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There is a commonly-held belief that only directors of large (listed) companies are liable under the Companies Act, and that directors of smaller companies are therefore not at risk.

This is simply not true!

Directors (in the broad sense – see below), of companies of all sizes can be held liable, and those of smaller companies are in many ways more likely to face consequences of their actions as they can ill-afford the potential legal fees to defend themselves, whereas directors of large companies have much greater resources at their disposal.

For the past decade, the duties of directors have been clearly defined in both common law and the Companies Act and increasing scrutiny and activism by various stakeholders – direct and indirect – is opening the way to greater risk for directors.

It’s important to recognise that directors can be held liable not just for their own actions, but those of other directors, too. Furthermore, this covers executive and non-executive directors, alternate directors, divisional directors, board committee members and prescribed officers (those officers of the company having executive control over a significant part of the business).

For the purposes of ease of reference, I will refer to all these categories as directors for the remainder of the article.

And in terms of the Act, penalties for directors who breach their duties can be severe, and include:

  • Being held liable for any loss, damages or costs sustained by the company and, by extension, any stakeholder in connection with the company. The old limitation of share capital no longer applies – directors have, in effect, unlimited liability here.
  • Having a fine, or jail sentence of up to 10 years imposed.
  • Being declared a delinquent director – in effect prohibiting them from acting as a director – or being placed under probation, thus severely limiting their ability to act.

And, of course, any criminal penalties that might be imposed, such as for fraud or reckless conduct in connection with the company, which would further prevent their ability to serve as a director.

It’s worth noting, too, that the effect of the unlimited financial liability can result in bankruptcy of the director(s) involved which would automatically prohibit them from acting as a director until fully rehabilitated.

The bottom line here is that a director can lose their ability to work in any senior capacity as a result of breaching their duties.

So what are these duties?

Common law requires that directors exercise care, skill and diligence, act in the best interests of the company, within the powers granted them and for proper purpose, avoid conflicts of interest and making personal profits at the potential expense of the company, and to exercise independent judgement in all matters related to the company.

The Companies Act sections 75 through 77 codify and extend these common law duties of directors, ensuring the interests of the company come first and personal interests are subordinate to this. They are outlined here:  

  1. To act in good faith and for proper purpose;
  2. In the best interests of the company; and
  3. With the degree of care, skill and diligence that may reasonably be expected of a person:
    • Carrying out the same functions in relation to the company as those carried out by the directors; and
    • Having the general knowledge, skill and experience of that director.
  4. To not use their position, or information obtained when acting in that capacity, to gain an advantage for themselves or any other person other than the company or a wholly-owned subsidiary of the company;
  5. To not knowingly cause harm to the company or its subsidiary/ies;
  6. To inform the board at the earliest practicable opportunity of any material information (unless bound by legal or ethical confidentiality);
  7. To disclose to the board any personal financial interest (or that of a related party) in any matter to be considered by the board or which might otherwise affect the company.

It is clear, therefore, that being a director is something to be taken seriously, that care must be taken in decision-making, and directors must put the interests of the company above their own, personal ones and may not – as was often the case in the past – utilise the assets of the company (whether physical or intellectual) for their own ends.

 

#BusinessFitness #Boards #CEO #Governance #NED #Risk #SmallBusiness

 

Some of my recent posts that might assist with further input on board issues include: