Understanding Directors' Duties: Navigating Sections 171 and 172 of the Companies Act 2006

Welcome to the second instalment of our four-part series on the important topic of Directors' Duties. In our previous article, "An Introduction to Directors' Duties and Their Responsibilities," Mollie Leak, Solicitor in our Commercial Litigation team, offered an in-depth overview of a Director's roles and obligations.

In this second article of the series, Mollie provides an in-depth analysis of Sections 171 and 172 of the Companies Act 2006, which outline the directors' duty to act within their powers and their responsibility to promote the company's success.

Duty to Act within Powers (Section 171)

Under Section 171 of the Companies Act 2006, directors are required to act in accordance with the company's constitution and use their powers only for the intended purposes. This duty prevents directors from misusing their powers by engaging in actions that, while technically within the bounds of the constitution, are carried out for improper reasons.

A company's constitution contains the articles of association, special resolutions passed by its members, and decisions made according to these articles. Together, they set the rules for how the company operates.

How to Identify a Breach of Section 171

Determining when a director fails to adhere to the company's constitution is usually straightforward. A director is in breach of their duty when they cause the company to engage in actions beyond its powers or that are illegal. This may include failing to follow the company's constitution or causing the company to make unlawful financial distributions.

However, proving a breach of the duty to act within one's powers for their intended purpose can be more challenging. Courts examine the director's intent and motive when assessing potential breaches. While proving dishonesty is not necessary, evidence of such conduct can confirm a violation of Section 171 of the Companies Act 2006.

Duty to Promote the Success of the Company (Section 172)

Section 172 of the CA 2006 mandates that a director must act in a manner that will promote the success of the company for the benefit of its shareholders. This duty extends to all decisions made by a director, not just those made by the board. When making decisions, directors should take into account:

• The long-term consequences of any decision.
• The interests of the company's employees.
• The necessity to nurture business relationships with suppliers, customers, and other parties.
• The impact of the company's operations on the community and environment.
• The importance of upholding the company's reputation for high standards of business conduct.
• The obligation to act fairly and treat all shareholders equitably.

The list of considerations provided under Section 172 is not exhaustive. Directors must evaluate other factors relevant to the company's success and balance their significance against competing considerations. This process involves making commercial decisions which fall under the directors' responsibility.

When considering these factors, directors must also exercise reasonable care, skill, and diligence, which may include seeking expert advice, particularly regarding matters like environmental impact. Furthermore, directors must adhere to the duty to act within their powers under Section 171, even if they believe, in good faith, that their actions will benefit the company and its shareholders. The duty to promote the company's success (Section 172) does not override the duty to act within their powers (Section 171).

What Defines Success?

In this context, success typically refers to the company's long-term growth and value. Directors should consider the benefits for both current and future shareholders when evaluating success. For example, a company might reject a transaction if it poses a risk to its long-term interests, even if it appears profitable for current shareholders.

How to Identify a Breach of Section 172

The duty to promote the company's success embodies the loyalty and good faith expected from a director. There must be evidence of conduct lacking good faith to establish a breach of this duty. The director's state of mind is crucial in determining this. For instance, an honest but mistaken belief that a specific action benefits the company does not constitute a breach of Section 172.

When there is no evidence that the director considered the company's best interests, the court will assess whether an intelligent and honest director could have reasonably believed the transaction was in the company's favour. If the director's decision is unjustified, the court will likely find a breach of duty.

How to Demonstrate That a Director Considered the Best Interest of the Company

Board meeting minutes can help demonstrate that directors have considered the factors outlined in Section 172 when fulfilling their duties. Minutes should capture discussions on relevant topics and record any decisions made. If anything is decided as not relevant in the meetings, this should also be noted.

Inconsistent board minutes may expose directors to risk by suggesting a lack of consideration for Section 172. Establishing and following a consistent policy outlining the company's approach to Section 172 can provide clarity and mitigate risk.

Get in Touch

For more information and advice on Sections 171 and 172 of the Companies Act 2006, contact Mollie Leak and our Commercial Litigation team on 023 8063 9311 or email enquiries@warnergoodman.co.uk.

Did you miss our previous article?
Read "An Introduction to Directors' Duties and their Responsibilities" here.