Guiding boards. Growing business.

Directors’ Duties in a Nutshell

There seem to be so many cases in the media around the globe of directors acting badly! Whether they are directors in conflict with one another on the front pages of the newspaper for all to see or companies that seem to be encumbered by the effects of boardroom decisions gone wrong or awry many of us are scratching our heads wondering what directors should be doing to avoid this. Perhaps, the place to start is to clarify the roles and responsibilities, and the actual legal duties of directors.

The one area of convergence in most of the corporate legislation internationally is around the duties and responsibilities of directors of companies (and this generally includes most other organisation types and forms). The twin duties of directors (governors) include an implied (or explicit) fiduciary duty and the triple responsibility to act with the required care, skill and diligence.

Let’s unpack these twin duties. Firstly, the concept of fiduciary duty is essentially the same as that used to describe the role of a trustee – this is the highest standard of care required in law. The roots of the word “fiduciary” originate in the mindset of a father looking after their child – the term originates from the Latin fiducarius that means “to hold in trust”, this in turn is a derivative of fides meaning trust or ‘good faith’. As such it is both a legal relationship and a moral or ethical relationship based on confidence and trust between two or more different parties. “A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence” (Bristol and West Building Society v Mothew (1998)).

The areas of convergence between various legal jurisdictions result in the following similarities:

  • Directors owe duties to the organisation and not to individual shareholders, employees or creditors outside exceptional circumstances;
  • Directors’ core duty is to remain loyal to the company, and to avoid conflicts of interest;
  • Directors are expected to display a high standard of care skill and diligence;
  • Directors are expected to act in good faith to promote the success of the organisation.

To put it bluntly, irrespective of whether they are a shareholder of the entity in question all directors (or officers) of a company are in essence looking after the property of the company. To clarify, there is a very important point relating to the nature of company ownership that is vital to understand before progressing. A shareholder of an organisation holds a share in the business but does not own the things that organisation owns – these are owned by the organisation. This point may seem blatantly obvious when put in such a straightforward manner but the main issue is how directors behave – they tend to behave as if they own the things the organisation owns as opposed to behaving as if they merely hold a share in the company and thus have no direct claim on the actual assets of the organisation. This misunderstanding (or misbehaving to be more accurate) has significant effects.

The phrase that most accurately represents a fiduciary duty is that of “acting in the best interests of the entity” alongside the requirement to act in good faith. Ultimately this becomes the test of a director (or trustee) in any decision and action. Did they, and were they seen to be, acting in the best interests of the organisation?

Secondly, the legal duty and responsibility of directors (and prescribed officers) of a company is to act with the required care skill and diligence in the performing of this fiduciary duty. The fiduciary duty creates the core reason for acting – the central motivation that should drive the thinking and behaviour of directors – the triple duty of care, skill and diligence start to provide some indication of how this duty is to be carried out. The specifics of what leaders in organisations should do daily is not spelled out in the legislative framework – it is left up to the interpretation of the leaders themselves. Many leaders miss this point when they look too intently to legislation to define exactly what they as leaders should be doing.

The behaviour of directors, acting individually and together as a board determine how they make decisions and what the company they direct actually ends up doing. These decisions and actions have a direct impact on company performance, the reputation of the business and the net effect on stakeholders – including everyone from customers and suppliers, to employees and the natural environment. Should this impact be negative, or even perceived as negative this could have potential liability implications for the directors in their personal capacity. It is definitely time for directors to better understand their legal duties, roles and responsibilities and determine how they can better decide and act into the future.