Becoming a it worth the risk?

Over the last decade the business world has changed. Corporate scandals on a considerable scale, amendments to worldwide securities regulations, increased shareholder awareness and extended rules on corporate governance have made being a company director an increasingly difficult task.  Directors have always been bound by many duties; the difference today is that stakeholders have far greater remedies against directors and the appetite for litigation appears to be increasing with the "blame culture".

The basic position, of course, is that a limited company exists as a legal entity in its own right; its liabilities do not extend to its officers.  In particular circumstances, however, that basic position is displaced and directors may have liability.  A limited company is an entity controlled by people. It can only act according to the actions of those people. There is a common theme for the circumstances in which personal liability may occur. That is when a person exercising control is dishonest or wilfully negligent.

Who is a director?

There are several types of directorship:

•           Executive director. A director who carries out executive functions in the company and is usually a full or part-time employee of the company.

•           Non-executive director. A director who is not an employee of the company or holder of an executive office. Such a director would usually devote part of his time to the affairs of the company as an independent adviser or supervisor.

•           De jure director. A person validly appointed as a director.

•           De facto director. A person who acts as if he is a director and is treated as such by the board but has not been validly appointed.

•           Shadow director.   A person whose instructions and decisions the other directors or the company accept and implement.  However, unlike a de facto director he may not carry out those actions himself.  He too has not been validly appointed.

In law, no distinction is recognised between the role and responsibilities of a non-executive director and those of an executive or other form of director.  All directors are subject to various statutory obligations, duties and responsibilities.

General Duties

The Companies Act 2006 codifies certain common law and equitable duties of directors. The duties are:

1.         Duty to promote the success of the company. In so doing, a director must take a long- term view of wider considerations such as employees, the environment, suppliers and customers.

2.         Duty to exercise independent judgment.

3.         Duty to exercise reasonable care, skill and diligence. As with the common law rules, a director is expected to exercise the level of care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and the general knowledge, skill and experience that the director has (e.g. if the director is an accountant he is expected to understand accounting function to a better degree than a fellow director with no finance training).

4.         Duty to avoid conflicts of interest (to the extent that these are not authorised by the other directors).

5.         Duty not to accept benefits from third parties.

6.         Duty to declare an interest in proposed transactions or arrangements of the company.

Remedies for breach of duties

The most commonly breached duty is that of “care, skill and diligence”.  The remedy is usually one of damages for which the director is personally liable.

Remedies for breaches of other general duties can include:

•           An injunction;

•           Setting the transaction aside, restitution and account of profits;

•           Restoration of company property held by the director;

•           Damages.

Some regulatory breaches include set financial penalties.  For example, large corporations with profits in excess of £20 million or gross assets in excess of £2 billion, are obliged to have a designated Senior Accounting Officer who will often be a director.  His duty is to ensure that the tax accounting arrangements are legally compliant.  This individual is personally liable for a £5,000 penalty for failing to comply with such a duty.

In cases of health and safety breaches there are a number of offences which may result in an unlimited fine and even a possible prison sentence.

Criminal Liability

Not only are directors at risk of personal (financial) liability but in certain circumstances they are exposed to criminal liability as well. The most common of these are listed below:

•           The offence of corporate manslaughter (Corporate Manslaughter and Corporate Homicide Act 2007) may result in criminal liability for a director whose negligent conduct has played a substantial role in bringing about the unlawful death of an employee.

•           Other serious health and safety breaches attributable to neglect on the part of the director may also expose the director to criminal liability and risk of imprisonment.

•           The Bribery Act 2010 imposes strict liability on a company where an offence of bribery is committed by a company’s director.  If found guilty of this offence a fine and prison are potential outcomes.

•           A director can be held criminally liable for thefts under the Theft Act 1986 and for fraud pursuant to the Fraud Act 2006.

•           There are a number of environmental offences that can lead to criminal liability.

•           It is also a criminal offence under the Financial Services Act for a director to knowingly or recklessly make a misleading or false statement to induce a person to buy shares.

Apart from the above situations which are relatively rare, directors’ criminal liability tends to arise when a company is either insolvent or is nearing this position (namely it is unable to pay its debts when they fall due).  It is at these times that directors typically expose themselves to the risk of criminal liability for a variety of acts:

•           Fraudulent trading (knowingly carrying on a business with the intention to defraud creditors)

•           Wrongful trading (pre liquidation) which is when a director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going insolvent and continues to trade.

Who can bring a claim against a director?

•           The company itself.

o          Often this happens in an insolvency.  The liquidator may review historic transactions and pursue claims against historic breaches.

o          In the UK there are relatively few instances of companies pursuing their directors outside the realms of insolvency. Historically, it has perhaps been regarded as inappropriate for a solvent company to sue its offending directors, and is seen as a deterrent to would-be directors from becoming involved with the company. It has more often been the case that the director in question would be prevailed upon to resign and the matter would go no further.

•           The State - regarding criminal acts.  It may be a specified Regulatory Authority, Environment Agency, or the Police depending on the facts.

•           Shareholders.  In certain limited instances, a company’s shareholders may bring proceedings to enforce the obligations of a director to his company. Where the conduct of a current director is scrutinised (other than in the case of an old board/new board rift, or clear disagreement between directors as to conduct), a company may not wish to pursue an action, perhaps because the company is being managed by the very directors who are said to have been involved in the wrongdoing. In these circumstances, shareholders are able to take the initiative in pursuing a director whose conduct they consider to have been inappropriate or to have caused the company loss. This route is called “shareholder derivative action” which is now provided for under Part 11 of the 2006 Act. Because the director owes his duties to the company, this involves the shareholder bringing an action against a director on the company’s behalf, which the company itself has not chosen to pursue.

How can a director protect himself/herself?

Whether or not a director is ultimately held liable for claims made against him, the associated defence costs can be extremely expensive, and the process can take up months or even years of a director’s valuable time. It is essential, therefore, that directors check that the company has in place an appropriate Directors and Officers (D&O) insurance policy and that payments to the policy are always made.

Posted on 03/12/2014 by Ortolan

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