Key takeaways
The myth of limited liability for directors
Incorporation is seen as a way to shield directors from personal liability, however it is not absolute.
Holding Directors personally liable for company liabilities
Particularly where there has been malfeasance, wrongful trading or tax issues.
Directors should minimise risk of personal liability
Taking professional advice, and taking out D&O insurance, are constructive first steps.
Incorporation of a limited company in England and Wales is often seen as a sensible corporate vehicle through which to trade for directors, on the basis that the company acts as a separate legal entity, meaning that it shields directors (and shareholders) from personal liability for business debts. In a limited company structure, personal liability is generally limited to the amount invested in shares in the company.
However, this protection is not absolute. Directors can in certain circumstances be held personally liable for company debts, face fines, or face disqualification from acting as a director (for up to 15 years). Some of these circumstances are considered in further detail below.
Direct Contractual Liability - for instance where a director has signed a personal guarantee in respect of company liabilities.
Overdrawn Director’s Loan Account (DLA).
Wrongful or Fraudulent Trading (sections 214 and 213 Insolvency Act 1986).
Misfeasance (Breach of Duty) (section 212 Insolvency Act 1986).
The general duties of directors are now set out in sections 171-177 of the Companies Act 2006 (CA 2006). In summary, these duties are:
To act within powers.
To promote the success of the company.
To exercise independent judgment.
To exercise reasonable care, skill and diligence.
To avoid conflicts of interest.
Not to accept benefits from third parties.
To declare an interest in a proposed transaction or arrangement.
When a company has entered liquidation, a liquidator will conduct investigations into the causes of the company’s failure with a view to ascertaining if there has been any breach of duty by the directors in relation to their management which has caused loss. Claims for breach of duty against a director can be pursued by a liquidator pursuant to section 212 Insolvency Act 1986. Such claims can encompass any of the following circumstances:
The misapplication or retention of money or other property of the company.
A director becoming accountable for money or other property of the company.
A director breaching a fiduciary or other duty in relation to the company.
A director otherwise being guilty of misfeasance.
If a director is found to have acted in breach of duty whilst in office upon a claim brought against them by a liquidator, they can be required to:-
repay, restore or account for any misappropriated money or property to the company, with interest.
Compensate the company by way of contribution to the company's assets.
Unpaid Tax Liabilities (HMRC) – in an insolvency context:-
Schedule 13 of The Finance Act 2020 allows HMRC to make directors involved in phoenixism, repeated company failures and non-payment of tax, tax avoidance or evasion, jointly and severally liable for a company’s tax liabilities if the company is in an insolvency process or at real risk of becoming subject to an insolvency process. HMRC can issue Joint Liability Notices (JLNs) to directors in the appropriate circumstances. The individual in receipt of such a notice is jointly and severally liable for the tax liability to the extent specified in the notice.
HMRC may also issue a personal liability notice (PLN) requiring a director of a company (serving at the time of default) to pay a specified amount for Class 1, 1A or 1B NICs that the company failed to pay, together with penalties and interest on the unpaid NICs. The right arises where HMRC determines that the company's failure to pay is attributable to fraud or neglect on the part of the PLN recipient.
Phoenix companies - (Section 216 Insolvency Act 1986): If a director re-uses the name of an insolvent company for a new business without following prescribed legal procedures required, they can become personally liable for the new company's debts.
Compensation Orders: Director Disqualification context:- The Secretary of State can apply for a compensation order against a director where a disqualification order has been made (or disqualification undertaking given) in relation to an individual, and the conduct of that individual has caused loss to one or more creditors of an insolvent company.
When deciding what amount to order as payable for compensation, the court will have regard to:
The amount of the loss caused.
The nature of the conduct that caused the loss.
Whether the individual in question has made any other financial contribution in respect of the conduct complained of.
How can directors mitigate against risks of personal liability
Avoid "All Monies" Guarantees: If a personal guarantee is required, try to limit the scope of the guarantees to specified loans/ sums, rather than all of the company debts.
Obtain D&O Insurance: Directors' and Officers' (D&O) liability insurance can help cover legal costs and/or the value of certain claims (subject to the policy terms) although most policies will not provide cover in relation to conduct determined to be fraudulent/dishonest.
Seek regular professional advice as and when required, whether that is from accountancy and/or legal professionals. Where there are concerns around actual or imminent insolvency, seek advice from insolvency practitioners.
Corporate Governance – ensure that the company’s financial records are properly maintained, hold regular board meetings and maintain proper written records of all board, shareholders decisions taken.
Act promptly – where correspondence and/or court action is received/issued in respect of outstanding company liabilities – act promptly and take professional advice at the earliest opportunity - particularly where PLNs/ JLNs are received in order to ensure that no stipulated deadlines are missed.
