Damaging, destructive and surprisingly commonplace, director misconduct is often at the heart of complex commercial litigation. When directors act outside the scope of their powers or breach their legal duties, whether through self‑dealing, negligence or deliberate wrongdoing, the consequences for a business can be severe.
At Swinburne Maddison, our Commercial Litigation team regularly advises companies and shareholders dealing with the fallout from director misconduct, helping them navigate the legal and commercial risks that follow.
What legal duties do Directors owe?
Under the Companies Act 2006 and long‑established common law principles, directors are bound by a range of fiduciary duties to the company. Some of the most important statutory duties include:
- Duty to act within powers (s.171) where directors must act in accordance with the company’s constitution and only exercise their powers for their proper purpose.
- Duty to promote the success of the company (s.172), meaning directors must act in good faith in a way they believe is most likely to benefit the company and its members as a whole.
- Duty to exercise reasonable care, skill and diligence (s.174) where directors are expected to meet the standard of a reasonably diligent person carrying out the same role, taking account of their own knowledge and experience.
- Duty to avoid conflicts of interest (s.175) so directors do not place themselves in situations where their personal interests conflict, or may conflict, with those of the company.
- Duty not to accept benefits from third parties (s.176), for example, directors must not accept benefits arising from their position as a director, or from doing (or not doing) something in that role.
- Duty to declare interests in proposed transactions (s.177), including any direct or indirect interest in a transaction involving the company, must be properly disclosed.
These statutory duties supplement older equitable duties that remain binding, including duties of confidentiality. Directors must use confidential information only for the benefit of the company.
Common types of director misconduct
While director misconduct can take many forms, the most serious cases are those that directly affect a company’s assets, cash flow, competitive position or the fair treatment of shareholders. These issues frequently arise in small or owner‑managed companies, where the separation between “the company” and “the individuals running it” can become blurred.
- Misappropriation of company assets is one of the most deliberate forms of misconduct and occurs when a director treats the company’s assets as their own. This may include:
- Using company funds to pay personal expenses
- Diverting money to connected businesses
- Removing assets or cash without justification or documentation
- Selective or manipulative dividend practices. These occur in shareholder fall‑outs and it is common to see controlling directors refusing to declare dividends, or paying them only to certain shareholders, while extracting value through inflated salaries, bonuses or management charges.
- Diverting business to a competing company. This is a particularly damaging form of misconduct whereby the director may be setting up (or becoming involved in) a competing business and systematically stripping the original company of its contracts and business opportunities, key customers and staff and cash and assets. The original company is often left as an empty shell, with shareholders presented with a situation they are told cannot be undone. This type of conduct is likely to breach most, if not all, fiduciary duties owed by the director.
- While not always deliberate, negligent mismanagement, gross incompetence or neglect can also give rise to liability, particularly where a director fails to exercise reasonable care, skill and diligence. Examples of this may include failing to maintain proper financial records, ignoring regulatory or compliance obligations or poor oversight of core business activities.
What are the consequences of director misconduct?
Experienced commercial litigators see countless variations involving misuse of confidential information, false invoicing and undisclosed conflicts.
What unites all cases is that the consequences are rarely trivial. Director misconduct can cause serious financial loss, operational disruption and long‑term damage to a company’s viability and relationships.
Where misconduct has occurred, companies and shareholders have several potential legal remedies, including:
- Unfair Prejudice Petitions (s.994, Companies Act 2006).
A shareholder may apply to court where the company’s affairs have been conducted in a way that is unfairly prejudicial to their interests. Common examples include exclusion from management, diversion of business and selective financial disadvantage.
Courts have wide discretion when granting relief, most commonly ordering a buy‑out of the affected shareholder’s shares, but potentially also unwinding transactions, awarding compensation or regulating the company’s future conduct. - Derivative Claims (ss.260–264, Companies Act 2006)
These allow a shareholder to bring proceedings on behalf of the company for losses caused by directors’ breaches of duty. Although court permission is required and the procedure is complex, these claims can be vital where the wrongdoing directors remain in control. - Unlawful Means Conspiracy
Where two or more individuals combine to harm the company or a shareholder using unlawful means, such as breaches of fiduciary duty, contract or fraud, additional claims may be available. - Direct Claims by the Company
Where control has passed to an independent board or insolvency practitioner, the company itself may bring claims against former directors for compensation, an account of profits or damages.
How to prevent director misconduct
While litigation can address the consequences of misconduct, it is always preferable to reduce the risk before problems arise.
Two key safeguards are:
- Well‑drafted shareholders’ agreements
These should go beyond boiler‑plate wording and include clear provisions on dividends, non‑compete obligations, share transfers, and good‑leaver/bad‑leaver mechanisms. Requiring super‑majority approval for major decisions can also help limit unilateral action. - Strong corporate governance
Robust financial controls, clear decision‑making processes and effective record‑keeping make misconduct harder to conceal and easier to address if it occurs.
Taking action
Even the strongest governance cannot completely eliminate the risk of director misconduct. Where it does occur, the impact is often swift, costly and difficult to reverse.
Early legal advice can be critical. If you have concerns about director conduct or shareholder disputes, our Commercial Litigation team at Swinburne Maddison can help you understand your options and protect your position. For more information, contact James Curran at James.Curran@swinburnemaddison.co.uk or call our team on 0191 384 2441.
