Risks and Possible Liabilities For Directors
The starting point with limited companies is that the company is a separate legal entity from those that own it (the shareholders) and those that manage it (the directors). In most situations it is difficult for a 3rd party to “pierce the corporate veil” and successfully make a claim against directors but this does not tell the whole story. In an increasing number of scenarios, because the directors have day to day control of a company, they are subject to potential statutory (criminal as well as civil), or common law liabilities for directors.
All company directors should ensure they are aware of potential personal liability, act accordingly, and consider ways in which to protect themselves legally.
The following are some of the most important risks for directors:
Health and Safety
Responsibility for health and safety is primarily the responsibility of the company and not individual directors but where a company commits a Health and Safety offence and directors have consented or connived with the commission of that offence of a director or been demonstrably negligent causing the offence, the director may be liable to be prosecution under section 37 of the Health and Safety at Work etc Act 1974 which carries a maximum sentence of 2 years in prison and an unlimited fine. He or she may also be disqualified from being a director for a period of time (section 2(1) of the Company Directors Disqualification Act 1986).
The Bribery Act 2010 contain some very harsh provisions against directors. In essence, directors can face criminal liability, including very sizeable fines, even where they have done nothing to encourage or countenance bribery or corruption and weren’t even aware of it. The Act places positive obligations on directors to take all reasonable steps proactively to prevent bribery and corruption. The starting point for any company will be based on having appropriate policies and training for staff but ongoing risk analysis, compliance monitoring and other initiatives are also necessary. The larger the company the more the directors will be expected to do to comply and businesses which trade internationally or in sectors which are more prone to corruption are expected to be especially vigilant.
The Insolvency Act 1986 contains various provisions for director wrongdoing. Although they only apply when a company has gone into liquidation (so therefore do not apply to administration and this is a reason why in some situations creditors will ensure as a matter of principle that a company is liquidated so that directors they suspect of wrongdoing will be investigated) they relate to the conduct of the directors before the liquidation.
Section 214 – Wrongful trading
A liquidator may apply to court for an Order that a director be found personally liable to replace company’s assets where the director knew or ought to have concluded there was no reasonable prospect the company would avoid insolvent liquidation and he or she has failed to take appropriate steps to minimise potential losses for creditors.
Section 213 – Fraudulent trading
Intent to defraud may be inferred if a person obtains credit knowing or suspecting that there will be no funds to pay the debt. If proven the director will, in addition to being liable to contribute to the company’s assets, be guilty of a criminal offence.
Section 212 – Recovery for misfeasance
The liquidator, a creditor or a shareholder can sue for damages where directors have misapplied or retained or become liable or accountable for any money or property of the company. This would include, for example, improper payments of dividends, using money for personal gain such as loans or excessive salary.
Sections 238 – Transactions at an undervalue
A transaction at an undervalue occurs where, in the 2 years prior to the company going into liquidation, assets are disposed of for significantly less than they are worth.
Section 239 – Voidable Preferences
A preference, which is liable to be set aside, occurs where one or more creditors receive preferential treatment to other creditors in the 6 months prior to liquidation (the period is 2 years if transactions under suspicion are with related entities such as shareholders or connected companies). The liquidator can apply to have transactions set aside but must prove that the directors acted with a desire to prefer creditors over others.
Directors who are found to have been involved in wrongdoing associated with insolvency, such as described above, may face disqualification, which in severe cases, can be for as long as 15 years.
In many small companies, especially those without a successful track record and history, it is very difficult to obtain finance without the directors giving personal guarantees.
In addition to the obvious risks of personal liability based on a default, many bank guarantees contain aspects which are not immediately obvious and which create additional risks. These include :-
- Most guarantees are drafted as providing continuing security, meaning the guarantee is not automatically cancelled even if it was taken out to guarantee a particular loan which has been paid off., The guarantee will continue, unless cancelled, and will apply automatically to other borrowings the company has with the lender.
- The amount owed potentially rising, including interest and possibly costs – if possible, it is always worth seeking to cap liability to a fixed amount.
- Personal Guarantees can be cumulative. If you have signed a guarantee and are then asked to sign a new guarantee for a higher amount, you may well be liable for both amounts.
- You should not assume, if other directors have also signed personal guarantees, that the bank will only expect you to pay back an equal proportion to others who have given guarantees. The lender may pick and choose who it goes against and has no obligation to be fair. When several directors give guarantees, indemnities should be considered between them so that if not all are proceeded against by the lender, those that aren’t are liable to repay the guarantors who have been pursued and have paid out.
What can directors do to protect themselves from all these risks?
- Remain aware, vigilant and professional at all times – keep up with the law
- Obtain legal and other advice when unsure of the implications of a situation in the company
- Document decisions and decision making processes to show a proactive and reasonable approach to issues
- Act with honesty, integrity and reasonableness at all times – this of itself can constitute a defence to most potential liabilities for directors.
- Seek an indemnity from the company against any financial liability or costs of defending criminal or regulatory proceedings.
- Obtain Directors & Officers Insurance although be aware that, as with any insurance policy, there may be exclusions for some matters and the policy may be voided by dishonesty, criminal activity and so on.