What Are the Legal Duties of a Non-Executive Director in the UK

Welcome to the NED Capital Podcast. Today we are looking at one of the most important subjects anyone considering a non-executive director appointment should understand: the legal duties of a NED in the UK.

There is sometimes a misconception that because a non-executive director is not involved in the day-to-day running of a company, their legal responsibilities are somehow less significant than those of an executive director.

They are not.

A NED is a director in law. The Companies Act 2006 applies to executive and non-executive directors alike, and the responsibilities that come with being a director should be understood before accepting an appointment.

NED does not mean limited responsibility

The fundamental purpose of a NED is to provide independent oversight, constructive challenge and strategic judgement.

They are not normally responsible for managing the business on a daily basis. That remains the responsibility of the executive team.

But this separation of responsibilities does not mean that a NED can simply attend board meetings, read the papers and approve whatever management recommends.

A NED has a responsibility to understand the organisation, consider the information provided, ask appropriate questions and exercise their own judgement.

The law does not provide a special lower standard simply because someone is working part-time or is not involved in operations.

That is one of the most important things prospective NEDs need to understand.

The seven statutory duties

The Companies Act 2006 sets out seven general duties applying to directors.

These include the duty to act within the company's powers, the duty to promote the success of the company, the duty to exercise independent judgement and the duty to exercise reasonable care, skill and diligence.

There are also duties relating to conflicts of interest, accepting benefits from third parties and declaring interests in proposed transactions.

These may sound like straightforward principles, but their practical application can become considerably more complicated when a board is dealing with difficult commercial circumstances.

A NED needs to understand not only what the board is deciding, but why the decision is being made and whether sufficient information is available to make that decision responsibly.

Independent judgement is central to the NED role

Perhaps the most important characteristic of an effective NED is the ability to exercise independent judgement.

Being independent does not mean automatically disagreeing with management.

It means forming your own view.

A strong NED should be able to support an executive proposal when the evidence supports it, while also being prepared to challenge that proposal when something does not appear right.

That can mean asking uncomfortable questions.

Are the forecasts realistic? Is the company taking too much risk? Has management considered the downside? Is the board receiving complete information? Are there conflicts of interest? Does the proposed strategy genuinely support the long-term interests of the company?

Constructive challenge is not a sign that a NED is failing to support management.

It is one of the reasons the NED is on the board.

The duty of care, skill and diligence

Another particularly important area is the duty to exercise reasonable care, skill and diligence.

A NED is expected to prepare properly for meetings and engage with the company's affairs.

That can involve reading board papers carefully, understanding financial information, questioning unusual developments and seeking further information where necessary.

A director should not simply assume that everything presented by management is complete and accurate.

This does not mean that a NED needs to become an expert in every aspect of the business.

It does mean recognising when something falls within their particular expertise and when further advice or information is required.

In fact, a NED's own professional experience can increase the expectations placed upon them. A financially experienced NED, for example, may be expected to recognise issues in financial reporting that would not necessarily be apparent to someone without that background.

What happens when a company is in financial difficulty?

The legal responsibilities of directors become particularly important when a company is experiencing financial distress.

As a company's financial position deteriorates, directors need to consider the interests of creditors. Continuing to trade when there is no reasonable prospect of avoiding insolvency can potentially expose directors to personal liability for wrongful trading.

This is an area where a NED should not simply rely on management's assessment.

If there are serious concerns about solvency, independent professional advice may be appropriate.

A NED who finds themselves on the board of a company experiencing financial difficulty therefore needs to understand the changing governance environment and ensure that the board is addressing the situation appropriately.

Can a NED be personally liable?

This is one of the questions prospective directors ask most frequently.

The answer is yes: NEDs can, in certain circumstances, face personal liability.

That can arise from breaches of statutory duties, negligence, misconduct and certain insolvency-related situations.

The fact that the individual is non-executive does not provide a general shield against personal responsibility.

This is why directors should understand the protection available to them.

Directors' and Officers' liability insurance, commonly known as D&O insurance, can provide important protection against certain claims and associated legal costs. Companies may also provide appropriate indemnities, subject to legal limitations.

However, insurance is not a substitute for carrying out the role properly, and it will not necessarily protect a director against every form of wrongdoing or misconduct.

Good governance protects directors as well as companies

Good governance is therefore not simply about protecting shareholders or the organisation.

It also helps protect individual directors.

A NED who prepares properly, asks appropriate questions, requests information when necessary and records important challenges is demonstrating that they are taking their responsibilities seriously.

Board minutes and records of decision-making can become particularly important if a decision is subsequently questioned.

A director should be able to demonstrate that they considered the relevant information and exercised their own judgement.

This is particularly important for NEDs because their role is one of oversight rather than operational management.

What should you ask before accepting a NED appointment?

Before accepting a board appointment, prospective NEDs should look carefully at the company and the circumstances surrounding the role.

What is the financial position of the business?

What are the major strategic and operational risks?

Are there any ongoing disputes or regulatory issues?

What is the board's current composition?

How effective are the board papers and governance processes?

What D&O insurance and indemnity arrangements are in place?

And perhaps most importantly, are you comfortable that you can properly discharge the responsibilities of the role?

These are not questions that should be asked only after accepting an appointment.

They should form part of the decision to accept it.

Understanding liability for company debts

A related question is whether a NED automatically becomes personally responsible for a company's debts.

The answer is more nuanced than simply saying yes or no.

A company is normally a separate legal entity, so directors do not ordinarily become personally responsible for ordinary company debts merely because they are directors.

However, there are circumstances in which individual directors can face personal liability, particularly where there has been wrongdoing, breach of duty or certain insolvency-related conduct.

Our guide, Are Non-Executive Directors Personally Liable for Debts?, explores this distinction in more detail.

Taking the responsibility seriously

Being a NED can be an extremely rewarding role.

It provides the opportunity to use years of commercial, financial, operational or sector experience to help an organisation make better decisions.

But it is important to go into the role with a realistic understanding of the responsibilities involved.

A NED is not simply an experienced person who attends a monthly meeting.

They are a director with legal duties, a responsibility to exercise independent judgement and an obligation to take reasonable care, skill and diligence.

Thank you for listening to the NED Capital Podcast. If you want to understand the subject in greater depth, read our guide to the legal duties of a NED. And if your concern is specifically whether a NED can become personally responsible for company debts, see our guide on NED personal liability for debts.