Limited liability in a company context means limited liability for shareholders but not for directors. Directors can have a number of different potential legal liabilities arising from their position as agent of the company, trustee of its assets, employee or professional adviser.
As a result of this directors need to be aware of their duties and responsibilities and ensure that they are properly discharged
Should Directors be Concerned about Personal Liability?
The concept of directors’ liability is nothing new. But as more pressure is being put on management to protect its organisation against the risks presented by ever developing challenges including cybercrime and GDPR, in addition to regulators and legislators calling for greater board accountability, the personal exposure of directors has rightly become more of a concern in the boardroom
It is a fundamental principle of English law that a limited company is a distinct legal entity from its directors and shareholders. In theory, this means that despite being responsible for making the day-to-day decisions and running the company, directors would not usually be liable for any obligations, debts and legal action.
However, there are circumstances in which a director can be held personally liable. In fact, under the Companies Act 2006 alone there are over 200 offences for which a director in the UK may be held personally liable. In addition to other legislation, offences include those relating to bribery, GDPR and data protection, health and safety, discrimination, financial reporting requirements and general mismanagement.
Directors Duty of ‘Reasonable Care’
The Companies Act 2006 states that “a director must exercise reasonable care, skill and diligence” when running a company. They must also comply with the following general duties:
- “act within powers” or in other words in accordance with the company’s constitution
- promote the success of the company
- exercise independent judgement
- avoid conflicts of interest
- not accept benefits from third parties
- declare an interest in a proposed transaction or arrangement. If a director is directly or indirectly interested in a proposed transaction or arrangement with the company, he or she must declare the extent of it to the Board before the company enters into that transaction or arrangement.
There are other duties that are owed to the company under the Act, such as keeping proper books and records, restrictions and conditions on entering into certain transactions with the company as well as gaining shareholder approval for loans over £10,000 from the company, for instance. Breach of these duties can result in directors being disqualified and incurring personal liability.
Claims by the company
The company itself can bring a claim against the erring director if it can show that it has suffered some loss. If the director has made some personal profit, they can be required to surrender the gain to the company.
A contract or other arrangement entered into by the director in breach of a duty will be void, though it may be open to the company to ratify the agreement if it wishes to do so.
The company may also seek:
- an injunction to stop the director from carrying out or continuing with the breach;
- damages by way of compensation where the director has been negligent;
- restoration of the company’s property;
- the rescinding of a contract in which the director had an undisclosed interest.
Claims by a company are often retrospective, brought by members of the existing board against their predecessors. (It is, after all, unlikely that a board will choose to sue itself; turkeys don’t vote for Christmas.) In 2002, for example, the newly installed directors of Equitable Life voted to pursue the company’s former directors for the losses it had suffered as a result of problems with its guaranteed income policies. It was only after several years of crippling litigation, which pushed a number of the defendants towards bankruptcy, that the company agreed to withdraw its claims.
Errant directors can also face claims against them when a company is sold. The new owners may appoint new directors and, if things go wrong, they may cast around for past breaches of duty and the opportunity to hold the old directors to account.
Claims by shareholders against directors
The Companies Act 2006 (the “Act”) contains a statutory statement of directors’ duties, listing 7 general duties which were intended to codify the pre-existing law on directors’ duties. The Act also confers further power on shareholders to make claims against directors. Prior to the Act claims could only be brought where directors wrongfully conferred the benefit on themselves, whereas since the Act a shareholder may bring a claim on behalf of the company in relation to “an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director”.
Such a “derivative claim” may be brought against a director or another person. The Act requires that a claimant show a prima facie case before being given permission by the court to proceed with any claim. Again, the Act provides a non-exhaustive list of factors that the court must take into account when considering whether or not to grant permission to proceed – e.g. whether a shareholder is acting in good faith, whether continuing the claim accords with the need to promote the success of the company and whether the shareholders would be likely to authorise the act or omission complained of.
Misfeasance Claims Against Directors
Misfeasance is a general term that covers wilfully incorrect or inappropriate actions as a director. It’s an accusation that might be made when a company is liquidated – part of the liquidator’s role is to carry out investigations into why the company failed.
They look into the actions of directors leading up to the liquidation for signs that they have knowingly worsened the position of creditors, or taken deliberate action that compromises their responsibilities as directors.
Claims by a liquidator or administrator
Once a company becomes insolvent, a liquidator or administrator will be under a duty to consider a claim against a director where a breach of duty is discovered. A claim will be treated as an asset of the company: it will be pursued and realised for the benefit of creditors.
Directors Duties in Insolvency and Liquidation
In law, if a company is insolvent then the directors have a duty to the creditors not themselves or the shareholders. As such, the first thing to to do is establish whether the company is insolvent. We have an online insolvency test to help you establish this. If your business is insolvent then you must act to ensure that you do not make the creditors’ situation worse.
Some directors are guilty of willfully piling up debt with no hope of paying back creditors – by doing this they are risking an action for wrongful trading that can lead to disqualification and personal liability for the company’s debts. Some directors breach their duty to creditors by removing assets from premises or selling assets to another company at less than full price.
This is known as a transaction at an undervalue, and can be reversed by the liquidator. Because of these regulations it is imperative that you seek advice before embarking on such a transaction.
Another trap that directors often fall into is assuming that the assets and monies in the company’s bank account belong to them personally. Even if a director has funded the business by putting his/her own money into the company this does not mean that assets belong to them. The assets belong to the company and the company owes them.
Should the company goes into a formal insolvency process they would be classed as a creditor and may receive some of the money back. But this is not guaranteed. Ultimately our advice though is not to fund a company personally without any sort of security for the debt.
Directors who are also trustees of their company’s occupational pension scheme or group life insurance scheme may face personal liability for any breaches of trust and breaches of certain regulatory requirements. In certain circumstances, directors may incur personal liability to pay money into (or provide other financial support for) a defined benefit pension scheme operated by their company or with which they are otherwise connected or associated.
The Government has said that legislation will be brought forward as soon as parliamentary time allows introducing a new criminal offence of “wilful or reckless behaviour” in relation to pensions. The new law is designed to ensure that company directors who allow defined benefit scheme deficits to escalate to unsustainable levels, or who endanger their workers’ savings through chronic mismanagement, face legal action.
Tax and insolvency
In terms of tax, the circumstances where the directors can be held personally liable for the tax liabilities of the company are relatively limited and largely confined to certain insolvency situations or where there has been an element of fraud/wilful default on the part of the relevant directors.
For example, in an insolvency situation, whilst it has no direct recovery powers, HMRC can (and more often than not will) require security for VAT in relation to any future businesses with which any of the directors of the insolvent company may become involved.
There are also some circumstances whereby HMRC can seek to recover outstanding PAYE debts and NICs from the directors. To be liable for outstanding PAYE debts a director must have ‘wilfully failed’ to deduct tax (meaning that the recovery power is most often applied in the case of small owner-managed companies or where the director has some personal influence or control over the company’s finances). NICs can be recovered if non-payment is attributable to the fraud or neglect of the director.
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For more information about your duties as a director, and the consequences of breaching those duties, call our experts on the numbers above or simply complete the online enquiry form. One of our professional will offer advice on the next step.