Strategy & Operations » Legal » Personal liability risk- what FDs need to know

Being a director can be difficult at the best of times but never more so when a company comes under financial pressure.  What are the personal liability risks to directors and what are their duties when a company becomes distressed?

Duties and responsibilities

The statutory duties of directors owed to the Company are as set out in the Companies Act 2006. They are:

  • To act within powers granted by the Articles;
  • To promote the company’s success;
  • To exercise independent judgment;
  • To use reasonable care and skill;
  • To avoid personal interest conflict;
  • Not to accept personal benefit arising from the role of director; and
  • To declare personal interests in any proposed transactions or arrangements by the company.

When the company is solvent these duties, although owed to the company, exist and should be exercised for the benefit of the shareholders. On insolvency there is a shift to act for the benefit of the creditors.

Conduct and decision making in distressed situations

To avoid personal liability to the company on insolvency directors must act in a way which does not worsen the position of its creditors. Actions for wrongful trading can be avoided where a board can show that it took every reasonable step to minimise the potential loss to creditors.

Misfeasance claims will be avoided where the board members have acted in a way which does not dilute the net asset position of the company and where they can show that creditors have been paid pro-rata. Transactions during a distress period must be considered carefully. Incurring further debt should be avoided.

Decision-making in distressed situations is a balancing exercise where the impact on (all) creditors takes priority. Whether (and for how long) a company should continue to trade is often a difficult decision and is one which requires, often daily, monitoring.

Trading on should continue only where there is a purpose which offers a better outcome for creditors such as a sale of the company or the business as a going concern or a new investment coupled with a restructuring to return the company to solvency.

Payments to some, but not all, creditors may be necessary to keep the business trading on. These decisions can only be taken where it is reasonable to do so and where there is a need to do so pending a sale or investment which will result in a better outcome for creditors.

Directors’ conduct will be considered both subjectively and objectively. Essentially, they will each be judged against their own skills, role and background as well as against what a reasonable person with such skills, role and background would have or should have done.

Taking professional advice (both legal and insolvency) offers directors guidance during a distressed period and whilst that directors cannot rely on such advisors to make decisions for them they can rely on the advice given to them by way of guidance.

Getting it wrong – personal liability

If a director or a board takes the wrong decision resulting in a worsening of the position of the creditors then the director can expect to be the subject of a claim for a contribution to the assets of the company from an officeholder.

Each officeholder appointed is required to undertake an investigation into the conduct of the directors of an insolvent company. These investigations may result in actions being brought against directors personally for compensation to the company under the Insolvency Act 1986.

Such claims may be for wrongful trading or misfeasance (breach of duty). Additional claims under the Companies Act 2006 may also exist. The proceeds of such claims are applied for the benefit of the unsecured creditors of the company.

Each officeholder is required to make a report of the directors’ conduct to the Disqualification Unit who will decide whether the conduct of the directors (or any of them) renders that person unfit to be involved in the formation, promotion or management of a limited company and, as such, should be disqualified from being a director for a period (of between 2 and 15 years) under the Company Directors Disqualification Act 1986.

Summary

Whilst the Courts consider the decisions and conduct of directors in the period before a formal insolvency without the benefit of hindsight they do look carefully at the conduct of the directors to determine whether the decisions made were made reasonable and aimed to minimise the loss to creditors.