Looking out for directors

For small and medium-sized businesses, directors often juggle strategic leadership with the day-to-day running of the business. But amid the operational demands, it’s crucial that directors don’t overlook their legal responsibilities. Breaching those duties isn’t just a theoretical risk — it can lead to personal financial liability, legal action, or even disqualification.

What are directors’ duties?

Under the Companies Act 2006, directors owe a range of statutory duties to the company. These include:

1. Duty to act within powers – Directors must act in accordance with the company’s constitution and only exercise powers for their proper purpose
2. Duty to promote the success of the company – Perhaps the most well-known duty, this requires directors to act in good faith and consider the long-term impact of their decisions on stakeholders including employees, customers, and the environment
3. Duty to exercise independent judgment – Directors should not simply follow the instructions of others (such as majority shareholders) without applying their own judgment
4. Duty to exercise reasonable care, skill, and diligence – This combines an objective standard (what would a reasonably diligent person do?) with a subjective one (what does this particular director know, or ought to know?)
5. Duties to avoid conflicts of interest, not accept benefits from third parties, and declare interests in proposed transactions – Transparency is key, and failing to disclose conflicts can result in both reputational and legal consequences

Why it matters for SMEs

In small and medium-sized businesses, directors often wear multiple hats – as founders, majority shareholders, and/or close associates. That closeness can make it easy to blur the lines between personal and company interests. However, the law draws a clear distinction and directors must act in the best interests of the company and be clear that there is a clear distinction between the company, themselves and any individual or group of shareholders. This is particularly important in SMEs because:

• There is often less formal governance – Unlike large corporates with legal teams and compliance departments, SMEs often operate less formally. Despite best intentions, limitations on both resources and time can increase the risk of inadvertent breaches
• Directors may be more exposed – In smaller businesses, directors are more likely to be hands-on across the whole business for example with financial decisions, employment matters, and supplier and other contractual relationships — all areas with potential legal exposure
• Creditors may rely on personal conduct – In times of financial stress, directors’ actions (for example, continuing to trade while insolvent or prioritising certain creditors) can lead to personal liability claims from creditors or insolvency practitioners

When things go wrong, a director’s decisions are often scrutinised. Good intentions are not an effective defence if the legal duties have been ignored and in circumstances such as insolvency or legal disputes, these actions can retrospectively be placed under the microscope.

Personal liability risks

While limited liability protects shareholders from business losses, directors do not enjoy the same protection when it comes to breaches of duty or misconduct. Some of the most common personal risks include:

• Wrongful trading – If a director continues trading when they knew (or ought to have known) the company couldn’t avoid insolvency, they can be ordered to contribute personally to the company’s debts
• Breach of fiduciary duty – If a director puts personal interests above those of the company, they could be liable to the company or its shareholders
• Fraudulent or negligent misstatements – Making misleading claims in accounts, loan applications or investor updates can result in personal liability
• Disqualification – Directors can be disqualified from holding office (in any company) for up to 15 years if found unfit, for reasons including misconduct, failure to keep records, or trading irresponsibly
• Criminal penalties – In serious cases, especially involving fraud, bribery, or health and safety breaches, directors may face prosecution

Practical tips for SME directors

Legal compliance doesn’t need to be overwhelming. A few key habits can significantly reduce the risk of personal exposure:

• • Document decisions – Keep board minutes, especially for high-risk or financially sensitive decisions. A written record can demonstrate that issues were considered properly. You can read more about effectively planning and utilising board meetings here
  • Separate business and personal interests – Avoid informal arrangements where personal and company finances overlap. Always disclose conflicts of interest early and manage them transparently. You can read more about director’s conflicts of interest here
  • Understand your responsibilities – Many directors are unaware of the full scope of their obligations. Training, even in the form of short legal workshops or online courses, can be invaluable
  • Review your company’s constitution and shareholder agreements – These documents often contain specific obligations or restrictions. Make sure they align with how the business operates. You can read more about getting to know your company books here
  • Seek professional advice when needed – Don’t wait until there’s a crisis. Accountants, lawyers, and insolvency practitioners can all help spot risks early

The team at My Inhouse Lawyer has experience of helping clients both in managing situations when things go wrong but more importantly, in helping avoid the crisis in the first place. Whether it is reviewing your documentation, improving governance practices or simply discussing a situation so you have a second opinion, please get in touch if you’d like to discuss