All directors of UK companies have to work within the bounds of corporate governance, and all have a duty to act within UK company legislation when working as a director. This means all directors have certain duties to the company and shareholders and others. Among these, the fiduciary duty means that you have to act in good faith in the best interests of the company, placing its interests above your own personal interests.

‘As a company director, an accusation of ‘breach of fiduciary duty’ can at best be extremely uncomfortable and, at worst, can lead to the breakdown of relations between you and your shareholders or fellow directors, and ultimately can lead to serious personal and financial repercussions,’ says Simon Bean, a Partner and Head of Dispute Resolution here at Wollens. ‘However, what amounts to a breach in practice is often a grey area for directors. It is important to know how to avoid a breach of your fiduciary duties and what to do if you are accused of a breach.’

Simon looks at who these duties are owed to, what a breach can mean for a director, and what to do if you are accused of a breach.

What are the main fiduciary duties for a director when a company is financially stable, and who are those duties owed to?

All directors should be aware that they owe certain duties to the company and its shareholders as a privilege of working under limited liability, and in order to ensure that everyone works within certain set boundaries and rules.

Fiduciary duties are owed to a wide range of people, including shareholders, creditors, other directors, and certain regulatory authorities. The main duties owed by directors are set out in company legislation. These include the duty to act only within the company’s constitutional powers; to promote the success of the company, and as such to act for the company as a whole, and not as an individual director or for a certain class of shareholders for example. Directors must act independently for the benefit of the company, and they must exercise reasonable care and skill as well as diligence in their actions and decisions for the company. They must avoid any conflict of interests, and this includes not taking bribes or benefits from third parties that might breach their duty of independence. In this regard they must also disclose any interest in any transactions. When a company is in financial difficulties there are additional duties, under insolvency legislation, to consider the company’s creditors in priority to the shareholders.

What is a breach of fiduciary duty?

In practice, what amounts to a breach of a fiduciary duty is not always clear cut in a commercially run entity. A director may be accused of a breach, when they believe they were acting in the best interests of the company, even though their action does not necessarily seem fair to a particular shareholder or a creditor. It often depends on who is making the accusation as to whether it is the case that there has been a genuine breach or not. A genuine breach is likely to be one where you have acted outside your authority, or where you have failed to exercise reasonable care as a director when taking actions or decisions.

Case study

By way of an example: A company has three shareholders: A (60%), B (30%), and C (10%). Shareholders A and B are also directors. The company needs additional funding to continue trading and pursue a new commercial opportunity. After taking advice and considering the company’s financial position, the directors A and B decide the best option is to issue new shares to raise capital from an external investor. The new investor agrees to inject significant funds, but only on the basis that they receive a large shareholding.

As a result, new shares are issued and the existing shareholders’ holdings are diluted. Shareholder C’s stake drops from 10% to 5%, and they allege that the directors have breached their fiduciary duties by diluting their shareholding and favouring the new investor, causing them prejudice.

However, this may not be considered as a breach of fiduciary duty on an objective basis, if the directors A and B can show that:

• the company urgently needed capital to continue operating and grow;
• alternative funding options were explored but were not viable;
• the investment was negotiated at arm’s length, and on commercial terms; and
• the decision was made in good faith to promote the success of the company as a whole.

Conversely, if it is clear that a decision taken by directors was not taken for the benefit of the company overall – especially if it benefitted you as a director to the detriment of another party – then there may be a genuine claim for breach of duty brought against you.

A claim can be brought by anyone who believes they have suffered harm from your action or inaction. This includes shareholders, as well as by certain regulatory bodies and insolvency practitioners.

How do these duties change when the company experiences financial difficulties?

When a company is in financial difficulty, the fiduciary duty shifts so that duties are predominantly owed to the company’s creditors, rather than to the shareholders.

Insolvency legislation sets out many examples of where the directors should be focusing more on the protection of creditors during this period. For example, when making decisions on continuing to trade, directors must ensure they are not making matters worse for creditors. If they genuinely believe that some limited continued trading will lead to the company turning itself around and being in a position to pay all creditors, then it may be reasonable to continue to trade while monitoring the position. However, continued trade in these circumstances, without considering the realistic financial position and likely outcome, is very likely to lead to a legitimate accusation of breach of fiduciary duty.

What are the consequences of breach of fiduciary duties for a director?

The consequences will depend on what is claimed and by whom.

A breach of duties to creditors when the company is in financial difficulty can have serious financial repercussions for a director. Continued trading, for example, causing additional prejudice to creditors over the final trading period, may mean a director must pay all creditors personally for losses incurred during that time.

Breach of fiduciary duty that is found following the formal insolvency of the business can also lead to a claim for disqualification as a director in the future by the Insolvency Service, and a claim for compensation for the breach.

How to respond to, and resolve, a claim of breach of fiduciary duty

It is important to take any claim of breach of duty seriously from the outset, as these disputes can escalate quickly. Even a claim with apparently little merit can take up a lot of time for a director, and can have ramifications for the business. An aggrieved shareholder or fellow director can cause difficulties to the smooth running of the business, even if they do not have a legitimate reason to do so.

For this reason, it is important not to fire off a quick response without thinking it through carefully. It is preferable to involve an independent third party, such as a lawyer, to be the point of contact to discuss a resolution. This can avoid misunderstandings, and take the heat out of a dispute, particularly in smaller companies and family run businesses.

The preference is always going to be to avoid court action if possible, and this can often be achieved through communication. It is important to keep records of decision making and preserve these to defend any actions and decisions taken where possible.

Negotiation can often lead to effective resolution. If this is not effective, then the parties may be able to resolve a claim by way of alternative dispute resolution methods such as mediation or arbitration. If none of these are successful, a claim may be brought through the courts, to allow a judge to decide if a breach has occurred, and if so, what the remedy for that breach might be.

How can we help?

A claim of breach of fiduciary duty can quickly escalate and affect the smooth running of the business, even if there is no merit to it. The involvement of a specialist lawyer with experience in this area can nip in the bud what could otherwise be a long and drawn out contentious matter for a business. If you receive a claim, do not sit on it. Our specialist solicitors can work with you to ensure it is resolved as quickly as possible with the least disruption to your business.

You can also complete an online enquiry form. One of the Wollens team will contact you as soon as they are available.