The Companies Act 2015, Part II: Director's General Duties - Greater Responsibility and Even Greater Liability?


The new Companies Act 2015 has gone to great lengths to usher in reforms particularly in the management of companies by clarifying the duties of directors, identifying actions to determine their unfitness for their role and penalties for the breach of their duties either by action or inaction on their part. A director now must not only grasp the new duties owed by a director under the Act but also comprehend the consequences of breaching these duties. 

Revamped Duties

The general duties enumerated below are not all together new, however, the law has now codified these duties previously found in judicial decisions. This has introduced new stakeholder interests to be considered by directors in discharging their duties and in doing so has widened the scope of director’s duties and conversely the personal liability to directors. 
 

Duty of a director to act within powers

This duty requires directors to act in accordance with the constitution of the company and to only exercise powers for the purposes for which they are conferred. In the event a director exceeds their powers, they must have their action ratified by shareholders or any agreement entered by them will be void constituting a breach of their duty and they are liable to be sued by shareholders to recover any loss as a consequence of their “illegal action”.

Duty to exercise reasonable care, skill and diligence

This is not a new duty. It requires that a director meet the standard of knowledge, skill and experience of a director in a similar role with the knowledge, skill and experience of the director in carrying out their functions. Therefore, directors hired for their specialist skills are required to perform to the standard expected of such a specialist. A failure to meet the reasonable standard and a director will be in breach of this duty and may face a suit on the grounds of negligence.

Duty to avoid conflict of interest 

The scope as to what constitutes conflict of interest is wide as it includes references to 1) a conflict of interest and duty; and 2) a conflict of duties. It also includes direct or indirect conflicts of interest, potential as well as actual conflicts of interest. This duty is not infringed if it cannot be reasonably regarded to give rise to a conflict of interest or the matter has been authorised by the other directors or ratified by the shareholders.

Duty to exercise independent judgement 

In exercising their powers, directors shall not allow their judgement to be impaired or compromised. They should upon evaluating the issues before them reach an independent decision; this however does not mean they cannot obtain advice.  A director is not in breach if the power exercised is beyond his role but is authorised by the constitution of the company or under an agreement that restricts the powers granted to the director.

Duty not to accept benefits from third parties

A director that contravenes this duty is liable on conviction to a fine of up to one million shillings. A director is not to obtain a benefit from a third party as a result of their position or as a consequence of their action (or inaction). It is to be noted that a third party is defined not to include:
1) an associate company; or
2) an agent of the company or of the associate company.

Duty to promote the success of the company

This is a controversial duty as it states that a director should act in a way in which the director considers, in good faith, would promote the success[1] of the company for the benefit of its members as a whole and in so doing the director shall have regard to:

  1. the long term consequences of any decision of the directors;
  2. the interests of the employees of the company;
  3. the need to foster the company’s business relationships with suppliers, customers and others;
  4. the impact of the operations of the company on the community and the environment;
  5. the desirability of the company to maintain a reputation for high standards of business conduct; and
  6. the need to act fairly as between the directors and the members of the company.

Director’s Liability and Shareholder Suits

The duty owed by a director is to the Company [2] and not to an individual or group of shareholders. Consequently, if an action is to be brought against a director for breach of any of the aforementioned duties, it is to be instituted by the board of directors. However, this may not occur for several reasons ranging from board partisanship to the director being a major shareholder or having a controlling stake in the company.

Derivative Actions 
To bring directors to heel, the Act provides for derivative actions. This is a suit brought by individual shareholders on behalf of the company against a director on the grounds of negligence, default, breach of duty or breach of trust by the director as a consequence of their action; actual, proposed act or omission. A director as defined in the Act includes shadow Directors [3] and for purposes of a derivative action includes present and past directors.

Relief or partial relief for directors   
The Act provides safeguards for directors to prevent shareholders from instituting derivative actions without merit. In order for a derivative suit to proceed against a director the shareholder will have to prove the merits of the case to the court or have the suit dismissed.
In the insurance market, there are Directors and Officers liability insurance policies provided to protect directors from personal liability. The Act also now states that a company can provide and maintain insurance for a director of a company or an associated company. However, this is limited by the Act stating that any “third party indemnity provisions” shall be void. Therefore, a director will incur liability to, a person other than the company, to fines imposed in criminal proceedings or penalties for non-compliance of requirements by a regulatory authority.

The Tight Rope (Questions Directors should be asking)

Directors in their current role or considering an appointment to the role of director should ask at a minimum, “does the constitution of the company increase my duties as a director?”, “are some of the provisions in the directors service contract or insurance policy void in light of the new provisions?”, “does my directors’ insurance policy adequately cover for any potential liability?”. Directors should also review the processes undertaken in reaching decisions in light of the requirement to consider stakeholders.

A Director should keep in mind the risks inherent to the role for breach of duties, including personal liability for fines, criminal sanctions, and in the event a company is insolvent, the potential to be disqualified from acting as a director for up to fifteen years and personal liability for debts if they knowingly [4] trade when the company is insolvent.

In our third article, we will highlight the changes introduced in the Act for the benefit of shareholders and the oversight provided on management.

 

[1] The term “promote success” has been greatly debated in foreign jurisdictions where a similar provision has been enacted. It has been deemed that success for commercial, profit-making companies means the “long term increase in value” of the company.

[2] Directors can owe duties to other stakeholders such as creditors under the Insolvency Act where the company is insolvent or under financial difficulty.

[3] The Act defines a director to include “any person in accordance with whose directions or instructions (not being advice given in a professional capacity) the directors of the body are accustomed to act”.
[4] A director, particularly non-executive directors who are not deeply involved or knowledgeable of the business of a company will still be held personally liable as they are expected to take reasonable care in executing their duties which involves obtaining the relevant information to make their independent judgment on issues before the board.


Disclaimer: This article has been prepared for informational purposes only and is not legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Nothing on this article is intended to guaranty, warranty, or predict the outcome of a particular case and should not be construed as such a guaranty, warranty, or prediction. The authors are not responsible for any actions (or lack thereof) taken as a result of relying on or in any way using information contained in this article and in no event shall be liable for any damages resulting from reliance on or use of this information. Readers should take specific advice from a qualified professional when dealing with specific situations.





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