Liable Laws
A directorship is the pinnacle of many people's careers - but with it comes a string of legal liabilities.
You've either been appointed to the board or you've set up a reseller comes a string of legal liabilities. business and become a director. Either way - and you may not know it - you now have responsibilities and obligations, all of which can leave you open to the full rigours of the law if you ignore them. Below is a guide to some of the things you should know about your new position.
A director is appointed under the company's articles of association, usually by the other directors or shareholders of the company. But, even if not specifically appointed, statute recognises the concept of a de facto director, namely a person who carries out the duties of a director irrespective of their title. Consequently, it is not possible for a director to avoid his duties by appointing nominal directors and merely assuming another title. Further, it is possible to have so-called shadow directors - people whose instructions are followed by directors.
Obligations
The law regards a director as being in a position of trust, owing his duties to the company itself, and various statutes lay down specific requirements for them. Failure to comply with these can result in criminal and/or civil sanctions.
The law also places a director under other duties such as a duty of care and skill, and a duty not to place himself in a position where there might be a conflict between the director's personal interests and those of the company.
There are many instances of potential liability for a director, including:
Criminal Liability
In many cases, if a company commits an offence and it is due to the negligence, consent or connivance of a director then he is equally liable for the criminal offence.
A director who secures or aids and abets a company to commit an offence or conspires with the company to commit an offence is equally liable with the company.
The Criminal Justice Act 1993 restricts an individual in possession of inside information from using that information.
It is an offence if a director, with a view to deceiving others, publishes information he knows is misleading, false or deceptive.
If a director fails to notify the Board of any interest in a transaction involving the company, then he commits a criminal offence.
Subject to limited exceptions, a company must not make loans to a director or guarantee a director's indebtedness.
Fraudulent trading, as defined by statute.
Civil Liability
A director must act in good faith and in the company's best interests.
A director must exercise his powers for proper purposes. For example, this specific duty could prevent a director from having his company issue further shares to defeat a takeover offer.
Generally, a director must not place himself in a position where his duty to the company conflicts or may conflict with his personal interests.
Where a director breaches this duty he will be made to account for any 'secret profit' made.
The directors are trustees of the company property under their control and will be liable for any misapplication of the company's assets.
Where a director enters into a transaction with the company over a certain value then shareholders' approval must be obtained.
There are provisions in the Companies Act 1985 imposing specific duties on directors, for example, to prepare annual accounts, keep records for VAT etc.
Fraudulent trading, as defined by statute.
Wrongful trading, as defined by statute.
A person who has been disqualified by the court from acting as a director but who continues to be involved with the company's management will be liable for all the debts of the company while he is involved with it.
Who May Bring An Action Against A Director?
Because a director owes his duties to the company, any action for breach of duty should be brought by the company itself. This is an alarming prospect for a minority shareholder, since most companies are controlled by the directors, who would obviously never permit the company to bring an action against themselves.
However, case law has established that a minority shareholder may bring an action in the name of the company if he can show that it would be a fraud on the minority of shareholders to prevent it.
Also, it is now possible for a shareholder to apply to the court for an order authorising proceedings on the ground that the company's affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members.
In practice, it is often not until a liquidator's investigation that a director's wrongdoing comes to light, so it will be the liquidator who brings any action against a director.
There are statutory provisions whereby certain third parties may bring actions against directors. For example, it may be possible for a third party to bring an action against a director where creditors may have been defrauded.
Personal Liability of Directors' Fraudulent Trading
This is a civil and criminal offence which in the past has proved to be of limited application since it requires proof that the business of the company has been carried on with intent to defraud its creditors.
Wrongful Trading
An action for wrongful trading may be brought against a person if:
The company has gone into insolvent liquidation.
At some time before the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid liquidation, and
That person was a director of the company at that time.
In connection with wrongful trading, it is worth noting that:
An action for wrongful trading may only be brought in a winding up, and the only person who may bring the action is the liquidator itself. Following such an application, the court can decide upon what contribution the director is obliged to pay to the company's assets.
The court will not make a declaration of wrongful trading if it is satisfied the director took every step with a view to minimising the potential loss to the company's creditors. Resigning from the Board is not sufficient.
Because the court considers the skill and experience of the individual director in question, the finance and managing director are most at risk, but the other directors cannot absolve themselves from liability.
Any individual director who disagrees with the course of action being embarked upon by the company, but is unable to persuade his fellow directors to change course, should ensure for his own protection that his disagreement is accurately minuted.
Restrictions On Re-Use Of Company Names
Except with the court's permission, it is a criminal offence for a person who has been a director of a company within 12 months of its going into liquidation to be involved for five years in the running of any other company bearing the name of the insolvent company, a name under which it carried on business, or a name which suggests association with it.
Such a director may not in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of such a company; or in any way, whether directly or indirectly, be concerned or take part in the conduct of a business carried on under such a name.
Any director in breach of these provisions will also be personally liable for the company's debts.
Other Offences Under The Insolvency Act
The Insolvency Act 1986 contains a number of further offences relating to malpractice before and during a liquidation. Examples include:
Fraud in anticipation of winding up, e.g. where a director fraudulently removes any part of the company's property or makes false entries in the company's books within the twelve month period immediately preceding the winding up.
When a company is wound up, a director will be deemed to have committed an offence if he has made or caused to be made any gift or transfer of, or charge on, the company's property - unless the conduct in question occurred more than five years prior to the commencement of the winding up, or the director proves that at the time of the conduct in question he had no intent to defraud the company's creditors.
Misconduct in the course of winding up, or falsification of the company's books.
Disqualification of Company Directors
A court must disqualify a person from being a director if he has been a director of a company which has at any time become insolvent, and his conduct was contributory to this.
An application for mandatory disqualification under this section may be made by the Secretary of State or, if he so directs, the official receiver.
The minimum period of disqualification is two years, and the maximum 15 years.
In determining whether a director should be banned, a court will look at things such as any misfeasance (transgression of the law) or breach of any fiduciary (given in trust) duty by the director.
These could be any misapplication or retention of company property, or the extent of the director's responsibility for the company entering into any transaction which may have defrauded creditors. Also, where the company has become insolvent, the extent of the director's responsibility for the causes of insolvency, any failure by the company to supply goods or services which have been paid for, and the entrance into any transactions which were undervalue or which gave preference to any person.
A court may also disqualify a person for the following reasons: if convicted of an offence in connection with the promotion, formation, management, liquidation or striking off of a company, or with the receivership of or management of a company's property; if the director has persistently failed to file, send or deliver any relevant document to the Registrar of Companies.
Finally, it is an offence for someone who is still technically bankrupt to act as a director of, or be indirectly concerned in the promotion, formation, or management of a company - except with the permission of the court.
Insuring Against the Risk
Although directors and officers (D&O) liability insurance has been available for many years, relatively few directors take advantage of the cover available.
Although companies are permitted to provide a limited indemnity to directors, it is only to the extent provided for in the company's articles of association and by statute. Consequently, most companies' articles make sure that the company only covers the liability of the director in defending any proceedings in which judgment is given in his favour or in which he is acquitted.
Broadly speaking, a D&O liability insurance policy will cover a director for claims which arise from any wrongful act committed while a director.
This includes awards of damages and costs made against the director together with the costs incurred by him in defending the action.
However, criminal liability cannot be insured against, and so the cover provided does not include fines, penalties, punitive or exemplary damages.
Similarly, the costs incurred in unsuccessfully defending legal proceedings which involve allegations of fraud, dishonesty or malicious conduct are not included.
Of course, the terms of any D&O liability insurance policy need to be carefully considered beforehand, and, as with any insurance, may contain exclusions which will need to be borne in mind.
D&O liability insurance will usually involve the issue of two policies.
The first policy reimburses the company itself and the second covers the director himself when it is not available from his company.
Keith Froud is a solicitor in the Leeds office of Eversheds.