How director's duties apply to arm's-length external organisations (ALEOs)

In recent years, local authorities have increasingly used ALEOs (Arm's Length External Organisations) to provide leisure, transportation, property development and care services. ALEOs are usually private companies limited by shares (but can also take the form of community enterprises, charitable organisations and trusts). Where an ALEO takes the form of a company incorporated under the Companies Act, local authority councillors and officers are often appointed directors of the ALEO, ensuring a link between the local authority and the services provided by the ALEO. There are many reasons why local authorities use ALEOs to provide services. However, local authority councillors and officers who take on the responsibility of an ALEO directorship must be mindful that when acting as a director they must act in the best interests of the ALEO, rather than the interests of the local authority.

1 Directors' general duties under the Companies Act 2006

In order to balance their duties to the company with the interests of the local authority's area, directors of ALEOs should be aware of what their duties towards the company are. Directors are tasked with the day to day management of the business. Their general duties under the Companies Act 2006 are as follows: 

1. to act within powers;
2. to promote the success of the company;
3. to exercise independent judgment;
4. to exercise reasonable skill, care and diligence;
5. to avoid conflicts of interest;
6. to declare interest in a proposed transaction or arrangement with the company; and
7. not to accept benefits from third parties.

Further details in relation to these general duties are contained in our 'Handy Guide to Directors' Duties', which is available here.

2 What happens if a director breaches their duty?

Breach of any of the above duties can carry serious consequences. Not least, the fact that a director who has breached any of their duties can be held personally liable for that breach. A claim against the director can be raised by any one of a number of interested parties.

The ALEO itself may bring a claim against the director in question. The remedy for such a claim would likely be financial damages, paid by the director to the company.

Where the company doesn't bring a claim against a director for breach of a duty, a shareholder can bring what is known as a 'derivative claim'. There is a high threshold which must be met by any shareholder bringing a derivative claim against a director, which is discussed in our previous blog.

A director in breach of their duties can also find themselves exposed to a claim brought by an insolvency practitioner, in the event the company becomes insolvent. This type of claim will usually relate to improper handling of company money but can also include breach of the director's duties. Indeed, the two are usually interlinked. 

3 Consequences of a breach of director's duties

Breach of director's duties can result in very serious financial, not to mention reputational, damage to the director in breach. Consequences of a successful claim may include payment of damages to the company, setting aside the transaction, liability for legal costs (potentially including the costs of the person or entity who brought the claim), disqualification from acting as a director, and in some cases, criminal penalties. Therefore, it is crucial that directors of all companies, including ALEOs, remain mindful of their duties while carrying out the day to day management and operation of the company. One of the lessons to take from this blog is that avoiding a conflict between directors' duties and the interests of the local authority's area requires careful consideration of what the ALEO's purposes, objects and powers ought to be at the stage of setting it up.

Brodies regularly advises clients on all aspects of corporate governance, including director's duties. If you have any queries arising from this blog, please do not hesitate to get in touch with any of the people mentioned below, or your regular Brodies contact.