Becoming a company director once meant possessing a public-school education, a bowler hat, and holding a strong belief in the phrase ‘my word is my bond’.

But that is no longer necessarily the case.

And so, with an air of inevitability, more directors are finding themselves in hot water as authorities and the media put malfeasance firmly in the spotlight. And the matter has been made more prominent with greater scrutiny on corporate governance following Russia’s invasion of Ukraine.

So, to highlight the ways in which directors can find themselves in trouble and personally liable for company obligations not met, Printweek spoke to two lawyers for their top five topics when providing legal advice.

Fox Williams
Paul Taylor, a partner at City firm Fox Williams, sees directors who find themselves in trouble on a regular basis. Experience has taught him that there’s a myriad of ways a director can find themselves in the limelight.

The first Taylor draws attention to involves statutory declarations which are made when a firm is heading for the buffers. He says: “If a company is in trouble, before it can enter into a members’ voluntary liquidation, the directors of the company must state that a company is able to pay its debts by way of a statutory declaration of solvency.” He adds that this sets out that the company can pay all its debts in full within the next 12 months. But if this declaration is made without reasonable belief in its accuracy, Taylor says that directors can become liable for an unlimited fine or up to two years imprisonment.

In addition, he cautions that if the declaration is not registered within 15 days of being made, both directors and the company can also be fined for each day that it remains unfiled.

But such declarations can be made in other circumstances and Taylor gives another example – the discharge of a company’s security at Companies House. Again, he says: “If a declaration is made without reasonable grounds, again there can be personal consequences for such a director.”

Second on Taylor’s list is the obvious matter of health and safety law breaches. He refers to the 2016 tragic incident at Alton Towers where directors were held liable for failures in health and safety.

He explains: “Under the Health and Safety at Work etc Act 1974, a director can be found secondarily liable where an offence by a company is committed with their consent or connivance or is attributable to their neglect.”

The penalty? An unlimited fine or imprisonment for up to two years. Worse – Taylor says that in cases “involving fatal incidents at work, a director can also be found criminally liable for involuntary or gross negligence manslaughter”.

He states that the Companies Act 2006 (CA 2006) sets out numerous general duties with which a director must comply. The one that applies in a health and safety context is section 172 – the duty to act in a way that promotes the success of the company for the benefit of its members. He says: “The Health and Safety Executive has guidance which sets out specific mechanisms by which a director can comply with its duties, for example, ensuring that effective monitoring and reporting systems are in place.”

Phoenix liability is the third problem area for Taylor, and it can occur where an entity re-emerges with essentially the same or similar name after an insolvency event involving an earlier company and the same directors.

The problem is that, as he says, the Insolvency Act 1986 (IA 1986), specifically section 216, makes it an offence for directors to re-use an insolvent company name in a new venture. He continues: “The test of this offence is whether the name of the newco is so similar that it will cause confusion to any creditors of the dissolved company.”

He explains that this section of the act stipulates that for any newco to be valid, directors will need a court order or need to provide a notice to all creditors in the form set out in section 216. The concern for Taylor is that “if these requirements are not followed and the newco fails in the next five years, the directors can be held jointly and severally liable for the debts of the newco”. And he drives the point home by reference to a November 2021 case, PSV 1982 Ltd v Langdon, where “the court held that a director in breach of section 216 is automatically responsible for the liabilities without the need for new proceedings against that director”.

Next comes vicarious and assumed liability. In detailing this one, Taylor tells how in an execution block involving a company there will often be the wording ‘For and on behalf of X Ltd’ under the director’s signature. This phrase, he says, “is used to indicate that the signatory does not intend to be bound
personally. Failure to insert the text may result in a director being deemed a party to the contract and therefore personally liable for any subsequent breaches”.

The problem for directors, as Taylor puts it, is that “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”.

Taylor’s final concern is tax evasion. He tells how 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. He says: “This liability was introduced to ensure individuals are held liable for bad behaviour and to allow HMRC to recover the full amount of any tax liability or penalty where companies are affected by potential or actual insolvency.”

Taylor notes that HMRC can issue notices under the act, but 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.

VWV
Zeena Asghar, a corporate solicitor in nationally based VWV, also sees numerous hazards for directors.
She acknowledges the fact that a company has a separate legal personality and is thereby responsible for its own debts, property and actions. But, like Taylor, she too finds directors who have become personally liable as a result of their involvement in a company.

Wrongful Trading is the first problem area she tackles. She too refers to IA 1986, noting that “a director of an insolvent company may become liable for wrongful trading under sections 214 and 246ZB if, at some point, before the start of liquidation or administration, they knew – or ought to have known – that there was no reasonable prospect the company would avoid insolvent liquidation or administration”.

A bit of a tongue twister. Nevertheless, in making her point, she says that consideration is given to the size of the business and the director’s function within the company and, in particular, what they knew and what a reasonable director would have known in the circumstances.

She mentions that directors should be aware of red flags indicating insolvency such as insolvency on a balance sheet basis, creditor pressure, late filing of accounts, and numerous proceedings or statutory demands issued against the company.

That said, Asghar notes: “A director may be able to raise a defence if they can prove that they took sufficient steps with a view to minimising the potential loss to the company’s creditors after they became aware that the company had no prospects of avoiding insolvent liquidation or administration.”

But to do this means taking professional legal advice, minimising debts and drawing up management accounts to establish the financial position of the company.

Further, Asghar advises: “Regular board meetings should be convened and all commercial decisions of the directors should be reported in full in the company’s minutes.” She says that it is important directors keep accurate records of their own activities, keep all financial records up to date and raise financial concerns with the board when they become evident.

And from a director’s perspective, she says that their liability – meaning how much they might have to contribute to the company’s assets – will typically be measured against the increase in the company’s net asset deficiency. This runs from the time when the director first realised there was no reasonable prospect of the company avoiding insolvent liquidation or administration up to when the company went into that process.

Asghar’s second area for concern is that of fraudulent trading.

And she outlines what she means: “A director who knows the company is unable to pay its creditors, but continues the business of the company regardless with the intention to defraud the creditors, can be found guilty of fraudulent trading under sections 213 and 246ZA IA 1986.”

She comments that case law has set a high standard of proof required in proving liability and a two-stage test has been developed by the courts. “In essence, a liquidator or administrator must demonstrate the director’s subjective state of knowledge; and show that the director’s conduct was dishonest applying the objective standards of ordinary decent people.”

And if fraudulent trading is proven, Asghar says that “a director may be liable to make personal contributions to the company’s assets… the amount of contribution, however, cannot be punitive”.

In practice, however, she says that fraudulent trading actions are rare due to the difficulty of establishing intent and are typically only brought against directors engaged in criminal conduct.

Next on Asghar’s list is misfeasance, or breach of director’s duties.

She explains that liability here arises under section 212 IA 1986 and occurs where “in the course of winding up a company, there has been a breach of any fiduciary or other duty of a director”. In simple terms, “this may involve a director that has misapplied or retained, or become accountable for, any money or other property of the company”.

However, Asghar does offer director’s a common law defence where the shareholders – who have a right to attend and vote at a general meeting – consented to the matter. But she says this defence comes with limitations and “it cannot be relied upon where the company was insolvent at the time”.

Alternatively, she highlights a statutory defence under section 1157 CA 2006 which may also assist “if the director can be said to have acted honestly and reasonably having regard to the circumstances at the time”.

“Ultimately though,” she says, “if misfeasance is established, then the director can be ordered to repay, restore or account for the money or property with interest, or personally contribute to the company’s assets.”

Fourth on Asghar’s list is a common bugbear of directors – lenders asking for personal guarantees.

The obvious problem here is that if the company defaults on the loan, a lender will be able to enforce the terms of the guarantee. And to make matters worse, she says: “In some circumstances, guarantees are also supported by charges over the personal assets of the directors… and this could require them to sell their homes to repay the company’s debt or lead to them being declared bankrupt if they do not have the sufficient assets.”

For her, it is important that directors understand the legal consequences and implications of entering into this type of guarantee. She recommends that directors ask for the guarantee to be capped at a certain level and avoid giving security in support; certainly, a director should seek independent legal advice to satisfy any concerns beforehand.

Asghar’s final risk factor relates to the failure to maintain company records. As she says: “These duties under the CA 2006 are often overlooked by directors, but can attract significant fines and/or criminal sanctions against directors personally.”

In overview, there are various records private limited companies are required to keep in their statutory registers which include register of members, directors and secretaries, and charges and debentures. Asghar comments: “While maintaining yearly filings at Companies House is commendable, it is not always sufficient to comply with the requirement of maintaining statutory registers.”

The problem is that the failure to maintain statutory registers is often only discovered when, for example, shareholders want to exit a company and the register of members needs to be produced and relied upon prior to completion of the sale. In this situation, registers will need to be updated or reconstituted prior to completion, which can cause significant delay to timings and incur additional costs.

Asghar further warns that if there are no records, then members of a company are not able to enforce their right to inspect a company’s statutory registers by giving the company 10 working days’ notice – less in certain circumstances. “Therefore,” she says, “the registers must exist!”

Summary
There is all manner of ways that a director of a company can end up in trouble. Some involve criminal law, while others involve civil law and personal exposure to company obligations. The reality is that there is only one way to forestall any likely troubles, and that’s for directors to be fully aware of their duties and obligations by taking good legal advice and not acting in haste only to repent at leisure.