Lifecycle of a tech startup series: Directors' Duties

Episode 11

11 May 2022

KNow Wear Limited has used the investment received to date to further develop the wearable tech product to the extent that it now has a minimum viable product with basic features to introduce to the market. The company has identified a test group of 100 consumers who will test this version of the product and provide feedback. Following the test phase the company will collate the feedback and further develop the product before releasing a final version of the product to the market.

You have identified two potential companies to manufacture the product. One of the manufacturers, based in Burnley, was introduced to you by your co-founder and fellow director Chris whose husband is on the board of directors of the manufacturer.

The second manufacturer is based in China. To encourage you to enter into a deal with the manufacturer in China, the CEO of the Chinese company has invited you on an all-expense paid 5 day trip to visit the factory in China. She has told you that the Chinese company will pay for you to stay at a lavish 5-star hotel, you will dine at a number of exclusive restaurants and the Chinese company has also organised for you to have private tours of several cultural landmarks during your stay.

You are conscious that, as a director of KNow Wear Limited, you owe duties to the company and in certain circumstances to the company’s shareholders, employees and creditors. You are also aware that breaching these duties can lead to civil or criminal penalties and so you have asked the company’s lawyers to remind you of the duties that apply to you as a director.

General Duties

The company’s lawyers have confirmed that the main duties owed by directors are set out in the Companies Act 2006 (Act), and all directors must comply with them. These include a duty to:

Act within their powers: a director must act in accordance with a company’s constitution, meaning the company’s articles of association and any resolutions or agreements made that affect the company’s constitution.

Promote the success of the company: a director must act in a way which they consider is most likely to promote the success of the company for the benefit of the company’s members as whole.

Exercise independent judgement: unless otherwise authorised to do so, a director must not rely on third parties when making decisions that relate to the company.

Exercise reasonable care, skill and diligence: this duty imposes both ‘subjective’ and ‘objective’ standards. It is necessary for directors to exercise the care, skill and diligence reasonably expected of a person who is carrying out the functions of a director (‘objective’) and, if a director has any particular or specialist knowledge (for example, as a result of them holding a professional qualification) they must also exercise reasonable care, skill and diligence using their own general knowledge, skill and experience (‘subjective’).

Avoid conflicts of interest: directors must avoid situations in which they have or can have a direct or indirect interest that conflicts with, or may conflict with, the company’s interests.

Not accept benefits from third parties: directors must not accept any benefit or inducement from a third party which is offered to them in connection with their directorship. This can encompass scenarios whereby company suppliers offer inducements to directors, for example extravagant corporate hospitality to approve contractual arrangements, in preference to competing suppliers. However, there will be no breach of this duty if it is reasonably regarded that a conflict of interest would not arise as a result of the director accepting the benefit.

Declare any interest in a proposed transaction or arrangement with the company: if a director has any direct or indirect interest in a proposed company transaction, that director should disclose their interest to the board of directors. An indirect interest may arise where a spouse or family member of a director wishes to enter into an agreement with the company.

Being mindful of the duty to declare any interest in a proposed transaction or arrangement with the company, you note that at any board meeting held to consider the company’s entry into a contract with the Burnley based manufacturer, in order to comply with his duties, Chris would need to declare his interest in the transaction - being that his husband is on the board of the manufacturer.

You note that the articles of association of the company, which were adopted by the company as part of the seed investment round, provide that a director who is in any way, whether directly or indirectly, interested in a proposed transaction or arrangement with the company may vote at the meeting and be counted in the quorum provided that such director has declared the nature and extent of their interest at the meeting.

In respect of the invitation for an all-expense paid trip from the manufacturer based in China, you consider that this may be an unreasonable inducement and consequently accepting this offer may cause you to breach your duty not accept benefits from third parties. Having taken legal advice, you understand that if you want to accept the benefit, to avoid breaching your duty, the shareholders of the company would need to pass a resolution to authorise you to accept the benefit. You decide in this instance to decline the invitation to travel to China but you consider establishing a company policy on the acceptance of corporate hospitality and gifts.

At the next board meeting of KNow Wear Limited, and with Chris having made the other directors aware of his interest in the transaction, the board ultimately resolves to enter into a contract with the Burnley based company to manufacture the initial run of products.

ABOUT THE AUTHOR

Luke Gregory works on a broad range of corporate and commercial matters including advising on company incorporation, bespoke articles of association and shareholder agreements, corporate governance, and Companies Act procedures such as off-market share buybacks and the removal of company directors.

 

Lifecycle of a tech startup series

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