use of the information.

It would generally be expected that an LA would be transparent about the information that it
holds. LA meetings and documents relating to those meetings are usually expected to be open
to members of the public. However, there are exceptions when meetings and documents involve
discussion of information which is confidential or exempt from public access. People have rights
to request information from local authorities and to inspect the accounts of LAs. These rights are
also subject to exceptions which allow local authorities to withhold access to confidential
information. If any such exceptions apply, it is important that they are observed and that decision
makers do not give exempt information to people simply because they are involved in an LA’s
companies. If a member or officer has been given information because that is necessary to
enable them to discharge their functions as a member or officer, it is important that they should
use it for that purpose only and not make it available to others, such as persons who may be
involved in an LA company in which the relevant member or officer is involved.

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End of Document

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