What is the meaning of fiduciary duties for company directors?

If you’ve recently become a company director for the first time, understanding what’s expected of you can feel overwhelming – particularly when legal terms like “fiduciary duty” come up.

When you become a director, you take on numerous responsibilities. Those responsibilities include ‘fiduciary’ duties, owed directly to the company. There are very few other areas in life where we use the term ‘fiduciary,’ so it’s not necessarily intuitive to know what it means when you become a director for the first time.

In this guide, we’ll break down what your fiduciary duties are, how to stay compliant, and what happens if a duty is breached.

What does ‘fiduciary duty’ mean?

‘Fiduciary’ literally means ‘loyalty’ or ‘trust’. A fiduciary duty arises in relationships where trust is paramount. For example, solicitors owe fiduciary duties to their clients, trustees owe fiduciary duties to the beneficiary of a trust, and directors owe fiduciary duties to the company.

In any situation, the fiduciary is generally expected to put the interests of the principal first, ahead of their own. For directors, that means putting the company’s interests ahead of their personal interests.

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What are fiduciary duties for company directors?

Fiduciary duties for company directors set out how you are supposed to act as a director of a company, to take care of the company and its shareholders. They are more than just guidelines; they are legal responsibilities. The overarching obligation is to act in good faith and in the best interests of the company. These duties apply equally to sole directors and board-run companies. Even if you are the sole director of your company, you must still be able to demonstrate compliance.

Fiduciary duties are unusual because they include some negative duties. In other words, they prohibit certain conduct. The duties are designed to deter abuse of the director’s position for your own benefit.

The core fiduciary duties directors must follow

There is no definitive, exhaustive list of fiduciary duties. That’s because the duties have been developed through various cases in the courts, and now some duties have been put into statute in the Companies Act 2006. See particularly sections 171 – 177 of the Companies Act 2006. Which set out the general duties of directors as:

• The duty to act within your powers
  • That is to say that you must act within your powers under the company’s constitution, i.e. the memorandum and articles of association.
• The duty to promote the success of the company
• The duty to exercise independent judgment
  • This includes refusing benefits from third parties
• The duty to exercise reasonable care, skill and diligence
• The duty to avoid conflicts of interest
• The duty not to accept benefits from third parties
• The duty to declare an interest in a proposed transaction or arrangement

Other duties arising out of common law include:

• The duty of confidentiality
• The duty to act in good faith
• Continuing duties after resignation

So, what does that look like in practice, in the day-to-day running of your business?

Real-world examples of fiduciary duties in action

These are a few scenarios in which you should be thinking specifically about your fiduciary duties as a director:

Business transactions

Your company will enter transactions frequently. You might be buying equipment for the business. Or at some point, you might expand and purchase another business altogether.

Directors cannot benefit personally from the company’s transactions without specific consent from the company. For example, if you’re a director of the company that your current business wants to purchase, you would stand to profit from the transaction. You would have to disclose your interest in the target company before the transaction begins. You’d also require authorisation from the other directors or the shareholders before the transaction could proceed.

Selling property

Your company may own property in its own right. As a director, you normally can’t authorise the sale of company-owned property to another company if you’re also a director of the purchaser company. That’s because you stand to profit from being on both sides of the transaction.

Accepting gifts from clients

Gifts and hospitality are often part and parcel of good business relationships. You can accept gifts from clients, but you must give proper disclosure that you have received the gift, and a rough estimate of its value. You can record this in a Gifts and Hospitality register and declare it at the next board meeting.

The Bribery Act 2010 makes it clear that gifts are allowed, so long as they are reasonable and proportionate and not intended to influence business decisions. Having a robust Gifts and Hospitality policy can protect you from overstepping the line on this.

When the duty shifts from the company to the creditors

It’s worth noting that your duties as directors can change. Most of the time, your duties are owed to the company. However, if the company gets into financial trouble, and it looks as though it may enter insolvency, the directors’ duties shift to prioritising the company’s creditors. Your duties to the company continue, but your duties to the creditors take precedence.

In that situation, you need to act in the best interests of the creditors, not just the best interests of the company.

What happens if a director breaches their fiduciary duties?

There can be legal consequences if you’re found to be in breach of your fiduciary duties. You could face a claim brought by the shareholders on behalf of the company (a derivative claim). In the most serious breaches, you could face disqualification proceedings.

However, in many cases, an alleged breach can be resolved by discussing it with the shareholders or by taking steps to remedy the issue. Whether or not this is possible depends on the specific circumstances of the issue. If it has come to light that you profited from a transaction, you may be able to rectify that by paying back the money.

The key message is not to panic. In the day-to-day running of a business, it’s not always clear which decision is in the company’s best interests. Shareholders and/or investors often have a different point of view on that than the directors. There may be times when shareholders allege a breach of duty or governance issues, and you may disagree.

You can try to resolve these issues with a sensible discussion. If it appears that a conversation won’t resolve the issues, it’s worth getting a lawyer’s perspective.

Defences to a breach of fiduciary duty

If you act dishonestly and intentionally breach your fiduciary duties as a director, then there are no real defences. But where an honest director finds themself in breach of their fiduciary duties, there are some legal defences available:

Consent from the company

If you informed the company of a potentially conflicting interest, and the company consented to the action, then you should not typically be accused of being in breach.

You should inform the company at a board meeting and at shareholders’ meetings, and the disclosure should be recorded in the minutes. You must be fully transparent about how much you expect to gain from the transaction.

Honest and reasonable behaviour

If you can show that you acted honestly and reasonably, you may not be liable for a breach, or at the very least, your liability may be limited. The court has the power to grant relief to a director who has acted honestly and reasonably under section 1157 of the Companies Act 2006.

In a court of law, a judge will look at the processes you have in place to ensure compliance. Were conflicts declared? Did you seek advice for an action that was high-risk? Are decisions recorded in board papers?

If you have this sort of good governance in place, you have a better defence to allegations of breach of duty.

How to manage fiduciary responsibilities as a director

Complying with your fiduciary duties as a director is largely about acting honestly, being diligent with your records and processes, and running the business well. Here are a few practical ways to do that:

• Draft comprehensive board minutes that specifically state that you considered the best interests of the company when you made decisions.
• Record your reasoning for decisions in board papers. Reference your fiduciary duties in the reasoning.
• Disclose any information that could be perceived as a conflict of interest, however small.
• Have your duties in mind whenever you make decisions on behalf of the company.
• Familiarise yourself with your powers under the articles of association and ensure you know their limits.
• Make sure the business is compliant with legislation, particularly Health & Safety legislation, data protection laws, anti-bribery and anti-corruption laws.
• Purchase Directors & Officers insurance, which will insure you for legal action arising out of any allegations of breach of fiduciary duty.

Stay compliant as a new company director

Fiduciary duties might sound complex, but they mostly come down to acting with honesty, transparency, and good judgment.

If you’re a new director or planning to form a company, getting set up on the right terms helps you stay compliant from day one. At 1st Formations, we’ve helped over one million new UK businesses start with confidence and stay compliant as they navigate running a business.