A recently published case has shone a new light on the well-known fact of English company law – that a company has its own legal personality and is therefore separate and distinct from its members and directors.
Thus, a company shields its members and directors from most liabilities. For directors, this protective veil is pierced in certain limited circumstances such as those set out below.
1. Not acting in good faith
2. Voluntarily entering into personal guarantees
3. Filing at Companies House
4. Wrongful trading
5. Breach of director’s duties
6. Breach of statutory duty including Healthy and safety legislation
7. Statutory declarations
8. Phoenix liability
9. Vicarious / assumed liability
10. Tax evasion
1. Not acting in good faith
The recently published case of Antuzis v DJ Houghton Catching Services Ltd, confirmed the principle that directors entering into contracts in bad faith can be held personally liable.
In Antuzis, it was held that the director and sole member of the company was liable for inducing the company’s breaches of contract where they were knowingly in breach of fiduciary or personal duties to the company.
The case of Antuzis looks at whether a director will be held personally liable if they are “acting bona fide within the scope of his authority”. In Antuzis, the discussion focussed upon “the officer’s conduct and intention in relation to his duties towards the company” rather than “towards the third party that provides the focus of the ‘bona fide’ enquiry”. As such the director should make sure he fully understands not only his statutory duties but what documents such as any shareholders agreement and articles of association set out.
2. Voluntarily entering into personal guarantees
A director can be personally liable when they have agreed to personally guarantee or otherwise secure the financial obligations of a company. These are often requested by banks to give a bank maximum protection for any loan taken out by the company.
It is often easier to pursue an individual, who has the guarantee, than enforce its security against the company. In such cases, the director is making themselves personally liable should the company not be able to fulfil its obligations to the third party.
The director’s liability can be limited by (a) not giving the personal guarantee at all, or (b) putting a monetary limit on the guarantee or linking any guarantee to a specific obligation (e.g., a specific loan).
3. Filing at Companies House
A company has an ongoing obligation to keep Companies House updated with all relevant changes to the company (for example, the appointment or resignation of company officers) and make trading disclosures about itself and the nature of its business. These filing obligations vary depending on the size of a company and whether it is public or private.
Directors of every company must prepare accounts for each financial year. If a company does not fulfil their filing obligations within the set time, a director can be liable for a fine of up to £5,000. A director can also be held liable to the company for any loss caused by the making of a misleading statement or any omission from the filings.
4. Wrongful trading
This statutory offence under sections 214 of the Insolvency Act 1986 (IA 1986) was a hot topic last summer, with the temporary relaxation of the regime coming to an end on 30 June 2021. This offence applies where a company has gone into liquidation or administration and a director knew, or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation or administration and failed to take every possible step to avoid further potential loss to a company’s assets and/or creditors. If the court decides that this has occurred, it can order the director to make an appropriate contribution to the company’s assets.
Further, to assess whether wrongful trading has occurred, the courts will apply both an objective and subjective test based on the circumstances of the director and a minimum threshold. As a result of this, not all directors will be held liable together (for example, sometimes executive directors may be held liable, whilst non-executive directors are not).
Note, courts will not impose sanctions if directors are able to show that they made honest and rational commercial decisions to protect the interests of creditors (even if they turned out to be wrong).
5. Breach of director’s duties
Directors’ duties are set out in the Companies Act 2006 (CA 2006), and also apply to:
- de facto directors (persons who act as if they are a director and are treated as such by the board despite not being validly appointed as such); and
- shadow directors (persons in accordance with whose directions or instructions the directors of a company are accustomed to act).
The seven statutory duties are as follows:
- to act within their powers;
- to promote the success of the company;
- to exercise independent judgment;
- to exercise reasonable care, skill and diligence;
- to avoid conflicts of interest;
- to not accept benefits from third parties; and
- to declare interests in proposed or existing transactions or arrangement with the company.
A director also has a duty of confidentiality to the company and to act in the best interests of creditors generally.
If a director were to breach any of the above, they could be liable pursuant to a derivative action, i.e. where a shareholder can bring a claim on behalf of the company and the director would need to make good any loss caused by their breach.
6. Breach of statutory duty including Healthy and safety legislation
As proven in 2016, after the tragic incident at Alton Towers, directors can also be held liable for failures in health and safety.
A director can be found secondarily liable under the Health and Safety at Work Act where an offence by a company is committed with their consent or connivance or is attributable to their neglect This can result in an unlimited fine or imprisonment for up to two years. Note, in cases involving fatal incidents at work, a director can also be found criminally liable for involuntary or gross negligence manslaughter.
As discussed above, CA 2006 sets out numerous general duties with which a director must comply. One such duty that applies in a health and safety context is the duty to act in a way that promotes the success of the company for the benefit of its members. The Health and Safety Executive has published guidance which sets out specific mechanisms by which a director can comply with its duties, for example, ensuring effective monitoring and reporting systems are in place.
7. Statutory declarations
Before a company can enter into a members’ voluntary liquidation (this is a solvent liquidation process most often used when the shareholders no longer want to continue the business), the directors of the company must state that a company is able to pay its debts by way of a statutory declaration of solvency. This sets out that the company can pay all of its debts in full within the next 12 months.
If this declaration is made without reasonable belief in its accuracy, directors can be liable for an unlimited fine or up to two years imprisonment. If the declaration is not registered within 15 days of being made, both directors and the company can be filed at an aggregate rate for each day it is not filed.
Another example of a director having to make such a declaration is on the discharge of a company’s security at Companies House. If a declaration is made without reasonable grounds, again there can be personal consequences for such a director.
8. Phoenix liability
A ‘phoenix event’ is an arrangement resulting in a entity re-emerging with essentially the same or similar name after an insolvency event involving a prior company which had overlapping directors.
It is an offence for directors to re-use an insolvent company name in a new venture. The test of this offence is whether the name of the new company name (newco) is so similar that it will cause confusion to any creditors of the dissolved company.
For any such newco to be valid, directors will need a court order or need to provide a notice to all creditors. If these requirements are not followed and the newco fails in the proceeding five years, the directors can be held directors jointly and severally liable for the debts of the newco.
9. Vicarious / assumed liability
In a signature block involving a company, you will often see the wording ‘For and on behalf of X Ltd’ under the director’s signature. This phrase is used to indicate that the signatory does not intend to be bound personally. Failure to do so may result in a director being deemed a party to the contract and therefore personally liable for any subsequent breaches.
The court will always look to interpret the intention of the contracting parties in deciding who should be held liable. Hence, it is vital that a director sets out their deliberate intention to signify on behalf of the company rather than as an individual.
10. Tax evasion
The Finance Act 2020 introduced a new form of liability for directors, whereby HMRC, in specific insolvency circumstances, can hold directors jointly and severally liable for tax or tax penalties. This liability was introduced to ensure individuals are held liable for bad behaviour and for HMRC to recover the full amount of any tax liability or penalty where companies are affected by potential or actual insolvency.
HMRC can issue notices in this regard only when the liability arises or is expected to arise from:
- tax avoidance
- tax evasion,
- repeated insolvency, or
- a penalty for facilitating avoidance or evasion;
and where the company begins insolvency proceedings, or is expected to do so, causing any of the tax liability to be lost to HMRC.
Conclusion
Even if a director is held liable on some of the points mentioned above, there may be ways to mitigate or limit the loss caused to the individual. This could be achieved by taking legal advice and considering the following factors:
- whether the company has Directors’ and Officers’ liability insurance;
- whether the company articles include a specific indemnity for directors;
- whether there is a right of contribution (for example, a bank could enforce a personal guarantee against any other guarantors); or
- whether there a claim for subrogation (for example, enforcing the security of a company held by the bank).
Contact us
We work proactively with company directors to advise them on their responsibilities, whether they are new to the role or more established. For further help on directors’ liabilities, or to obtain legal advice on mitigating your loss as a director, please contact Paul Taylor or Claire Bowler.
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