OVERVIEW OF DIRECTORS’ DUTY TO ENHANCE FINANCIAL INTEGRITY, AND SHAREHOLDERS RIGHTS

(Insight: Corporate commercial series 6)

Directors are the custodians of a company’s governance, entrusted with steering its strategic direction and ensuring compliance with legal and financial obligations. Their responsibilities extend beyond operational oversight into critical areas such as financial reporting, audits, insolvency management, and the protection of shareholder rights. Unlike auditors who serve as independent examiners of a company’s financial statements, directors bear primary responsibility for the accuracy, integrity, and transparency of those statements. Auditors provide assurance and verification, but directors are accountable for the underlying financial records, disclosures, and decisions that shape the company’s financial health. This distinction underscores the directors’ pivotal role as they are not merely overseers but fiduciaries, legally bound to act in the best interests of the company and its stakeholders.

The Role of Directors in Financial Reporting

Under the Companies Act, directors bear the primary responsibility for ensuring that a company’s financial statements present a true and fair view of its financial position. This duty is codified in Section 635 and 636 of the Companies Act, which requires directors to approve financial statements only if they are satisfied that they give such a view. To discharge this obligation, directors must establish and maintain robust internal financial controls designed to prevent fraud, misstatements, and errors. The Act further requires directors to prepare a directors’ report under Section 654, which must include details such as the company’s principal activities, the names of directors during the financial year, and any recommended dividends.  By signing the financial statements, directors formally assert their accuracy and compliance with applicable accounting standards (such as IFRS or GAAP) and statutory requirements. Failure to prepare or approve compliant statements constitutes an offence, attracting a fine not exceeding KES 500,000. Where material uncertainties exist, they are legally obliged to disclose them transparently, ensuring that shareholders and creditors are fully informed of potential risks. This framework underscores that directors, unlike auditors, carry the primary accountability for the preparation and presentation of financial statements, while auditors serve as independent examiners of those assertions.

Responsibilities during routine Audits

An audit is not a passive exercise for directors, it is an active engagement that requires diligence and transparency. During routine audits, directors are obligated to provide auditors with unrestricted access to company records, personnel, and documentation. Supplying false or misleading information to auditors constitutes a criminal offence, reflecting the seriousness of this duty. In addition, directors must sign a Management Representation Letter, formally acknowledging their responsibility for the financial statements and confirming that all significant facts have been disclosed. This obligation flows directly from their statutory duty under Section 635 and Section 636, which require directors to ensure that financial statements give a true and fair view of the company’s financial position.  Once the audit is complete, directors must carefully review the auditor’s Management Letter, which highlights weaknesses in internal controls, and take corrective action to strengthen governance and compliance. Failure to address such deficiencies may expose directors to liability under provisions such as Section 637 and 638, which mandates adherence to prescribed accounting standards and disclosure requirements. Thus, routine audits reinforce the principle that directors are not merely overseers of financial reporting but active custodians of accountability, ensuring that the company operates with integrity and in compliance with the law.

Responsibilities During Insolvency

Insolvency is defined as a situation where the company is placed in liquidation with insufficient assets to cover its debts and liabilities, or where it is under administration. When a company enters insolvency, the directors’ primary duty shifts from shareholders to creditors. Under the Companies Act, 2015, directors are required to take every reasonable step to minimize potential loss to creditors. This obligation is reflected in provisions such as Section 1002, which prohibits fraudulent trading, and Section 787(2), which addresses wrongful trading by directors who continue to incur debts when they know there is no reasonable prospect of avoiding insolvency. Under Section 218, courts have a statutory duty to disqualify unfit directors and secretaries of insolvent companies.

A disqualification order must be made if the court is satisfied that the individual was a director or secretary of a company that has become insolvent, and that their conduct makes them unfit to participate in company management. In assessing unfitness, the court considers matters outlined in the Second Schedule, including conduct during insolvency. Importantly, misconduct connected to insolvency is also taken into account. The period of disqualification ranges from a minimum of two years to a maximum of fifteen years, reflecting the seriousness of directors’ duties and the need to protect creditors and the public from irresponsible corporate management. Failure to comply with these duties can expose directors to personal liability, fines, and disqualification. Thus, insolvency law reinforces the principle that directors’ responsibilities intensify during financial distress, requiring them to act prudently, transparently, and in the collective interest of creditors rather than shareholders.

Personal Liability and Disqualification

The corporate veil does not always shield directors from personal liability or professional consequences, particularly in cases of insolvency or misconduct. Under the Companies Act, 2015, Section 133, the acts of a director remain valid even if their appointment was defective, they were disqualified, had ceased to hold office, were not entitled to vote, or if the resolution appointing them was void. Under Section 506 of the Insolvency Act, the director may be liable if during liquidation it appears that the director knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation, the liquidator may apply to the court for an order requiring that officer to contribute to the company’s assets. The court may also disqualify the officer from acting as a director or in company management, unless it is satisfied that the officer took reasonable steps to minimize potential losses to creditors. Directors can be held personally liable to contribute to the company’s assets if they are found guilty of wrongful trading or fraudulent trading. In addition, courts have the power to disqualify directors whose conduct renders them unfit to manage a company. This framework demonstrates that directors’ responsibilities are not merely collective but can carry severe personal consequences when breached.

Fiduciary Duties of Directors

Fiduciary duties serve as the moral compass of directors, rooted in principles of trust and accountability. Under the Act, directors are required to act within the powers conferred by the company’s constitution, ensuring that their decisions align with the objects and governance framework of the company. They also carry the duty to promote the success of the company in good faith for the benefit of its members as a whole, a principle reflected in Section 143, which emphasizes acting in the best interests of the company. In addition, directors must exercise the care, skill, and diligence expected of a reasonably diligent person with both the general knowledge and the specific expertise of a director, as outlined in Section 145. Equally important is the duty to avoid conflicts of interest, codified in Sections 146, which prohibit directors from placing themselves in positions where personal interests conflict with those of the company, including restrictions on transactions with the company unless properly disclosed and approved. These fiduciary obligations highlight that directors are not merely managers of corporate affairs but trustees of the company’s integrity, required to balance power with responsibility and ensure that their conduct consistently advances the company’s long-term success.

Rights of Minority Shareholder

Minority shareholders are those holding less than 50% of voting rights and are often vulnerable to majority oppression. The Act provides specific protections to safeguard their interests. Under Section 654, they have information rights, including the entitlement to receive annual accounts and attend general meetings. They also retain voting rights on key resolutions, such as the appointment or removal of directors, as provided in Section 284 and related provisions governing shareholder meetings. Importantly, minority shareholders may institute derivative actions under Section 238, allowing them to bring proceedings on behalf of the company against directors for breach of duty, particularly where fiduciary obligations under Sections 142–149 have been violated. Furthermore, they are protected against unfair prejudice under Section 780, which permits them to petition the court if the company’s affairs are being conducted in a manner that is oppressive or unfairly prejudicial to their interests. These statutory safeguards ensure that minority shareholders are not powerless within the corporate structure, but instead have enforceable rights to hold directors accountable and to protect their stake in the company.

How minority shareholders can protect their rights

Minority shareholders in Kenya, often holding less than 50% of voting rights, face the risk of majority oppression, but the Companies Act, 2015 and contractual mechanisms provide avenues for protection. A well-drafted shareholders’ agreement can serve as the strongest safeguard, incorporating provisions such as veto rights over critical decisions ensuring minority voices are not ignored. Contractual protections may also include tag-along rights, which guarantee that if majority shareholders sell their stake, minority shareholders can participate in the transaction on the same terms, thereby preventing exclusion from strategic exits. Statutorily, minority shareholders may seek remedies under Section 780, which allows them to petition the court if company affairs are conducted in a manner unfairly prejudicial to their interests. Additionally, under Section 219 and Section 780(3), they can apply for a court order to wind up the company on just and equitable grounds or compel a buyout of their shares at fair value. These protections ensure that minority shareholders are not powerless but have both contractual and statutory tools to safeguard their investments and enforce accountability against directors and majority shareholders.

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