Directors are appointed by a company to run its affairs on a day to day basis. They are distinct from shareholders, who are the people who actually own the company. Shareholders delegate their right to manage the company to the directors, who in turn owe an absolute duty of loyalty and trust to the company and its shareholders. This relationship is known as a fiduciary relationship, and also applies to relationships such as trustee and beneficiary, and solicitor and client.
The day to day duties of a director are set out in statute (s171 – 177 Companies Act 2006) and also enforced in common law. There are numerous duties, but the one that I will concentrate on in this article is the duty of loyalty.
What is the duty of loyalty?
The duty of loyalty dates back to 18th Century decision of Keech v Sandford (1726) and can be said to be the keystone of the fiduciary relationship. It is best illustrated by the facts of the case itself.
Keech v Sandford
The case concerned the relationship between a trustee (Sandford) and the beneficiary of that trust (Keech). The beneficiary of the trust was a child and the subject of the trust was the lease of Romford market in Essex.
When the lease came to be renewed, the landlord told the Mr Sandford that he would not renew the lease in favour of a child, but that he would grant the lease to Mr Sandford. Sandford accepted the proposal and took the lease, earning profit over the years.
When Mr Keech grew up, he sued Sandford for the profit he had earned on the lease. The court found in favour of Keech and ordered Sandford to pay over his profits. The reasoning of the court was that a trustee owes a beneficiary a strict duty of loyalty and by accepting the lease, Sandford had breached this duty. The court found that it was irrelevant that the landlord would never have renewed the lease for the child, or that anyone else in the world could have legally accepted the lease.
What does this mean practically for a company director?
It means that a company director must never put himself in a position of conflict with the company. Also, he must never personally take advantage of an opportunity that should properly belong to the company.
By way of example; imagine that the customers of a company no longer wish to deal with the company, but offer instead to deal directly with the director. The director then agrees to set up a company to service those customers. This would be a breach of the director’s duty of loyalty to the company.
If a director does breach his duty, then there is the significant risk that he has put himself at risk of a derivative claim, or a claim under S.994 of the Companies Act by the shareholders. The director may also be at risk of being the subject of disqualification proceedings.
Do you need advice on your duties as a director? If so the commercial litigation team at Levi Solicitors can help you. Call today on 0113 244 9931.