Directors' Liabilities

Directors’ Liabilities John Devoy

Partner & Head of Litigation

No Immunity

• A Company Director is not immune from civil and criminal

personal liability as a consequence of the separate legal

identity of the company nor the fact that the Director only acts

as agent for the company.

• A Company Director can be personally liable for breaches of

statutory provisions or common law duties of care.

Statutory duties

Company Law

• Section 1121 Companies Act 2006 – Liability of officers in

default

• ‘…..in the event of contravention of an enactment in relation

to a company, an offence is committed by every officer of the

company who is in default.’

What ‘enactment’ can a director

contravene?

Section 171 Companies Act 2006 provides that:

• ‘A director of a company must

(a) act in accordance with the company’s constitution, and

(b) only exercise powers for the purposes for which they are conferred.’

• Therefore, if a director allows the company to enter into a transaction that goes beyond the company’s power, then he can be personally liable for the losses that a contracting party suffers.

Sections 172 -177

Companies Act 2006

Provide for various duties owed by directors to their companies:

• s.172 – Duty to promote success of company

• s.173 – Duty to exercise independent judgment

• s.174 – Duty to exercise reasonable care, skill and diligence

• s.175 – Duty to avoid conflicts of interest

• s.176 – Duty not to accept benefits from third parties

• s.177 – Duty to declare interest in proposed transaction or arrangement

s.178 – Civil consequences of breach

of general duties

• (1) The consequences of breach (or threatened breach) of sections 171 to 177 are the same as would apply if the corresponding common law rule or equitable principle applied.’

• They are enforceable against directors in the same way as any other fiduciary duty.

Companies (Trading Disclosures)

Regulations 2008

Section 6 of these Regulations provides that:

• Every company shall disclose its registered name on: – its business letters, notices and official publications

– its bills of exchange, promissory notes…

– company cheques

– orders for money, goods or services purporting to be signed by or on behalf of the company…

• Every company shall disclose its registered name on its websites.

Section 10 Companies (Trading

Disclosures) Regulations 2008

• provides that where a company fails to comply with this s.6 requirement an offence is committed both by the company and ‘every officer of the company who is in default’. A person guilty of an offence is liable on summary conviction to be fined both for the past contravention and for any continued contravention.

Health and Safety Legislation

s. 37 Health and Safety at Work Act 1974

• If a health and safety offence is committed with the consent or

connivance of, or is attributable to any neglect on the part of,

any director, manager, secretary or other similar officer of the

organisation, then that person (as well as the organisation) can

be prosecuted.

• See Armour v Skeen 1977 -the Director of Roads for Strathclyde Regional Council was successfully prosecuted under s.37(1), on the grounds that the offences committed by the council were attributable to his neglect: he had failed to produce a written safety policy for his department, though the council had required him to. The court held that, although the Director of Roads was not a "director" in the sense of the word as used in s.37, it was clear that he came within the category of "manager, secretary or other similar officer of the body corporate"

• Re Harper Building Contractors and Lee Harper 2005 – 12 months imprisonment

• Tafa v Matsim Properties Ltd 2011 – director jointly liable with company for injuries of employee

The Health and Safety (Offences) Act

2008

• Came into force on 16 January 2009 and increased maximum

fines in the Magistrates Court for health and safety offences

from £6,000 to £20,000. There is no maximum in the Crown

Court and fines regularly exceed £100,000.

Sex Discrimination Act 1975 and

Race Relations Act 1976

• Although a director cannot be held personally liable for an

unfair dismissal by the company, a director can find himself/herself personally liable for a claim for wrongful dismissal if it is shown that he/she was responsible for inducing the company to commit the breach of contract

• See Miles v Gilbank 2006 – director ordered to pay £25,000

• See Armitage, Marsden and HM Prison Service v Johnson 1997 – award of £21,000 made jointly and severally against HM Prison Service and its employees

S.21 of the Immigration, Asylum and

Nationality Act 2006

• Created a new criminal offence for an employer to employ somebody knowing that the employee is an adult subject to immigration control and:

• Has not been given leave to enter or remain in the UK or

• The leave to enter or remain in the UK is invalid, has ceased to have effect (whether by reason of curtailment, revocation, cancellation, passage of time or otherwise) or

• Is subject to a condition preventing the employee from accepting the employment

s.22(3) the Immigration, Asylum and

Nationality Act 2006 provides that

• If the offence is committed by a corporate body with the

consent or connivance of an officer of the body, both the officer and the body shall be liable for the offence. The reference to body includes a reference to a director, manager or secretary, a person purporting to act as a director, manager or secretary and, if the affairs of the body are managed by its members, a member.

Environmental Responsibilities

• There is a whole host of environmental legislation that provide

for the personal liability of directors for the environmental

offences of their companies not the least of which is the

Environmental Protection Act 1990. The EA does aggressively

pursue directors.

Common Law duties of care

The two primary common law duties owed by directors to their

companies are:

• A duty to act honestly and in good faith and

• A duty to exercise reasonable skill and care

Directors also have a duty of care to third

parties, including employees

• The Thomas Saunders Partnership v Harvey 1989

• Re D’Jan of London Ltd 1993

• Williams v Natural Life Healthfoods 1998

• Standard Chartered Bank v Pakistan National Shipping Corp 2002

• Contex Drouzhba Ltd v Wiseman 2007

Personal Guarantees

• Beware the personal guarantee. Banks are usually quite overt

in their insistence on a PG before they lend your company any

money. Trade suppliers aren’t always as up front about it.

How can you, as a director, protect your

position to avoid personal liability coming

home to roost?

• Familiarise yourself with the duties contained within s.172-177 CA 2006

• Make sure you work out and understand the key risks of the business and put in place adequate controls to manage those risks

• Take advice from professionals, including solicitors, accountants and insurance brokers

• Ensure that both you and your staff are properly trained, particularly when dealing with health and safety issues

• Have “adequate procedures” in place to prevent bribery from occurring

• Document all decisions taken at Board meetings (and do take the time to have Board meetings)

• Get an indemnity from the company to cover you for any personal liability Put in place, or insist on the company putting in place, Director and Officer liability insurance to cover personal liability (and read the policy!)

• Take out insurance for employee claims (see Aaron & Partners’ ‘Assure and Protect’)

• Read very carefully all contracts you are asked to sign and watch out for PGs in the small print

• Don’t make promises you know the company can’t keep

• Make it very clear in letters and contract documents that you are acting on behalf of the company and not in any personal capacity (always sign your letters off “For and on behalf of XYZ Ltd)

Liabilities of Directors Arising on

Insolvency (1)

The Twilight Period (1)

• When a company is insolvent but before it has entered a formal insolvency procedure it is in the “Twilight Period”.

• Once in the Twilight Period directors must consider the interests of the company’s creditors when making decisions about the company’s affairs.

• Failure to take account of the interests of creditors once in the Twilight Period could result in claims against directors personally by an Administrator or Liquidator subsequently appointed requiring the directors to contribute to the company’s assets from his or her personal assets.


Insolvency (1)

The Twilight Period (2)

• How do you know when the company is in the Twilight Period? – If it is unable to pay its debts as they fall due; or

– It’s liabilities exceed its assets; and

– There is no reasonable reason to expect the situation to improve in the near future.

• What should you do as directors in this situation? – Take professional advice regarding the potential implications of any

significant contracts or deals the company is proposing to enter.

– Record your decisions and the reasons for them fully in board minutes.


Insolvency (2)

Re-Use of Company Names – A Trap for the Unwary (1)

• Section 216 of the Insolvency Act 1986 provides that it is a criminal offence for a person who has been a director of a company which goes into insolvent liquidation to be a director or otherwise be involved in the management of a company which is known by a name the same as or similar to any name by which the insolvent company was known in the 12 months prior to its liquidation.

• Restriction lasts for 5 years from the date of liquidation.

• Aims to prevent owner managers liquidating their company to avoid paying its liabilities and then setting up again as if nothing had happened.


Insolvency (2)

Re-Use of Company Names – A Trap for the Unwary (2)

• In addition to being guilty of an offence, a person who breaches section 216 is also personally liable for all the debts of the second company incurred while that person is in breach.

• Exceptions – there are a number of highly technical exceptions but you should take advice if you find yourself in this situation as the rules are complex and the penalties for getting it wrong are high.

• If you do find yourself in this situation- consider whether you need to use the same or a similar name – if not then the problem is avoided BUT – beware re-using email addresses.


Insolvency (3)

Wrongful Trading (1)

• Under section 214 of the Insolvency Act 1986, a director can be required by the Court to contribute to the assets of the company in liquidation out of his or her personal assets if at some point prior to the winding up commencing he or she knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation.

• Extent of the contribution ordered to be made will be roughly equivalent to the amount by which the sums due to creditors of the company increased beyond the point at which the Court decides that the directors should have seen the writing on the wall.


Insolvency (4)

Fraudulent Trading

• Under section 213 of the Insolvency Act 1986 if, in the course of winding up

the company, it appears that the business of the company has been carried

on with intent to defraud creditors the Court can require any person who was

knowingly party to carrying on the business in this manner to contribute to

the company’s assets from their personal assets.

• Not restricted to directors.

• Rare because most businesses are not run fraudulently.


Insolvency (5)

Preferences (1)

• Section 239 of the Insolvency Act 1986.

• A preference occurs where, at a relevant time (as defined by the Insolvency Act) a company does something which puts one of its creditors in a better position than would have been the case in the event of the company going into insolvent liquidation e.g. repaying a loan made by a director to the company.

• The “Relevant Time” is 2 years prior to the onset of insolvency in the case of a preference to a connected person or 6 months in all other cases. The company must also be unable to pay its debts at the time of the transaction or become so as a result of it.


Insolvency (6)

Transactions at Undervalue Section 238 Insolvency Act 1986

• A transaction at undervalue occurs where at a relevant time (as defined by the Insolvency Act) a company transfers any assets belonging to it for less than the full value of that asset.

• Relevant time is 2 years prior to the onset of insolvency. The company must also have been unable to pay its debts at the time of the transaction or have become so as a consequence of the transaction.

• Remedy is for the Court to set the transaction aside or order the recipient of the asset to pay the company the correct value of the asset less the sum already paid (if any). Authorising a transaction at undervalue would be evidence of misfeasance by a director and would be relevant to disqualification proceedings.

• If you want to sell assets – do so in arms length transactions or at least get genuine valuations and do not sell for less than that amount.


Insolvency (7)

Misfeasance

• A Liquidator or Administrator can bring a claim against a director who it is

alleged has acted in a way which prejudiced the interests of the company’s

creditors at a time when the company was insolvent.

• If the claim succeeds, the director can be required to pay to the company

such sum as the Court determines to compensate the creditors for the loss

the director’s actions caused.

• Avoid transactions at undervalue and preferences.

• If you think the company may be insolvent, take advice as early as possible.

This may enable the company to be saved and at least will give you,

personally as directors, a steer on what you should be doing to protect your

own positions.


Insolvency (8)

Director’s Loans

• It is common for owner managers to be paid by the company through dividends rather than through the payroll as this produces a tax/NI saving.

• Drawings are taken monthly on account of the dividend to be declared at year end out of profit. However, dividends can only be declared out of profit (including retained profit). If there is no profit then the drawings are usually recorded as director’s loans in the accounts.

• On insolvency, the Liquidator or Administrator will expect loans to directors to be repaid. Claiming at that stage that the drawings were remuneration is not a defence – had it been remuneration tax and NI would have been paid.

• Therefore, if the company is insolvent reconsider any decision to pay yourself by way of drawings on account of dividends – the downside of paying PAYE and NI can save a substantial claim against you personally later.


Insolvency (9)

s.121C Social Security Administration Act 1992

• Where a company fails to pay PAYE and NI contributions on

time and the failure to do so is attributable to a Director’s fraud

or neglect, then HMRC can serve a Personal Liability Notice on

the Director.

• See Leslie Livingstone v HMRC [2010]

Claims against directors by

aggrieved creditors

How to avoid liability

• If you know the company will not be able to pay, stop incurring credit immediately and take professional advice quickly. While this may by unappealing it is better than personal liability.

• If you believe, with reasonable justification, that the company will be able to pay then hold a board meeting to consider whether to trade on and if you decide to do so, clearly record your reasons for believing the company will be able to meet its liabilities.

• Always read the contracts you are asked to sign on behalf of the company.

• Beware taking income as drawings on account of dividends.

John Devoy

01244 405523

[email protected]

Thank you. Any Questions? Thank you. Any Questons?

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Directors' Liabilities