Becoming an SME (Small and Medium-sized Enterprise) in today’s world can be incredibly exciting! The idea of starting a business and watching it blossom into something successful, knowing you’ve curated the business you want is fulfilling. But with success comes great responsibility.
Why Directors duties matter
One of the most important yet often overlooked responsibilities when operating as a UK limited company, is understanding directors’ duties. While the term might sound like a corporate “buzzword”, it is far from it. Running a small or medium-sized enterprise at times can be overwhelming particularly having to wear so many different hats -which is generally the life of an SME business owner, and so understanding your directors’ duties is crucial to running a healthy and sustainable business.
Whether you’re an individual business owner or a team of directors, once you step into the role of directorship you owe legal and fiduciary duties to your company which are set out in law under the Companies Act 2006.
The 7 general (formally referred to as statutory duties) duties of a director
- Duty to act within powers: a director must act in accordance with its company’s constitution and governance documents and only exercise powers for the purposes for which they are conferred.
- Duty to promote the success of the company: a director must act in a 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, but they are also obliged to pay attention to the interests of the company’s employees, the need to foster business relations, the long-term consequences of the company’s actions, the impact on the community and the environment, the desirability for maintaining a reputation for high standards and in certain circumstances the interests of its creditors.
- Duty to exercise independent judgment: a director must make decisions independently, without subordinating their powers or being influenced by others.
- Duty to exercise reasonable care, skill, and diligence: a director must perform their role to the standard of a reasonably diligent person with the same level of skill and knowledge of that expected from the role.
- Duty to avoid conflicts of interest: a director must not place themselves in a position where there is a conflict between the duties they owe to the company, and either their personal interest or third-party interests (unless the company consents).
- Duty to declare interest in a proposed transaction: a director must declare to the board if they have any personal interest in a company transaction.
- Duty not to accept benefits from third parties: a director must not accept gifts or personal benefits that could compromise their impartiality.
In addition to the above:
- The duty to promote the success of the company is subject to any enactment or rule of law which requires directors to consider or act in the interests of its creditors (“creditor duty”) which is important to consider in the context of insolvency. If a company becomes insolvent a director has a fiduciary duty to act in the best interest of its creditors.
- Directors have other administrative statutory duties to the company such as the obligation to keep the statutory books updated and to file accounts and annual returns. A company’s constitutional document can go further to extend certain obligations and also modify certain rules, therefore it is important that a director understands these and how they influence their duties.
What is the impact of not complying?
- Legal: directors can be held personally liable and despite being a small company and even under resourced this is no exception. Unlike larger corporates, SMEs most likely do not have dedicated departments such as HR, legal, or compliance to prevent poor decision-making, making it even more critical for the business owner to be mindful of their legal responsibilities.
- Growth: director’s fiduciary duties to the company are fundamental to ensuring that the company operates properly. Investors and banks will want assurance that their investments are being managed with good governance that contribute to long-term success.
- Reputation: upholding directors duties sets a standard to its employees, clients and stakeholders which demonstrates that the business is reliable, trustworthy and a company that carries out its business with ethical decision-making.
Consequences for breaching?
- Personal liability: a director could be held personally liable for any losses suffered by the company.
- Disqualification: a breach could result in a director being disqualified from acting.
- Criminal charges: a breach involving fraud, dishonesty, or trading while insolvent could lead to a director facing criminal prosecution.
- Reputational damage: a breach could damage a director’s professional reputation and the company reputation that they have spent time to build.
Can you be protected against liability?
Generally, there is no exemption for a director from liability for negligence, default, breach of duty or breach of trust in relation to the company, neither can a director be indemnified for such claims. Insurance on the other hand is permitted to be taken out to help cover legal costs and potential damages arising from certain claims related to their role.
What can you do now?
It is important for directors to have a clear understanding of their roles and responsibilities as this is fundamental to the operation and longevity of a company. Typically, directors of SME’s are often the key decision makers and do not have the large corporate structure to mitigate poor decision-making, therefore making it essential that directors have a thorough understanding of their duties.
A good starting point is understanding the company’s constitutional documents, including the articles of association, and being fully aware of both legal and financial obligations. Additionally, maintaining detailed records of decision-making including board meetings and resolutions, helps demonstrate governance practices and provides accountability. Directors must also ensure that personal and company interests remain separate, maintaining transparency at all times. In areas of uncertainty we would always recommend seeking legal advice.
