When directors can be held personally liable?
Directors can be held personally liable when they fail to uphold their legal duties, engage in misconduct, or when the corporate veil is pierced, moving beyond the limited liability protection typically afforded to companies.
Understanding Director Liability
While a company is a separate legal entity, offering its directors and shareholders protection through limited liability, there are specific circumstances where this protection is lifted, and a director's personal assets can be at risk. This typically occurs when a director acts outside their authority, neglects their duties, or engages in fraudulent or illegal activities.
Key Scenarios for Personal Liability
A director can be found personally liable for a company offence if they consented or connived in an illegal activity, or caused it through neglect of their duties. Beyond this, several key areas expose directors to personal liability.
1. Breach of Statutory Duties
Directors have a range of statutory duties under company law, such as the Companies Act 2006 in the UK. Failure to comply can lead to personal liability.
- Duty to promote the success of the company: Acting in good faith to promote the success of the company for the benefit of its members as a whole.
- Duty to exercise independent judgment: Not allowing personal interests or other parties' interests to override their judgment.
- Duty to exercise reasonable care, skill, and diligence: This includes 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 actually has.
- Duty to avoid conflicts of interest: Directors must not place themselves in a position where their personal interests conflict with the company's interests.
- Duty not to accept benefits from third parties: Benefits received by reason of being a director or doing (or not doing) anything as a director.
2. Insolvency and Wrongful/Fraudulent Trading
This is a critical area where directors often face personal liability, particularly if a company enters insolvency.
- Wrongful Trading: If directors continue to trade when they knew, or ought to have known, that there was no reasonable prospect of the company avoiding insolvency, they can be held personally liable for the company's debts incurred after that point. This typically occurs when the company's financial position is deteriorating, but directors fail to take appropriate action, such as seeking professional advice or ceasing to trade.
- Fraudulent Trading: This involves carrying on the business with intent to defraud creditors or for any fraudulent purpose. This is a criminal offence and carries severe penalties, including unlimited personal liability for debts and potential imprisonment.
- Transactions at an Undervalue: Selling company assets for less than their true value, especially if done to deprive creditors, can result in the transaction being reversed and directors being held liable.
- Preferential Payments: Paying off certain creditors (e.g., friends, family, or other associated companies) in preference to others when the company is insolvent.
3. Breach of Fiduciary Duties
Directors owe fiduciary duties to the company, meaning they must act in utmost good faith and put the company's interests before their own.
- Misuse of Company Assets: Using company funds or assets for personal gain or unauthorized purposes.
- Taking Corporate Opportunities: Diverting a business opportunity belonging to the company for personal benefit.
- Secret Profits: Making undisclosed profits from a transaction involving the company.
4. Specific Legal Breaches
Beyond general corporate duties, directors can be personally liable for specific legal infringements.
- Health and Safety Breaches: If a company commits a health and safety offence, directors can be held personally liable if the offence was committed with their consent or connivance, or was attributable to their neglect. This is particularly relevant under the Corporate Manslaughter and Corporate Homicide Act.
- Environmental Offences: Similar to health and safety, directors can be personally liable for environmental damage or pollution caused by the company if they were complicit or negligent.
- Tax Evasion/Failure to Pay Tax: Directors can be held personally liable for unpaid company taxes (e.g., PAYE, VAT) if there's evidence of neglect or fraud.
- Intellectual Property Infringement: Directors can be personally liable if they authorize or procure the company's infringement of patents, trademarks, or copyrights.
5. Personal Guarantees
Often, directors provide personal guarantees for company loans, leases, or supplier contracts. In such cases, if the company defaults, the director is contractually obliged to pay the debt personally, regardless of whether they breached any duties.
6. Piercing the Corporate Veil
In rare circumstances, courts may "pierce the corporate veil," disregarding the company's separate legal personality to hold directors personally liable. This usually occurs in cases of extreme misconduct, such as:
- Sham or Façade Companies: Where a company is merely a front for an individual's activities, designed to avoid existing legal obligations.
- Fraud: Where the company structure is used to perpetuate fraud.
Preventing Personal Liability
To mitigate the risk of personal liability, directors should:
- Understand Your Duties: Be fully aware of all statutory, fiduciary, and contractual duties.
- Act with Diligence: Exercise reasonable care, skill, and diligence in all company affairs.
- Seek Professional Advice: Consult legal and financial experts when facing difficult decisions, especially concerning insolvency or complex transactions.
- Maintain Accurate Records: Keep clear and comprehensive records of all decisions and financial transactions.
- Ensure Compliance: Implement robust systems to ensure compliance with all relevant laws and regulations.
- Review Personal Guarantees: Understand the implications of any personal guarantees signed.
- Obtain Directors' & Officers' (D&O) Insurance: While not protecting against all forms of liability (e.g., fraud), D&O insurance can cover legal costs and some damages incurred from liability claims.
By adhering to their duties and acting responsibly, directors can largely protect themselves from personal liability and ensure the continued success of their company.
