Preserving Corporate Integrity: Limits and Safeguards on Directors’ Authority
Introduction
Company directors hold a pivotal role in steering corporate strategy and ensuring legal compliance. However, with this power comes a framework of statutory duties and legal checks and balances designed to prevent directors from acting beyond their authority and to ensure they act in the best interests of the company and its shareholders.
This framework is primarily codified in the Companies Act 2006, supported by common law principles and reinforced through judicial precedent. The Companies Act 2006 is the cornerstone of corporate governance in England and Wales. It codifies directors’ duties, many of which were previously governed by common law and equitable principles. These duties are set out in Sections 171 to 177 of the Act and apply to all directors, including executive, non-executive, de facto, and shadow directors.
Statutory Duties and Practical Interpretations
Directors have a duty to act within their authority, i.e. in accordance with the company’s constitution, and they should only exercise powers for their proper purpose. The constitution includes the articles of association, any shareholder agreements, and board resolutions. Breaching this duty can result in personal liability and the invalidation of decisions. In Howard Smith Ltd v Ampol Petroleum Ltd [1974], the Privy Council held that directors had acted beyond their powers by issuing shares to dilute a majority shareholder’s influence, demonstrating that powers must be exercised for a proper purpose.
Directors must also act in good faith to promote the success of the company for the benefit of its shareholders. This includes considering long-term consequences, employee interests, business relationships, community impact, and fairness amongst shareholders. In Regentcrest plc v Cohen [2001], the court emphasised that the directors’ subjective belief in promoting the company’s success must be honest and reasonable.
A further duty is to exercise independent judgment, meaning directors must not simply follow instructions from others unless legally required. They must apply their own judgment and avoid undue influence, but they must also exercise reasonable care, skill, and diligence. This duty is both objective and subjective, requiring directors to meet the standard expected of a reasonably diligent person with their knowledge and experience. In Dorchester Finance Ltd v Stebbing [1989], non-executive directors were found liable for failing to exercise sufficient oversight, which reinforced the principle that all directors must be actively engaged in a company’s governance and the promotion of its best interests.
Directors must avoid situations where their personal interests conflict with those of the company. This includes financial interests, relationships, and competing directorships. In IDC v Cooley [1972], a director was held liable for secretly securing a contract for personal gain that should have been pursued by the company. In the same way, they cannot accept gifts or benefits if they risk compromising their independence or creating a conflict of interest. Directors are also required to declare any personal interest in proposed company transactions to the board. Failure to do so can result in civil penalties and reputational damage.
Enforcement
The above statutory duties are enforced through a combination of internal governance mechanisms, such as articles of association and shareholder agreements; shareholder rights; and legal remedies. For example, if shareholders owning more than 50% of shares with voting rights wish to remove a director, they can do so by calling a special general meeting and passing a resolution to do so.
Shareholders can also bring claims for unfair prejudice if directors act in a way that harms their interests. This includes misuse of powers, exclusion from decision-making, or misappropriation of assets. They can also bring derivative claims against directors on behalf of the company for breaches of duty, but the evidence must be very compelling and the bringing of the action must be shown to be very clearly in the company’s best interests.
Directors who breach their duties may also be disqualified from holding directorships for up to 15 years under the Company Directors Disqualification Act 1986. Grounds include fraud, wrongful trading, persistent breaches of statutory obligations. In Re Barings plc (No 5) [1999], directors were disqualified for failing to supervise rogue trader Nick Leeson, leading to the collapse of Barings Bank, despite his activities being hard to understand, which demonstrated that the standards of diligence and supervision expected of directors are reasonably high.
Under Section 214 of the Insolvency Act 1986, directors can be held personally liable if a company goes into insolvent liquidation and they continued trading when they knew or ought to have known the company was insolvent. If there is evidence that this was done with the intention of defrauding creditors, they could be guilty of fraudulent trading under section 213.
Beyond legal enforcement, companies implement internal checks such as board committees to oversee specific areas, non-executive directors to provide independent oversight, company secretaries to ensure compliance with legal and procedural requirements, and external audits to verify financial integrity and detect misconduct.
Conclusion
The legal framework governing the conduct of directors is robust, combining statutory duties, judicial oversight, and internal governance mechanisms. The Companies Act 2006, supported by case law and enforcement tools, ensures that directors act within their authority and in the best interests of the company. These checks and balances are essential to maintaining corporate integrity, protecting stakeholders, and fostering trust in the business environment. By its very nature and breadth, however, the Companies Act 2006 can be somewhat daunting to someone less familiar with company law. Expert legal advice around its application and interpretation should therefore always be sought by anyone unsure as to their rights or risks as a director or shareholder of a company.
This article is intended for information purposes only and provides a general overview of the relevant legal topic. It does not constitute legal advice and should not be relied upon as such. While we strive for accuracy, the law is subject to change, and we cannot guarantee that the information is current or applicable to specific circumstances. Costigan King accepts no liability for any reliance placed on this material. For further details concerning the subject of the article or for specific advice, please contact a member of our team.
Archie Berens
Corporate Specialist
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