Becoming a director
Leading from the front.
Becoming a director of a limited company can be very satisfying, bringing with it a high level of responsibility and trust. You’ll need to follow statutory rules and duties and there can be legal consequences if you fail to keep them. We take a closer look at the role and responsibilities of directors of limited companies, and how to make sure you keep within the law.
Anyone can become a director, with a few exceptions:
Disqualified by the company's own Articles of Association (the rules relating to the running of the company).
- An undischarged bankrupt.
- Disqualified by a court order.
- The company's auditor.
You don't have to be a company shareholder or employee. But, if you do any work, either full-time or part-time, for the company you may need to have a director's service contract. You may need to register this, and keep a copy for inspection at the company's registered office.
If someone effectively acts as a director, even without the title, they may still legally be seen as a director. This could apply to a lawyer or accountant, who advises a company's directors and whose guidance the directors usually take. They could be seen as a 'shadow' director.
As a director you hold a position of trust – you ‘direct’ the company's operations on the shareholders' behalf, acting through the board, which usually controls company business. The extent of the directors' authority depends on the company's Articles of Association. So before you become a director, it’s best to take legal guidance on what the extent of your obligations will be.
As a director, some duties may be specific to you, but there are a number that apply to all company directors:
- To act within your powers to ensure the company follows its constitution as set out in the Memorandum and Articles of Association.
- To act in good faith to promote the success of the company for the benefit of its members. You must also take into consideration employees, suppliers, customers, the environment and the community.
- To carry out your duties with reasonable care and skill. Higher standards may be expected from executive directors who are responsible for an area in which they have specialist knowledge or a professional qualification.
- To exercise independent judgement.
- To make sure that there is no conflict of interest and duty.
- To disclose to the company any personal interests you do have. You must not divert business opportunities to yourself that ought to be available to the whole company.
- To make a declaration of interest if appropriate. You may not be allowed to vote on matters if there is a conflict of interest.
- Not to seek or gain benefit from a third party by reason of your being a director, or by doing or not doing something.
- Not to take bribes.
- Not to act fraudulently, including with the intention of defrauding creditors. Not to engage in wrongful trading – allowing the company to carry on trading when you know (or ought to know) that it is insolvent. This can lead to personal liability.
- To carry out the statutory obligations set out in the Companies Act 2006 and other legislation.
Some parts of the law make directors personally liable for certain actions they may take while fulfilling their duties, including:
- The Insolvency Act 1986 which can lead to personal liability where directors allow the company to trade wrongfully or fraudulently.
- The Health and Safety at Work Act 1974.
- Laws relating to the control and disposal of hazardous waste.
Non-executive directors take a less active role in company management but the law makes no distinction between the duties of non-executive and executive directors. So as a non-executive director, it's vital that you know what your fellow directors are doing and understand the true state of the business.
Position of maintaining trust
Directors must be extremely careful if they want to take advantage of an opportunity for private profit in an area of activity similar to that of the company - even if the company has rejected the particular proposition. For example, you should always take guidance before buying or selling any assets from or to the company. Shareholders' approval is needed before a director, or someone connected with the director, may acquire a substantial company asset, or vice versa.
If a director profits personally from his or her position, even if the company itself hasn't suffered because of their action, a court can order him or her to pass on any profits made to the company.
In a company, you may have several roles - as well as acting as a director, you may also own shares, lend the company money and guarantee loans. When there is a conflict of interest between your various roles, the courts will usually support you if you can show you have acted honestly and reasonably. The law also requires you to provide Companies House with information about shareholders and directors and, of course, to file your accounts. If you don't do this, you could be fined.
Before forming an incorporated company
Be very careful when negotiating contracts with outside parties on behalf of a company that is yet to be formed, as you may be personally liable for anything you negotiate. Unless the other party agrees to the contrary, the deal will be seen as one entered into by the would-be director acting on their own behalf.
Make sure that the company's full name is displayed at the registered office and on cheques. All company letterheads must show the registered office and business address, if this is different, along with the company number, you must put all or none of the directors' names on letterheads.
You have a legal duty to prepare accounts, which are usually presented at the annual general meeting of shareholders. You should be able to interpret these because you are responsible for either producing them, or for providing accurate information to an auditor so that they can be prepared. You also have to sign to confirm that they are accurate.
Copies of these accounts must be submitted to the Registrar of Companies within ten months of your year-end or you will be fined. Accounts have to be independently audited, although small and medium-sized companies may be able to file abbreviated accounts at Companies House, and very small or dormant companies may be exempt from audit altogether. Your accountant will be able to give you details about the type of accounts which you need to prepare.
You must keep all paperwork safe. Legally, you must keep:
- petty cash records, bank paying-in counterfoils, goods in and out records, and all company records, including personnel records, for six years
- annual earnings summaries for 12 years
- registers of directors and secretaries, applications for share documents, pension fund investment details, corporate balance sheets and minutes of general meetings permanently.
The company may not pay for goods and services which you receive personally.
Other disclosure requirements
The Memorandum of Association, filed at Companies House, should contain the company's name, registered office and objectives. The Articles of Association outline the rules about how the company will be managed. These can be the standard ones set out in the Companies Act 1985, or the board can set out its own.
Professional advisers often recommend you adapt the standard Articles so that they suit the requirements of your company in relation to issues such as the circumstances in which (and the parties to whom) shares can be sold.
Directors must inform Companies House of changes in the company's registered address, directors and secretary, along with the annual returns and certain specified resolutions.
When you issue shares, you must comply with the Companies Act 1985,the Financial Services and Markets Act 2000 and the company's Articles of Association.
Unless your company opts out of the obligation to hold annual general meetings for the shareholders, you must hold meetings every year. You are not legally required to hold board meetings for directors, although it is good practice to do so. Make sure that all directors are given reasonable notice to attend board meetings.
You should always appoint someone to take minutes. These need to be published at the next board meeting and approved.
Directors often attend meetings in two capacities: as a manager and as a board member. The emphasis of the meetings must be on directing rather than managing.
If you disagree with a point raised at the meeting, be sure that it is recorded in the minutes, even if your motion is not carried.
As a director you are responsible for making sure the company complies with the law. You could be personally liable if there is fraud, or even negligence. Directors can be found individually liable if they act negligently or in breach of trust. You can get insurance which will protect you against the financial consequences of such a finding, but make sure you double-check any exclusions on the policy.
Company directors are often asked to give personal guarantees for loans, overdrafts and other financial liabilities. Think through the implications of this carefully – if your guarantee is secured by a mortgage on your house, for example, you could lose your home if things go wrong. Always seek professional guidance first.
Liability for the company's debts
A company’s limited liability protects directors and shareholders, except when they have contributed capital to the company, or can be called upon to do so – for example, with partly paid shares. If the company gets into financial difficulties, seek professional guidance immediately. While directors normally have no personal liability for the company's debts, there are situations where it may be possible for creditors to claim from you personally.
Directors and borrowing
There are strict legal limits on how much directors can borrow from the company, though loans by directors to their companies are legal and quite common. Ask your accountant about the tax implications of borrowing from the company.
Handling capital issues
Directors can only distribute the company's profits after tax through taxable dividends according to the rules laid down in the Articles of Association.
If you believe that the company is at risk of becoming insolvent, don't put creditors or guarantors at a disadvantage in terms of recovering their debts from your company by increasing the company's liabilities or transferring or selling the company's assets.
Also, be careful when selling company assets – you shouldn't sell them for less than they are worth and, in certain circumstances, you will need to seek shareholders' agreement first.
If a company finds itself in financial trouble and carries on trading to the detriment of its creditors (a practice known as wrongful trading), any director who should have recognised the "point of no return" before it had been reached, can be held personally liable for the debts if the company then goes into liquidation. Directors must therefore be aware of the company's financial status and ensure that someone competent monitors its solvency.
A director can be cleared of this liability if a court is satisfied that, when the director realised that the company was not able to recover, he or she took reasonable steps to minimise potential losses to creditors.
Other factors that may help convince a court that you acted properly include making sure that:
- the board was properly constituted.
- board meetings took place with detailed agendas of what was to be discussed.
- board meetings were properly minuted.
- proper management information was provided and records kept.
If you are successfully sued for damages, you may claim a contribution from anyone else who is also found to be responsible. However, a court can lift this liability wholly or partially if it is satisfied that you acted honestly and reasonably and, on balance, ought fairly to be excused.
If your company reaches the "point of no return",
- you may feel tempted to resign. But you won’t necessarily be free from your obligations and liabilities as a director: you must be seen to have taken positive steps to do everything possible to ensure that the scale of a company's problems – or your perception of them – is brought to the attention of the full board of directors.
- you should ensure that the company takes all possible steps to recover, including seeking professional guidance.
Directors are not automatically disqualified from being directors of other companies because one company they worked for went into liquidation. Only a court can order disqualification.