Directors’ Duty to Exercise Independent Judgment: Understanding Section 173 of the Companies Act 2006
The Directors’ Duties Series – Part 3
This article is part of our directors’ duties series. It examines section 173 of the Companies Act 2006, which requires directors to exercise independent judgment. Directors may consider the views of colleagues, shareholders and professional advisers, but the decision must ultimately be their own.
What Does the Duty to Exercise Independent Judgment Mean?
Section 173 requires directors to assess the available information and reach their own conclusion rather than subordinate their powers to another person’s wishes. The duty is owed to the company, not to the shareholder, investor or other person who may have appointed or influenced them.
In practice, directors should not:
- automatically follow instructions from a shareholder, investor or parent company;
- allow a dominant director or founder to make decisions on their behalf;
- accept professional advice without applying their own judgment; or
- delegate a matter without retaining appropriate oversight.
Independent Judgment Does Not Mean Acting Alone
The duty does not require directors to make decisions in isolation. They may seek advice, consider the views of others and reach the same conclusion, provided that they form their own view. Directors may also question or challenge fellow board members, but must continue to act within the company’s constitution and collective decision-making process. Independent judgment does not allow them to bypass a properly made board decision.
How Does the Duty Apply to Nominee Directors and Group Companies?
Nominee directors appointed by a shareholder, investor or lender may take the appointing party’s views into account. However, they must not treat those views as binding or automatically place that party’s interests above those of the company.
The same principle applies within a corporate group. A subsidiary’s director must consider the subsidiary’s own position rather than simply adopt the parent company’s instructions. Competing interests may also engage the separate duties concerning conflicts and declarations of interest.
Delegation and Exceptions Under Section 173
Directors do not have to carry out every task personally. Where permitted by the company’s constitution, they may delegate work to another person or committee. However, they should choose someone suitable, maintain appropriate oversight and intervene if concerns arise.
Section 173 also recognises that a director’s duty of independent judgment does not prevent the company from entering into binding agreements. Directors must exercise their independent judgment when deciding whether the company should enter into an agreement. Once it has been validly entered into, complying with it later will not breach section 173 simply because it limits the board’s future choices.
This principle was recognised in Fulham Football Club Ltd v Cabra Estates plc [1994] 1 BCLC 363. The directors had exercised their judgment when approving the agreement, so complying with it later did not mean that they had surrendered their independence.
The directors must still comply with all their other statutory duties when delegating work or approving an agreement.
Practical Considerations for Directors
Directors should review the relevant information, ask questions, identify any conflicts or external pressure, ensure that delegation is properly authorised and record the reasons for important decisions.
Professional advice may be particularly valuable where there are competing interests, shareholder pressure or uncertainty about a director’s authority. However, responsibility for the final decision remains with the director.
What Happens if the Duty Is Breached?
A breach may expose a director to a civil claim by the company. Depending on the circumstances, remedies may include an injunction, rescission of a transaction, an account of profits or financial compensation. A shareholder may also seek permission to bring a derivative claim on the company’s behalf, while serious misconduct may contribute to disqualification proceedings.
The same conduct may breach several duties, including those concerning acting within powers, promoting the company’s success, exercising reasonable care, skill and diligence and avoiding conflicts of interest.
How Can We Help?
When board disagreements, shareholder pressure or competing group interests arise, our experienced solicitors advise companies, directors and shareholders on corporate governance and alleged breaches of directors’ duties. We can also review company articles, shareholders’ agreements and proposed transactions before disputes arise.
Our multilingual team can assist clients in English, Mandarin and Cantonese. Contact Chan Neill Solicitors LLP today for advice tailored to your circumstances.
This article is for general information only and does not constitute legal advice.