Understanding Directors’ Duties: A Guide for Entrepreneurs

Starting and growing a business is exciting, but becoming a director carries responsibilities that many entrepreneurs do not fully appreciate. While directors often focus on strategy and growth, they are also subject to a range of legal duties which, if overlooked, can expose them to personal liability.

Whether you are launching a new business, joining a family company or sitting on the board of an established business, understanding your duties as a director is an essential part of protecting both the company and yourself.

What are directors' duties? 

Directors owe a number of statutory duties to the company under the Companies Act 2006. These duties largely reflect long-established principles of English law and are designed to ensure that directors act responsibly and in the best interests of the company (and in some circumstances its creditors).

The principal duties require directors to:

• act within the powers given to them by the company's constitution;
• promote the success of the company;
• exercise independent judgment;
• exercise reasonable care, skill and diligence;
• avoid conflicts of interest;
• not accept benefits from third parties because of their position as a director; and
• declare any interest in proposed or existing transactions involving the company.

These duties apply to all directors, irrespective of whether they are founders, executive directors, non-executive directors or family members sitting on the board. They also apply to those who act as directors without being formally appointed.  

Acting in the company’s best interests and exercising independent judgment

Two of the most important duties are the obligations to act within the company's powers and to promote the success of the company.

In practice, this means complying with the company's articles of association and any restrictions on board decision-making, whilst ensuring that decisions are taken for the benefit of the company as a whole rather than for personal reasons.

Promoting the success of the company does not simply mean maximising short-term profit. Directors are expected to consider wider factors, including the likely long-term consequences of decisions, the interests of employees, relationships with customers and suppliers, the company's reputation and the need to act fairly between shareholders.

For founder-led businesses, this can be particularly important. While the interests of a founder and the company will often align, they are not always the same. Directors must be careful to distinguish between what benefits them personally and what is genuinely in the best interests of the company. This is perhaps most obvious in relation to founder pay. Similar issues can arise where a founder resists returning surplus funds to shareholders, or where contracts with management-connected parties are not on arm’s length terms.  

Directors must also exercise their own independent judgment. While shareholders, investors and fellow board members may express strong views, directors cannot simply follow instructions without considering the matter for themselves.

Understanding conflicts of interest

Conflicts of interest are one of the most common challenges faced by directors and can arise in many different situations, including where:

• a director wishing to buy an asset from the company;
• a director holding an interest in a supplier, customer or competitor;
• a director participating in a transaction involving a family member or connected party; or
• a founder pursuing another business opportunity which overlaps with the company's activities.

A conflict does not necessarily prevent a transaction from proceeding. However, it must be identified and managed appropriately. Depending on the circumstances, the company's articles, the board or the shareholders may be able to authorise the conflict, provided the relevant procedures are followed.

Directors should also remember that they must not accept benefits from third parties by reason of their position as a director where doing so could give rise to a conflict of interest.

Failing to identify and disclose a conflict can result in decisions being challenged and may expose the director to personal liability.

When can directors be personally liable?

Many entrepreneurs assume that operating through a limited company provides complete protection from personal liability. While incorporation offers significant protection, directors can still be personally liable in certain circumstances.

For example, a director may face claims for breach of duty where the company has suffered loss as a result of their actions. In some situations, shareholders may also seek permission from the court to bring a claim on behalf of the company and transactions can be unwound. Serious misconduct can result in a director being disqualified from acting as a director in the future.

Directors are particularly at risk where a company is in financial difficulties. Where a company is insolvent, bordering on insolvency or insolvency is probable, directors have a duty to the creditors of the company. A director can also be required to personally make a contribution to the company’s assets where they commit ‘wrongful trading’ or ‘fraudulent trading’. Wrongful trading involves carrying on trading where the director knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvency. Fraudulent trading involves carrying on a business with the intent to defraud creditors (or for another fraudulent purpose).  

These risks are often greatest in owner-managed and family businesses, where decision-making can become informal and governance procedures are not always followed as closely as they should be.

Practical steps to protect yourself

Most directors can reduce their exposure significantly by adopting sensible governance practices. In particular, directors should:

• maintain clear records of important decisions, including board minutes, to record why particular decisions were made;
• identify and disclose potential conflicts at an early stage;
• understand the company's articles of association and any shareholders' agreement;  
• consider taking out directors and officers insurance; and
• seek professional advice where appropriate (particularly if there is any risk of insolvency).  

Good governance is not simply about compliance. It can also help businesses make better decisions, avoid disputes and create a stronger foundation for long-term growth.