Personal liability: Leading with confidence

Leading with confidence

How directors can reduce their risk of personal liability during times of financial uncertainty – Charlotte Clarke of Pattersons Commercial Law explains the ins and outs

Many businesses emerged from Covid-19 restrictions with the hope of a rebound in the economy. However, companies are now facing additional pressures arising out of the cost-of-living crisis, spiralling inflation, supply chain difficulties, and employee retention issues. Government statistics for England & Wales also show that there were 2,114 registered company insolvencies in March 2022; more than double the figure of 992 registered in March 2021. The uncertain outlook for the UK economy is yet a further test for directors.

During these challenging times, it is more important than ever for directors to be fully aware of the duties they owe as a result of their office as well as understanding who they owe their duties to and what the implications can be – commercially and personally – if a company’s financial position takes a turn for the worse.

When can a director be personally liable for a company’s losses?

Generally, a director will not incur personal liability for the company. Nonetheless, there are circumstances that can lead to this situation. Ordinarily, directors owe duties to their company (Companies Act 2006). One of the statutory duties requires directors to promote the success of the company for the benefit of its members as a whole. But, if a company experiences financial difficulties that result in it being insolvent, or close to insolvency, this duty is modified so that the directors are required to consider the interests of the company’s creditors when making decisions. If a company subsequently enters into an insolvency process, directors can face personal liability for losses incurred by the company if they are found to have breached any of their directors’ duties. Such claims are usually brought by the company’s liquidator and involve an allegation that the directors failed to consider the interests of the company’s creditors when they knew (or ought to have known) the company was insolvent. Many directors believe (incorrectly) that for a claim against them to be successful, it must be shown that they have acted dishonestly. However, even routine actions such as paying a creditor could be questioned if the company is found to have paid certain creditors but left others unpaid at a time when the company was insolvent.

When is a company insolvent?

The Insolvency Act 1986 does not define ‘insolvency’. Instead, it sets out the following tests for when a company is deemed unable to pay its debts: ◆ Failure to comply with a statutory demand ◆ Failure to satisfy enforcement of a judgment debt ◆ The court being satisfied that the company is unable to pay its debts as they fall due (the ‘cash flow’ test) ◆ The court being satisfied that the liabilities of the company (including contingent and prospective liabilities) exceed the assets of the company (the ‘balance sheet’ test)

It’s important that directors seek professional advice if they believe their company could fulfil the criteria for any of the above tests.

IT IS MORE IMPORTANT THAN EVER FOR DIRECTORS TO BE FULLY AWARE OF THE DUTIES THEY OWE AS A RESULT OF THEIR OFFICE What can directors do to protect their position?

Directors can reduce their risk of incurring personal liability for company losses by: ◆ Holding regular board meetings to review the company’s financial position ◆ Keeping written records of all decisions made by the directors including the options considered and the reasons for making a particular decision ◆ Collating up-to-date financial information for the company on a regular basis and making the same available to all directors before agreeing on a course of action ◆ Seeking advice from professional advisors in respect of their directors’ duties and the options available to the company if it is experiencing financial difficulties

If you are a director and concerned about the financial position of your company, you should seek professional advice at the earliest opportunity to avoid inadvertently exposing yourself to personal liability for losses incurred by the company. Forewarned is forearmed!