This article about director’s responsibilities was posted in the recent Cicero newsletter which focussed on directors’ duties around the world. If you would like a copy of the whole newsletter please contact us on firstname.lastname@example.org and we will send it on to you....
Our colleagues at Munday’s in England produced an article describing the legal responsibilities of directors in the United Kingdom. These apply to all directors and are quite straightforward but there are areas where businessmen still seem to become confused and this is the subject of our article
One area where particular care must be taken is in relation to start-ups. There are two main sources of concern here – an academic founder who is still active in the university, and an “Investor-director”.
Unlike in the U.S., it is common in the U.K. for a founding academic to retain an academic position as well as becoming a director of a start-up, which may or may not be spun out of the university where he holds the post. The new company may contract with the university to have development work undertaken by the university, often in the same academic’s laboratory and under his supervision. The potential for conflicts of interest is enormous. There is also potential for cross contamination of intellectual property or funding within the laboratory or for an over optimistic interpretation of results. In the very early stages where perhaps it is really only a one person company it is hard to avoid some duplication of role and the potential for conflict may not greatly matter but as more shareholders join the company the situation may become more sensitive. Appointing strong independent directors to the board or to a scientific advisory board as soon as is feasible may offer at least a partial solution. A lawyer experienced in the area or a patent agent with a close relationship to the project can also work with the company to ensure some clarity of function and demarcation between the company and the academic institution.
As the company grows investors are usually brought in and they will often want to appoint a representative to the board of a company into which they are putting funds. This usually suits both parties: the investor gains confidence that its funds are being appropriately applied and a better understanding of the business while the company gains a board member from outside the day to day management team who can bring a different perspective to the board’s deliberations. Problems may arise however where the investor-director sees his role more as a representative of the investor rather than a co-director with exactly the same responsibilities and duties as the other board members.
Legally the position is very clear, every director has an obligation to take his decisions independently and in good faith to promote the success of the company for the benefit of its members as a whole. Directors cannot base their decisions of what is in the best interests of the investor that has appointed them and both the investor and the investor-director must be made to understand this. It is rarely much of a problem in large established companies as the people appointed and the investors concerned are usually well aware of their responsibilities and in any case the board will likely be quite large and diverse so their influence may well be limited. With a small company, especially a start-up, the investor and the investor-director are likely to have much greater influence over the company and the other directors and may also be less experienced in holding a directorship. Again it may be the company’s lawyer that has to bring this up.
The law provides that any director, subject to compliance with certain formalities, can be removed by a vote of the holders of the majority of shares in the company. This should offer a remedy in situations where a director fails to live up to his responsibilities in particular to act in the interests of all the shareholders. Many investors try to get around this by putting a provision in the investment agreement obliging all the other shareholders to vote in favour of the appointment of “their” candidate and to refrain from voting for his subsequent removal. These provisions are to the benefit of no one as it can lead to a dysfunctional board and should be resisted. The agreement could easily provide for the investor to put forward an alternative if their first director were rejected however investors will argue hard to retain the clause.
A further argument that is sometimes put forward in relation to investor directors having a privileged position is that they are “only” non-executives and so should not be held to the same level of responsibility as those directors who are involved with the day-to-day running of the company. This is a misunderstanding of the law. U.K. law does not make any distinction between the responsibilities of different directors. Anyone appointed to the board of a company is expected to familiarise themselves sufficiently with the company to carry out their duties effectively and management should ensure that not only is this facilitated on the appointment of any director but that staff and information are made available thereafter at the director’s request when they feel they need more information or to understand a matter more thoroughly. The availability of training and access to information and staff should be made clear in the contract appointing the director. Some estimate of the time commitment should also be included and discussed in advance with the proposed director as some investors appoint the same person to the board of a number of their investee companies and this can mean that your company is not getting the level of engagement you expect.
Young companies need strong and well organised boards so it is important to ensure that everyone understands and accepts their responsibilities from the beginning.