Companies
The obligations imposed by company law are onerous and there are severe penalties for non-compliance with many of the duties imposed on directors. It is important for Elected Members and Officers appointed to act as company directors to ensure that they understand the duties and obligations which the law imposes on them.
A company is a separate legal entity which can hold property in its own right, enter into contracts, employ staff and sue and be sued in its own name. A company is distinct from its members, who may be either shareholders or guarantors.
Whether a company is limited by shares or by guarantee, the day to day management of the company is usually vested in the directors. The members ultimately control the company by electing the directors and deciding the major issues at general meetings. The main differences are as follows:
- in a company limited by shares the shareholders share the ownership of the company and its profits and if the company is wound up each shareholder is liable to pay an amount equivalent to the nominal value of his or her shareholding;
- a company limited by guarantee does not normally seek to make a profit and in the event of the company being wound up, the members guarantee to make a payment to the level of their guarantee (usually a nominal figure of £1.00). Hence companies limited by guarantee are more commonly used for voluntary and public bodies, especially where charitable status is sought.
A company is controlled by reference to its ‘constitution’, which is contained in the Memorandum and Articles of Association. These documents will set out the powers of the company, and the rules by which it is to be managed. Any act carried out by the company that is outside the powers set out in the Memorandum will be unlawful, and a director involved in such an act may be personally liable for any resulting losses.
In general Elected Members and Officers should avoid taking executive or managerial responsibility for the company’s activities because the duties of executive or Chief Executives can be particularly onerous. This is because executive directors are directly responsible for particular aspects of the company’s affairs. For example, a finance director will have responsibility for the company’s financial position, which could give rise to liability for allowing the company to trade while insolvent if the company goes into liquidation. However, all directors, including part-time and non-executive directors, are required to make themselves fully aware of the company’s financial position and should attend Board meetings regularly. Ignorance of transactions entered into by the company through a failure to make proper enquiries may not be an adequate defence to a charge of negligence brought against such a director.
In some situations, the Council may nominate Elected Members or Officers to act as “observers” on the board of directors of a company. Although such observers have no specific legal status, Elected Members and Officers should be aware that if an observer’s involvement increases to such an extent that it could be said that there is an active engagement in the management of the company, he or she may be deemed to be a “shadow or defacto director” which may entail liabilities. Any person appointed to this role should, therefore, ensure that the extent of their role as an observer is clearly defined and agreed to avoid involvement in managing or directing the management of the company.
Under the Companies Act 2006 (‘the Act’), directors owe a number of legal and fiduciary duties to their company. These are duties to:
- Act within powers (section 171 of the Act)
- Promote the success of the company (section 172)
- Exercise independent judgement (section 173). Although it is permissible to take account of the interests of a third party (in this case the Council), a director cannot vote simply in accordance with the Council’s instructions.
- Exercise reasonable skill, care and diligence (section 174)
- Avoid conflicts of interest (section 175). There may be actual or potential conflicts between the interests of the company and those of the Council. A Member or Officer cannot waive their statutory responsibilities as a director; hence they may have to cease to act as a Elected Member or officer in relation to the particular matter. In extreme cases, the only proper way for the conflict to be resolved may be for the Elected Member or Officer to resign either from the company or from the Council.
- Not accept benefits from third parties (section 176)
- Declare interest in a proposed transaction or arrangement with the company (section 177). Directors must therefore disclose any interests they or their family may have in relation to the company’s contracts. Whether they are then allowed to vote will depend on the company’s Articles of Association. Equally, Officers are not allowed under cover of their office to take any more than their proper remuneration so they must obtain the consent of the Council if they are to receive any remuneration from a company to which they have been appointed by the Council.
Elected Members acting as directors should be aware of these duties, particularly those which could lead to:
- A conflict with their role as Elected Member of the Local Authority (for example, the duties to promote the success of the company, to exercise independent judgement, and to avoid conflicts of interest)
- Personal liability for the debts of the company.
The fact that a director is appointed to a company board as a representative of the council does not diminish these duties.
Liabilities and Indemnities
Directors cannot be indemnified by a company against liability arising out of negligence, fraud or breach of duty or trust. The company’s Articles of Association may however allow for directors to be indemnified by the company in respect of the cost of defending such proceedings, where the director concerned is granted relief by the court or acquitted.
The Council does have limited powers to provide indemnities for Elected Members or Officers when appointing them to act as directors. It is also appropriate for a company to purchase insurance to protect its directors against claims of negligence, breach of trust or duty, or other default. Before taking up an appointment, directors should ensure that such insurance is in place and that the provision of the insurance is within the powers of the company.