Legal guide for company directors and CEOs in the UK

Yes – as part of their overriding duty to promote the success of the company, directors must have regard to a number of “stakeholder factors”, including the following:

• Likely consequences of any decision in the long term
• Interests of the company’s employees
• Impact of the company’s operations on the community and the environment.

These factors therefore directly reference the environment and the welfare of employees, but the requirement to consider the long-term consequences of decisions means that matters of sustainability, and the long-term success of the company, should be at the forefront of directors’ minds.

ESG issues are attracting increasing attention and as a result, there is greater pressure on directors to prioritise those considerations when discharging their duties. This has been given additional impetus by the UK’s role as host for the 26^th United Nations Climate Change Conference (COP26) to be held in Glasgow in November 2021.

Besides their general directors’ duties, there are a multitude of other laws and regulations applicable to companies and their directors which relate to ESG considerations. These include direct obligations such as health and safety legislation, requiring companies and their directors to ensure that the company is operating safe working practices, and anti-bribery legislation imposing potential criminal penalties on companies and their directors if they employ bribery or corruption in the operation of the business. There are also reporting obligations as noted below which seek to promote high standards of ESG compliance by making information regarding the company’s performance available to stakeholders. These legal obligations are supported by an increasing number of corporate governance requirements, particularly for listed companies. For example, the UK Corporate Governance Code sets out best practice for companies in respect of corporate governance and protecting shareholder interests, and includes ESG requirements such as an emphasis on diversity in the composition of the board. There are also industry-specific obligations for certain classes of company such as financial market participants and energy companies.

There has been no recent change with respect to the general duties of directors, as these already encompass ESG considerations to the extent that those considerations are relevant to the long-term success and sustainability of UK companies. However, there is a continuing trend to introduce specific obligations with respect to ESG matters. For example, UK premium listed companies are currently required to report on climate-related matters on a “comply or explain” basis by reference to the framework promulgated by the Task Force on Climate-related Financial Disclosures (TCFD). The UK’s Financial Conduct Authority has indicated that it expects to extend these obligations to all UK-listed companies in the near future, and is consulting on a requirement to make reporting mandatory by removing the option to “explain” any non-compliance. As the UK focuses on trying to meet its stated commitments to reduce carbon emissions, we can expect a range of further rules and regulations which are designed to change the behaviour of private sector companies. These will create an additional burden for directors who are responsible for ensuring ESG compliance.

The disclosure and reporting obligations for directors in relation to ESG matters will vary according to the size and nature of the company. Some of the key obligations currently in place are as follows:

• Most UK companies are required to prepare a strategic report as part of their annual report and accounts, which broadly focuses on the disclosure of future strategy for the company and the key risks that it faces. For quoted companies, the strategic report must include information on environmental matters and policies, including the impact of the company’s business on the environment; employees; and social, community and human rights issues. In addition, for companies which are traded companies, as well as banks and insurance companies with more than 500 employees, the strategic report must contain information on environmental, employee, social, human rights, anti-corruption and anti-bribery matters. This includes details on the company’s business model, policies in relation to these matters and their outcomes; due diligence processes; the principal risks and impacts of the company’s business on such matters and how they are managed.
• In addition, unless the company qualifies as a small- or medium-sized company, the strategic report must include a stand-alone “Section 172 Statement” which describes how the directors had regard to certain matters when carrying out their duty to promote the success of the company. This therefore requires companies to be open and transparent about their decision-making, with particular reference to the ESG stakeholder factors noted above.
• Companies with 250 or more employees must publish specific figures about their gender pay gap. In addition, listed companies with over 250 employees must also publish pay ratio information, comparing the pay of their CEO to the median, lower quartile and upper quartile pay of their UK employees.
• A company with a turnover exceeding GBP 36 million must publish a modern slavery statement, describing the actions it has taken to deal with slavery and human trafficking risks in its supply chain as well as in its own activities.
• Larger companies must disclose information on their carbon emissions and energy efficiency in their annual directors’ report. They must also include information in that report on how the directors have engaged with employees, and how they have had regard to the interests of employees and the interests of the company’s suppliers and customers during the relevant year.

In the UK, companies have a single board, rather than a separate management board and supervisory board.

The board of a UK company may comprise both executive directors and non-executive directors. This guide concentrates on the rules applicable to executive directors; that is, directors who have an executive role within the company. However, in general, the law does not distinguish between executive and non-executive directors. Consequently much of the information in this guide will apply equally to non-executive (or supervisory) directors.

There are few restrictions on who can become a director. In particular (unless the company’s constitution requires it):

• an individual director is not required to be resident in the UK, and there is no nationality requirement (although for tax purposes, some companies may include a provision in their constitution as to the residency status of some or all of the directors);
• a company need not have more than one director. Whilst a sole director may also be a company secretary, the same individual cannot purport to act as both director and secretary at the same time/in relation to the same function. A private company need not have a company secretary;
• a director may be appointed to the board of more than one company (however they will owe the same general duties to each company and will need to observe the conflict rule explained below);
• a director does not need to be an employee of the company; and
• a director does not need to hold any shares in the company.

At present another company - whether incorporated in the UK or elsewhere - can be appointed as a director as long as at least one director is a natural person, but under new (but not yet implemented) legislation, corporate directors are to be banned except in certain (as yet unspecified) cases where their use is not considered to hinder transparency. No official announcement of an implementation date for this new legislation has been made, but it is expected that the government will implement the prohibition in the future.

A director is required to disclose personal details to the company to be kept on a register of directors, including his or her full name and previous names, nationality, date of birth, usual residential address and a service address (which may be the company’s registered office). This information will also appear on the public register at Companies House, with the exception of (i) the director’s residential address and (ii) the day (but not the month or year) of the director’s birth, which are protected from public disclosure.

It is necessary to distinguish between appointment as a director and appointment as an executive, since each is legally a separate matter. The method for appointment of a director is determined by the constitution (that is, the articles of association) of the company, and in some cases by a separate shareholders’ or investment agreement. However:

• a director can normally be appointed either by the existing directors, or by resolution of shareholders;
• in the case of a subsidiary, the parent is often permitted to make an appointment by written notice to the company;
• notification of the appointment, authenticated by the director, must be filed with Companies House within 14 days of the appointment. No fee is payable;
• the minimum number of directors is one (or such higher number as is prescribed by the articles of association;
• there is no maximum number of directors unless a maximum is prescribed by the articles of association.

Appointments are generally made on an open-ended basis, and not for a fixed term, as the term will be a function of the related contractual relationship. If desired, the articles of association can provide for fixed term appointments, with the option of reappointment at the end of the term.

Appointment as an executive director involves the creation of an additional contractual relationship. The forms which this can take are discussed below. This aspect of the appointment is normally a matter for the board.

Persons who have not been formally appointed but who in reality act as directors can be liable in the same way as directors who have been formally appointed. Also, persons in accordance with whose instructions or directions the board is accustomed to act can have certain obligations as “shadow directors”, especially if the company goes into insolvent liquidation. These obligations will include the general duties owed by directors (see below), where and to the extent they are capable of applying.

A director may resign his or her office at any time by notice to the company (although this may constitute a breach of his or her employment or consultancy contract). A director is always subject to removal by resolution of shareholders under a statutory procedure, which gives the director the right to protest. The articles of association (particularly in the case of a wholly-owned subsidiary) will often permit the parent company to remove a director by notice to the company, and will often provide that a director may be removed on the occurrence of certain events (such as in the event of bankruptcy, serious illness, or prohibition by law). It is unusual for directors to be able to remove one of their number from the board, although the board may resolve to terminate the director’s service contract, termination of which may require the director’s immediate resignation. If directors are appointed for a fixed term, or are required to seek reappointment periodically, their appointment will terminate if they are not reappointed at the relevant time. The resignation or removal of a director must be notified to Companies House within 14 days of the cessation of their appointment.

As an internal matter, unless approved by the board (for example, by the delegation of powers to a managing director, or by the passing of a specific resolution), no director is entitled to commit or act on behalf of the company. In practice, directors are usually granted a level of delegated authority consistent with their role in the company. In particular, a managing director will have certain powers delegated to him or her by the board - sometimes these powers are almost as wide as those of the board itself. No separate filing is necessary in connection with the appointment of a managing director.

As regards third parties, a director will be regarded as having ostensible authority to bind the company, even if he or she has no actual authority to do so.

Consequently, a director acting without proper authority (and therefore in breach of his or her duties) may nevertheless cause the company to become liable to a third party, but not if the third party knows that the director is not authorised.

Generally, a company is permitted considerable flexibility regarding the operation of the board. All directors must be given notice of each meeting, although there are no specific requirements as to the form this should take, unless the company chooses to prescribe rules in its articles. Some companies’ articles provide that notice need not be given to a director who is out of the country. This will often be inappropriate and can be changed. It is generally accepted that (unless prohibited by the articles) a board meeting may take place electronically such as by telephone or video link.

The articles usually permit the board to delegate most of its powers to committees, which may include non-directors. Typically such delegation is for specific purposes - for example, to allow the efficient handling of a crisis or a specific M&A transaction.

The articles of association often allow directors to appoint alternates - that is, a person (including, but not necessarily, another director) who can act as a director in the appointor’s absence. The alternate is regarded as a fully-fledged director (and, for example, is subject to the same disclosure requirements as a director and while acting as alternate owes the same duties to the company as a director does).

Appointment as a director does not of itself constitute a contract with the company. The articles of association will generally entitle a director to remuneration on terms agreed by the board and to reimbursement of expenses. An executive director will also have a contractual relationship with the company:

• as an employee under a service agreement, or as a consultant providing services under a consultancy agreement; or
• through a company or firm which contracts with the company to provide the director’s services.

The tax treatment of these options is different in each case. Broadly, shareholder approval is required if the agreement gives the director a guaranteed term of more than two years (unless the company is wholly owned by another corporation). Termination of any such contract will not automatically terminate the directorship (although the contract may require that the director resigns in such circumstances). Termination of the directorship may constitute a breach of the related agreement.

It is important that directors realise - especially if they have other business interests - that it is not a simple matter to shift between roles and to treat themselves as free of their duties when not “wearing their director hat”. The Companies Act 2006 imposes duties relating to conflicts of interest: to avoid actual or potential conflicts of interest (especially in relation to the exploitation of property, information or opportunities that come to them by virtue of their role); not to accept benefits from third parties; and to declare any interest in a transaction or arrangement that the company proposes to enter into. A director must also declare his or her interest in an existing transaction or arrangement of the company, if not declared before it was entered into. As a rule, no breach will occur where the conflict is authorised by non-conflicted directors or by shareholders, or the relevant interest is appropriately declared, but the authorisation or the articles of association may impose restrictions that prevent the conflicted director from taking part in decision-making as regards the matter giving rise to the conflict.

In addition to the duties of directors in regards to conflicts of interest, the Companies Act 2006 imposes a number of other general duties on directors: to act within their powers; to promote the success of the company; to exercise independent judgement; and to exercise reasonable care, skill and diligence. Of these, the duty to promote the success of the company is usually seen as the most fundamental. It requires a director to act in the way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so to have regard (amongst 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; and
• the need to act fairly as between members of the company.

Directors are also subject to a wide range of statutory duties (for example, health and safety) and specific duties under the Companies Act 2006 (such as the duty to keep accounting records). There are also restrictions on certain dealings between the company and its directors (and persons connected with them), such as sale and purchase transactions, and loans to directors.

The director’s duties are owed to the company itself, rather than to its shareholders. In practice, when the company is solvent, this means acting in the best interests of the shareholders as a whole.

Where a company is threatened with insolvency, the directors will need to give increased attention to the interests of creditors. In particular, once the directors know (or ought to know) that the company is likely to become insolvent, they must consider the interests of the creditors as paramount and take those interests into account when carrying out their duties to the company. The liquidator of an insolvent company has the power to review the conduct of the directors in the period leading up to the insolvency. Under s214 Insolvency Act 1986, a director of a company in insolvent liquidation may be ordered to make a contribution to the company’s assets if, at a time prior to the winding up of the company, they knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation or insolvent administration. This is known as “wrongful trading”. A director may have a defence against a claim for wrongful trading if they took every step with a view to minimising losses for creditors.

A liquidator may also bring an action against the directors of an insolvent company in respect of fraudulent trading, misfeasance or breach of fiduciary duty, and therefore directors of a company in financial difficulties should be mindful of these potential risks.

As soon as the directors are aware that a company is in financial difficulty, they should seek external advice.

Directors owe their duties to the company and are therefore potentially liable to the company itself in respect of any breach of those duties. However, directors will not generally incur direct liability to individual shareholders. Most of the general duties under the Companies Act 2006 are fiduciary duties and as a result a director in breach may be liable to compensate or account to the company without the company having to prove a loss. As well as being liable to fines and other penalties for breaches of various statutory duties and offences (for example, under the Bribery Act 2010), directors can also be personally liable to the company in other ways, such as for making unlawful distributions of the company’s assets. It is also possible for directors to assume personal liability to third parties if the circumstances show that they held themselves out as doing so, or if they led the third party to believe that they had authority to act on the company’s behalf when in fact they did not.

As described above, the directors of a company which is threatened with insolvency must take the interests of creditors into account when carrying out their duties to the company. The key areas of liability of the directors of an insolvent company include:

• wrongful trading: if the company goes into insolvent liquidation, the directors can be ordered to contribute to the company’s assets where losses are increased as a result of their failure to stop the company from trading when there was no reasonable prospect of it avoiding the liquidation;
• fraudulent trading: if the directors carry on the business of the company with the intention to defraud creditors (including potential creditors) of the company or creditors of any other person or for any fraudulent purpose will be personally liable to contribute to the company’s assets. This could include payment of a dividend if the motive is to put those funds beyond the reach of creditors;
• misfeasance: a liquidator, a creditor or a shareholder can recover money or damages from the directors of a company who have misapplied, retained or become liable or accountable for any money or property of the company, or have been guilty of misfeasance or breach of fiduciary or other duties in relation to the company.

A disqualification order may be made by the court against a director (or shadow director) of a company that becomes insolvent, if the director’s conduct as a director makes them unfit to be concerned in the management of a company. A disqualified director shall not, without leave of the court, be a director of a company or in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of a company for a specified period beginning with the date of the order.

There is a statutory regime for derivative claims, enabling members, subject to the court’s permission, to require action to be brought on behalf of the company against directors who are or have been in breach of their duties or have been negligent. In the case of private limited companies, the main threat of legal action against directors for breach of duty is likely to emerge only in the event of the company’s insolvency.

Companies may grant indemnities to their directors in respect of certain third party liabilities. The articles of association need to be checked to see whether there are any restrictions on the granting of such indemnities.

If permitted by the articles (and subject to directors’ general duties), companies may agree to indemnify a director in respect of liabilities (such as damages, costs and interest) in a civil action by a third party (i.e. not the company itself or a UK company in the same group) and also in respect of defence costs as the action proceeds, even if judgment is given against that director. However, the company cannot indemnify a director for his or her liability to the company itself where judgment is given against the director. Although a company may agree to lend funds to a director for defending a claim by the company itself or any criminal proceedings, the loan must be repayable immediately if judgment is given against the director or he or she is convicted. Directors cannot be indemnified for any fine in criminal proceedings or any penalty imposed by a regulator, or any costs incurred in defending criminal proceedings where the director is convicted.

A company is permitted to purchase directors’ and officers’ insurance on behalf of its directors, and it is usual for such insurance to be put in place. In addition, a parent company may be able to provide a more extensive indemnity to the director than the company itself.

Solvency

The highest priority is to address the short- and long-term financial sustainability of the company. This will require a careful assessment of projected cash flow solvency as well as balance sheet solvency. Directors must ensure that they have up-to-date management information on which to base their decisions, together with a firm grasp on how the company’s markets and prospects are likely to be affected by the crisis. Uncertainty over the timetable for exit from current lockdown rules, and the speed of economic recovery, means that directors will have to plan for a variety of different scenarios, and develop alternative plans that can be implemented as necessary, particularly if the worst case outcomes seem likely. Directors of companies threatened with insolvency should (i) seek specialist advice, both legal and financial, (ii) ensure that all directors and key stakeholders are kept informed and onside, and (iii) keep a clear record of their decision-making, and the materials available to them to review. Where the company is part of a wider group, the directors must keep in mind that they owe their duties to the company itself and not to the wider group or the parent company.

Risk

Even if the company’s solvency is not in question, directors are likely to be faced with a number of difficult decisions as they develop their strategy for the company. For example, the need to ensure safe working conditions for staff will often conflict with purely commercial objectives. Consumer-facing companies will also have to manage new reputational issues as public expectations of those companies shift as a result of the crisis, and ensure their communication strategy is adequately prioritised. Directors need to find a way to balance these competing considerations, in the long-term interest of the company.

Logistics

Directors should address the logistical challenges which international lockdown rules and social distancing create. Existing operations including supply and distribution chains, and internal processes such as accounting, reporting and HR management, will be disrupted. During the crisis, it may be difficult for directors to hold meetings in the normal way. There is no restriction under UK law on holding virtual meetings (although the company’s constitution should be checked). Care should be taken to ensure that changes to decision-making processes do not adversely affect the company’s tax residence – see our CMS publication on this topic. Methods of communication with shareholders should be reviewed, and consideration given to any upcoming shareholder meetings, or any required shareholder authorisations. Many shareholder authorisations may be obtained by written resolutions, and communications to shareholders can be sent electronically (subject to any prohibitions in the company’s constitution).

In considering the issues noted above, directors need to be aware of the measures that have been announced by government authorities to assist companies through the crisis, and determine which ones are relevant to the company.

In the UK, the most relevant measures for companies include:

• emergency finance facilities for SME and large businesses;
• an extension of three (3) months to the deadline for filing accounts at Companies House;
• the Coronavirus Job Retention Scheme;
• assistance for businesses to pay statutory sick pay;
• deferment of VAT tax payments;
• business rates relief for the retail, hospitality and leisure sector; and
• relaxation of “wrongful trading” legislation, which is helpful in reducing the risk of personal liability for directors as a result of the crisis (see further below).

These relief measures are covered in more detail in other CMS publications (see our COVID-19 page). More generally, directors’ duties remain as before, as set out in the rest of this guide. The key duty is to promote the success of the company for the benefit of its members as a whole, and that should be the guiding principle for all actions taken by directors.

The UK Government announced on 28 March 2020 that it would temporarily suspend the “wrongful trading” rules, to remove the threat of directors incurring personal liability during the COVID-19 pandemic. The change in law (which has not yet been formally implemented in legislation), will apply retrospectively from 1 March 2020. It is not yet known if the wrongful trading suspension will be an absolute suspension (as if s214 of the Insolvency Act 1986 was not in force at all for the relevant period) or if it will simply exclude liability for a director who misjudges the effects of COVID-19. For further information, please see our CMS publication on this topic.

All other checks and balances to ensure directors continue to fulfil their legal duties and obligations will remain in place.

The Financial Reporting Council has released guidance for companies on corporate governance and reporting during the COVID-19 pandemic, which can be viewed here. The key messages from the FRC to companies regarding corporate governance at this time are:

• develop and implement mitigating actions and processes to ensure that directors continue to operate an effective control environment, addressing key reporting and other controls on which directors have placed reliance historically but which may not prove effective in the current circumstances;
• consider how directors will secure reliable and relevant information, on a continuing basis, in order to manage the future operations, including the flow of financial information from significant subsidiary, joint venture and associate entities; and
• pay attention to capital maintenance, ensuring that sufficient reserves are available when any dividend is paid, not just when it is proposed; and that the company will retain sufficient resources to meet its needs.