What Is Directors' Duty of Care?

Directors of companies in England and Wales are subject to statutory duties designed to ensure proper management of company affairs and protection of corporate interests. One of the most significant of these obligations is the duty of care, skill and diligence, which governs how directors must perform their roles and make decisions. This duty is primarily set out in section 174 of the Companies Act 2006 and reflects both long-established common law principles and modern statutory standards.

The duty of care is central to corporate governance. It applies to all directors, regardless of company size or sector, and breaches can result in personal liability, financial penalties, or disqualification from acting as a director.

Legal Basis of the Duty of Care

The statutory duty of care is found in:

• Companies Act 2006, section 174

Section 174 requires a director to exercise:

• Reasonable care
• Reasonable skill
• Reasonable diligence

This provision codifies earlier common law principles developed through case law and reflects a combined objective and subjective standard.

The Two-Part Legal Test

The standard applied under section 174 is not uniform for all directors. Instead, it includes two layers:

1. Objective standard

A director must meet the standard expected of a reasonably competent person carrying out the same functions. This ensures a baseline level of competence across all directors.

2. Subjective standard

The law also considers the individual director's actual knowledge, skill, and experience. If a director has specialist expertise, a higher standard may apply.

This dual test ensures that directors with greater qualifications are held to a higher standard than those with limited experience.

Key Legal Principles

Delegation and supervision

Directors may delegate tasks to others, including managers or external professionals. However, delegation does not remove responsibility. Directors must still:

• Monitor delegated work
• Ensure appropriate reporting systems exist
• Intervene where issues arise

Failure to supervise properly can amount to breach of duty.

Reliance on professional advice

Directors may rely on advice from solicitors, accountants, or other professionals. However, reliance must be reasonable in context. Blind reliance without proper oversight may still result in liability.

Business judgment principle

Courts generally avoid second-guessing commercial decisions made in good faith. However, this does not protect directors who:

• Fail to inform themselves properly
• Ignore obvious risks
• Act without adequate consideration

Key Case Law

Re D'Jan of London Ltd [1994]

This case is a leading authority on directors' duty of care. A director signed an insurance form without reading it, resulting in the company losing insurance cover. The court found this to be negligent, establishing that directors must take reasonable care even in small or informal companies.

Re City Equitable Fire Insurance Co Ltd [1925]

An earlier case that set a low subjective standard for directors. Modern law has moved beyond this approach, requiring a more rigorous combined standard.

Re Barings plc (No. 5) [1999]

This case confirmed that directors must supervise delegated responsibilities and ensure effective internal controls, particularly in large organisations.

When Directors Breach the Duty of Care

A breach occurs when a director's conduct falls below the statutory standard. Common examples include:

• Failing to attend or properly engage in board decisions
• Ignoring financial warning signs
• Inadequate oversight of company operations
• Signing documents without proper review
• Failing to implement basic risk management systems

The court will assess the facts of each case, including the director's role and the company's circumstances.

Legal Consequences of Breach

Where a breach of duty is proven, potential consequences include:

1. Financial liability

Directors may be required to compensate the company for losses caused by their negligence.

2. Contribution orders in insolvency

In insolvency proceedings, directors may be ordered to contribute to company assets if their conduct worsened the company's financial position.

3. Disqualification

Under the Company Directors Disqualification Act 1986, directors may be banned from acting as directors for a specified period.

4. Court relief in limited circumstances

Courts may relieve liability if the director acted honestly and reasonably, depending on the circumstances.

Practical Implications for Directors

To comply with the duty of care, directors are generally expected to:

• Understand the company's financial position
• Actively participate in board decisions
• Maintain awareness of key risks
• Ensure adequate record-keeping and reporting systems
• Seek professional advice where necessary
• Supervise delegated tasks appropriately

The standard increases with the complexity and size of the business.

Common Misunderstandings

“Small company directors are held to a lower standard”

Not entirely correct. The objective standard still applies. However, context may influence what is considered reasonable.

“Relying on professionals removes liability”

Reliance must be reasonable. Directors remain responsible for oversight.

“Bad outcomes equal breach”

A poor business result does not automatically indicate negligence. The court focuses on the decision-making process, not outcomes alone.

Key Takeaways

Directors' duty of care is a statutory obligation requiring directors to act with reasonable care, skill, and diligence when managing a company. It is assessed using both an objective standard and the director's personal expertise. Courts consider whether decisions were properly informed, whether supervision was adequate, and whether reasonable steps were taken to manage company affairs. Breaches can result in personal financial liability, disqualification, and other legal consequences. The standard is flexible but requires active, informed, and responsible participation in company management.