Because I am based in the United States and because my experience has been concentrated in the U.S., my focus in this blog has primarily been on issues and developments in the U.S. — although I do enjoy the occasional opportunity to write about developments elsewhere. Because I know that many of this blog’s readers are based outside the U.S., I welcome the chance to try to expand this site’s geographic scope when I can. For that reason, I am happy to be able to publish the following guest post about director duties and exposures in the U.K. This post was submitted by Nick Lindsay; a solicitor admitted in England and Wales and a governance professional at Elemental CoSec. He advises UK companies on legal, governance and compliance issues.
I would like to thank Nick for his willingness to publish his article on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. If you would like to submit a guest post, please contact me directly. Here is Nick’s guest post:
In the modern international business, it is common practice to have subsidiaries spread across the globe. The local subsidiary poses many advantages; allowing the business to meet local compliance requirements; insulate the rest of the group from local risks; and efficiently structure the tax burden of the local operation. However, the local subsidiary can expose the directors to significant risks that differ from their local jurisdiction. These risks may well attach to them personally and may not always be mitigated by D&O insurance. It is therefore critical that the directors understand the jurisdiction they are acting in and don’t just assume that it is the same as home.
Here I have set out the D&O risks faced when setting up a UK subsidiary, although the principles will likely apply to numerous other jurisdictions as well. As the D&O Diary has a US focus, I will look at the example of a US incorporated company that has a UK subsidiary. The UK subsidiary could have solely US resident directors, solely UK resident directors or a mixture. All of these arrangements can be made to work depending on the commercial realities, but pose their own risks.
Director’s Duties in the UK
In the UK, every director of a company owes certain fiduciary duties to the company. It used to be thought that a non-executive director owed a lower standard of duty and could largely defer to the executive directors however, it is now clear from case law that all directors owe the same duties to the company.
The main duties are set out in sections 171-177 Companies Act 2006, though they are others contained in case law and certain specific legislative sections. The main duties on a UK director are (i) a duty to act within their powers, (ii) a duty to promote the success of the company, (iii) a duty to exercise independent judgement, (iv) a duty to exercise reasonable care, skill and diligence, (v) a duty to avoid conflicts of interest, (vi) a duty not to accept benefits from third parties, and (vii) a duty to disclose interests in a proposed transaction or arrangement.
These duties need to be exercised positively and it has been held by the courts that any director that ‘fetters’ their discretion by mindlessly following the direction of another (for example the decision of the head office) would be in breach of these duties.
Failure to comply with some of these duties is potentially a criminal offence (for example, failure to declare an interest in an existing transaction) and the penalties may fall on the director personally.
Under section 251 Companies Act 2006, a shadow director is a person in accordance with whose directions or instructions the directors of a company are accustomed to act. This definition could include a manager at the US head office, where the directors of a UK subsidiary blindly follow the manager’s instructions. It is also not uncommon to see subsidiary boards that ‘ratify’ the decisions of senior management at the parent company and, again, this would pose a risk that the US manager would be considered a shadow director.
A shadow director is largely subject to the same director’s duties as a de jure director, although this is only to the extent that the corresponding common law rules or equitable principles apply. A shadow director is also subject to a number of offences under the Insolvency Act 1986.
The large risk posed by the shadow director rules, is that the individual will generally not realise that they are a shadow director and that they are taking these risks. Therefore there may not be appropriate risk mitigation or insurance to protect them. As set out above, there is also the risk that the de jure directors will be failing in their duties to the company, by following the instructions of the shadow director rather than exercising their own independent judgement.
Company indemnities, D&O Insurance and their limitations
Like many jurisdictions, the UK has placed limits on what can be covered under a company indemnity (ie an indemnity from the company in favour of the directors). This is to stop directors escaping liability for their failures, simply by having the company meet the claim. It also helps to protect the creditors of a company where the directors have failed in their duties.
As set out in Chapter 7 of Companies Act 2006, a company may not generally exempt a director from, or indemnify him against, liability in connection with any negligence, default, breach of duty or breach of trust by him in relation to the company. As a result, the company cannot generally exempt or limit the liability of a director for breach of his duties as a director. However, the company can provide a ‘qualifying third party indemnity’ which is an indemnity against a liability incurred by the director to a person other than the company or an associated company provided that such liability is not a fine imposed in criminal proceedings or a sum payable to a regulatory authority by way of a penalty in respect of non-compliance. Further the indemnity cannot cover liability in defending any legal proceedings in which he loses.
The company may also provide a qualifying pension scheme indemnity, the details of which are set out in section 235 Companies Act 2006.
The limits of these indemnity provisions makes the terms and structure of any D&O insurance policy absolutely critical to ensure that the directors are still protected notwithstanding the above limitations.
This article is provided for general information only and no liability is accepted in respect of its contents. Specific advice should always be obtained if you are in any doubt as to your legal obligations.