Becoming a limited company director doesn’t require an exam, but it does come with an expectation that director’s understand their legal rights and responsibilities.
In this article, we’ll explore what happens when directors either fail to understand these laws, or fail to abide by them.
Directors Duty of ‘Reasonable Care’
The Companies Act 2006 states that “a director must exercise reasonable care, skill and diligence” when running a company. They must also comply with the following general duties:
- “act within powers” or in other words in accordance with the company’s constitution
- promote the success of the company
- exercise independent judgement
- avoid conflicts of interest
- not accept benefits from third parties
- declare an interest in a proposed transaction or arrangement. If a director is directly or indirectly interested in a proposed transaction or arrangement with the company, he or she must declare the extent of it to the Board before the company enters into that transaction or arrangement.
There are other duties that are owed to the company under the Act, such as keeping proper books and records, restrictions and conditions on entering into certain transactions with the company as well as gaining shareholder approval for loans over £10,000 from the company, for instance. Breach of these duties can result in directors being disqualified and incurring personal liability.
Directors Responsibilities in Insolvency
Directors owe a duty to the company and its creditors. If a company is in trouble and faces insolvency, the directors must consider or act in the interests of creditors and maintain the confidentiality of the company’s affairs.
They need to fully understand their responsibilities in accordance with the Act. Although these provisions apply when a company has gone into liquidation, they also relate to director conduct prior to liquidation. See our full piece on directors responsibilities in insolvency…
When a company is at risk of becoming insolvent, directors frequently find themselves in a quandary: to carry on trading or to put the company into administration or liquidation. Directors have a duty to minimise the loss to creditors and the steps that should be taken vary depending on the circumstances. Nonetheless, the situation must be carefully assessed with the professional help and guidance of a licensed insolvency practitioner who will establish the best course of action. Failure to do so holds the director liable for accusations of wrongful trading, a serious civil offence.
To avoid allegations of wrongful trading, directors should record the decisions taken and the reasons behind them regularly in Board minutes. This applies to any director of a company, which goes into liquidation. It’s important to understand that directors cannot simply escape personal liability by resigning.
The liquidator can apply for a court order that makes a director personally liable to contribute to the company’s assets if he or she knew or should have known that there was no reasonable prospect that the company would avoid becoming insolvent and then failed to take every step to minimise the potential loss to the company’s creditors.
Directors who intend to defraud existing and potential creditors are personally liable to contribute to the company’s assets. An example of an intent to defraud is when a director takes credit from suppliers, knowing full well that there is no prospect of paying the creditor on time.
However, to justify a finding of dishonesty, there must be substantial evidence. If fraudulent trading is proved, the director is, in addition to being personally liable to contribute to the company’s assets, guilty of a criminal offence.
Recovery of Money for Directorial Misfeasance
The official receiver, liquidator, creditor or shareholder can recover money or damages from directors who have “misapplied or retained or become liable or accountable for any money or property of the company, or have been guilty of misfeasance or breach of fiduciary or other duties in relation to the company”.
This includes improper payments of dividends, use of monies for an improper or unauthorised purpose, use of monies in contravention of the Act as well as unauthorised loans or payments to directors.
Transactions at an Undervalue
This occurs when a company gifts a business asset to someone or sells it for significantly less than its value. The liquidator can apply to have the transaction set aside if it occurred within two years of the company’s liquidation.
A preference is a transaction that has the effect of placing a creditor in a better position if the company were to go into liquidation than if the transaction hadn’t occurred. For instance, repaying a creditor to whom the director has given a personal guarantee over others.
If the transaction occurs within six months of the company’s liquidation, the liquidator can apply to have it set aside but must have substantial evidence that the director entered into the transaction wanting to produce a preferential effect.
A director faces disqualification for a maximum of five years for persistent default in various duties, such as failing to submit documents to the Registrar of Companies. He or she also faces disqualification of two to 15 years is he or she is shown to be unfit to manage a company. In determining unfitness, the court considers whether the director has been a party to wrongful or fraudulent trading, a transaction at undervalue or a preference or has failed to comply with the various duties relating to the company’s accounts or has breached any duty owed to the company.
Being disqualified means that he or she will not be able to form, promote or manage a company in the UK during the disqualification period.
Concerned about Possible Liability for Directorial Negligence?
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If you would like to know more about the duties owed to a company by a director and how to avoid negligence and disqualification, please call 08000 746 757 or email [email protected] for free and confidential advice from one of our professional advisers.