Assume you are a director of a struggling firm that owns and operates a small business that has suffered considerable losses over the last three years and is unable to pay its creditors. You and the other directors, as well as management, are considering applying for bankruptcy protection, but believe that if the firm can function for another 12 months, it will break even and its prospects will improve. You and the rest of the board agree certain moves that will allow the company to limp along for another 12 months, including borrowing extra debt secured by the company’s final unencumbered assets. Unfortunately, a year later, those efforts have proven futile, and the company is now worth far less than it was a year ago in terms of liquidation value. Did you establish personal culpability by prolonging the company’s misery, reducing the value of the company to its creditors in a bankruptcy proceeding?
This graphic clearly shows that not everything is worth saving, and that it is sometimes preferable to take immediate but painful action to avoid future loss. In many business reorganization circumstances, this is undoubtedly the case. While shareholders, directors, and officers often try to save and keep their company alive despite the fact that the company’s chances of survival are small, there is a major risk involved. Under the so-called “deepening insolvency” doctrine, keeping a firm alive when it is plainly beyond recovery can result in personal culpability for the company’s directors, officers, professionals, and even lenders. According to the deepening insolvency hypothesis, a director or executive can be held accountable for extending the existence of a financially challenged company while lowering its liquidation value. This article will quickly address the general responsibilities of directors and officers, as well as the deepening insolvency concept, and will offer some advice to directors and officers of financially distressed businesses.
Directors’ and Officers’ Duties
Directors and officers owe the corporation and its shareholders fiduciary and loyalty duties. The duty of care compels directors and executives to carry out their responsibilities honestly and in the best interests of the company. Self-dealing, usurpation of business chances, and earning improper personal benefits are all prohibited under the duty of loyalty. In general, the business judgment rule protects the actions of directors and officers, which states that the courts will not second-guess actions taken by directors and officers if they acted on an informed basis, in good faith, and in the honest belief that such actions would be in the best interests of the corporation.
Many courts have ruled that when a corporation becomes bankrupt, the directors’ and officers’ fiduciary responsibilities are owed to the creditors, not the corporation or the shareholders. The fiduciary duties of directors and officers are less obvious when a corporation is in the “vicinity of insolvency.” In addition to the company and its shareholders, many courts have extended the fiduciary duties of directors and officers to the corporation’s creditors and other constituents. The word “insolvency proximity” has yet to be defined. Due to the lack of a clear legal definition of “vicinity of bankruptcy” and the fact that directors and officers may owe fiduciary duties to several parties, directors and officers sometimes find themselves in a conundrum as to when and to whom they should execute their fiduciary duties.
Deepening Insolvency Theory
Directors and executives face a potential conflict between their fiduciary obligations owed to the corporation and its shareholders in maximizing profit and their fiduciary duties owed to creditors in protecting and conserving corporate assets when firms approach the “vicinity of insolvency.” When a company approaches insolvency, some of the most important questions are whether the company should declare bankruptcy, when it should declare bankruptcy, and if the directors’ and officers’ activities would prevent or exacerbate the insolvency. According to the “deepening insolvency” theory, if a corporation’s directors and officers increase corporate debt and extend its life, the directors and officers may be held liable because the corporation’s continued operations have the effect of increasing losses and deepening its insolvency, lowering the value of its assets and harming creditors. According to one bankruptcy court,
“The Debtor’s condition was not like that of someone who has been sitting in the rain all day and cannot get much wetter. It’s more analogous to a boxer with one black eye who, although being hurt, may still fight and win. If such fighter (debtor) loses the bout and ends up in the hospital (bankruptcy court), a doctor (judge) can conclude that it was the extra injuries (deepening insolvency) that led to his hospitalization.” 1
The hypothesis of growing insolvency was first acknowledged as a damages theory. The tort of growing insolvency has recently been recognized by an increasing number of courts as a separate cause of action. The Court of Appeals for the Third Circuit held in Official Committee of Unsecured Creditors v. R.F. Lafferty & Co. that the Pennsylvania Supreme Court could recognize the tort of deepening insolvency as “an injury to the Debtor’s corporate property resulting from the fraudulent expansion of corporate debt and prolongation of corporate life.” 2 The lawsuit contained allegations that certain third-party experts illegally influenced two lease-financing firms participating in a Ponzi scheme to issue fake debt certificates, causing their insolvency to worsen and compelling them to file for bankruptcy. 3 Deepening insolvency was recognized as a separate cause of action by the court for three reasons. It noted first that the theory was essentially sound because fraudulent and concealed debt can depreciate corporate property by forcing an insolvent corporation into bankruptcy, which incurs legal and administrative costs, creates operational limitations that impair the corporation’s ability to operate profitably, shakes the confidence of other parties who do business with the corporation, and undermines the corporation’s reputation. “These harms can be avoided, and the value within an insolvent corporation can be saved,” the court observed, “provided the corporation is liquidated in a timely way, rather than kept afloat with false debt.” 4 The soundness of the deepening insolvency cause of action, according to the court, was substantiated by the theory’s expanding acceptance, which included recognition by various federal and state courts. Finally, the court emphasized that where increasing insolvency causes injury to corporate assets, the law must provide a remedy by recognizing deepening insolvency as a cause of action, according to Pennsylvania jurisprudence.
The United States Bankruptcy Court for the District of Delaware concluded that the Delaware Supreme Court could accept increasing insolvency as a cause of action under Delaware law after using the Third Circuit’s methodology.
5 In the case of In re Exide Technologies, Inc., the corporation’s official committee of unsecured creditors sued the corporation’s pre-petition secured lenders, alleging that the secured lenders contributed to and were liable for the corporation’s deepening insolvency and eventual bankruptcy by extending credit to the corporation in exchange for additional collateral when the corporation had little or no hope of recovery, and causing the corporation to acquire additional collateral. 6 The Exide court determined that the deepening insolvency hypothesis was sound, judicially acknowledged, and conformed to the Delaware courts’ policy of providing a remedy for an injury, using the same criteria as in the Lafferty case. However, not all courts have acknowledged the theory as a distinct cause of action.
Elements of the Deepening Insolvency Theory
The elements or legal standards for a claim have not been stated by the Lafferty court, the Exide court, or any other court that has recognized the deepening insolvency cause of action. In general, two sorts of claims underpin the deepening insolvency cause of action: a mismanagement claim against directors and officers, and a misrepresentation claim against both management and its professionals, such as accountants. 7 Mismanagement claims against directors and officers are frequently based on the theory that the directors and officers violated their fiduciary duties by taking actions to artificially extend the life of the corporation, such as incurring additional debt, resulting in increased insolvency and the diminution and dissipation of the corporation’s assets and value. 8 These claims aren’t usually based on deception or other wrongdoing. The artificial or fraudulent prolongation of an insolvent corporation’s life, misrepresentation or omission of the corporation’s financial condition, and increased level of insolvency of the corporation caused by the prolongation and incurrence of additional debt are all common misrepresentation claims against management and professionals. Some cases, such as the Lafferty and Exide cases, include fraud or negligence. However, no court has addressed whether fraud or carelessness must be a part of the growing insolvency cause of action. As a result, while some courts have recognized the idea as a separate cause of action, the elements of that cause of action vary greatly between states and federal circuits.
Damages Under the Deepening Insolvency Theory
Similarly, the amount of damages in a case of growing insolvency is unclear. Damages under a deepening insolvency claim may include, among other things, legal and administrative costs caused by bankruptcy; impaired and lost ability of the corporation to operate profitably due to certain operational limitations that may be imposed on the corporation; lost profit and value due to the loss of confidence of other parties who have dealings with the corporation; and impairment of the corporation’s relationship with its creditors. However, the court did not explain how these products’ damages should be calculated.
Although the exact amount of damages is unknown, it is clear that directors and officers face greater risks of liability and damages, as the deepening insolvency theory creates a new and distinct cause of action for which liability and damages can be assessed, in addition to traditional causes of action like breach of fiduciary duty, misrepresentation, and fraud. The culpability under this approach is questionable because the courts have not set any boundaries to the increasing insolvency cause of action.
Protections Available to Directors and Officers
As previously stated, directors and officers have fiduciary responsibilities to the corporation and its shareholders. When a company becomes bankrupt, however, creditors are due fiduciary duties as well. In cases of worsening insolvency, the norm of care for directors and officials is unclear. In such cases, some courts have applied the business judgment rule to the acts of directors and officers, while others have found that the best interests of creditors take precedence. Even where the law recognizes that directors’ and officers’ duties include the creditors’ interest, the Delaware Chancery Court concluded that the business judgment rule applies. 9 The business judgment rule establishes a presumption that directors and officers behave in good faith and in the corporation’s best interests. As a result of the business judgment rule, directors and officers are protected from liability under the deepening insolvency theory. However, the rule does not totally protect directors and officers from accountability, especially as they may be held to a lower standard in the event of insolvency.
What Should be Done When the Business Faces Insolvency
As the number of courts that accept the deepening insolvency theory as a separate cause of action grows, directors and officers may face severe liability if they fail to assess the financial condition and the corporation’s chances of survival and recovery realistically. The possibility of severe personal liability for directors and officers, as well as professionals and lenders, remains because the courts have yet to identify any legal boundaries or measures of damages under this paradigm. What should directors and officers do if the company goes bankrupt?
First, directors and executives should assess the corporation’s future viability in a realistic and practical manner. They should keep in mind that not every business is worth continuing, and that doing so could expose the directors and officers to personal culpability under the increasing insolvency hypothesis. This isn’t to argue that if a company is about to go bankrupt, directors and officers should declare for bankruptcy as soon as possible to avoid personal accountability. The necessity and timeliness of filing for bankruptcy or reorganization should be a substantial part of the directors’ and officers’ assessment and judgment.
If the company’s chances of recovery are poor, directors and executives should be wary about taking on more or excessive debt. Similarly, when the corporation is on the verge of insolvency, directors and officers should be wary of issuing more security to secured lenders in order to extend the life of the business. Directors and officers should be aware that they may have fiduciary responsibilities to creditors in addition to the corporation and its shareholders.
As the company approaches insolvency, directors and officials should be aware of and actively monitor the financial status of the company. Directors and officials should use actual market valuations and be on the lookout for accounting errors in this regard.
Directors and officers should make sure that their official actions are covered under the corporation’s articles of incorporation or bylaws. The corporation should have enough liability insurance for its directors and executives.
Most importantly, directors and officers should follow the business judgment rule’s requirements, which include making informed decisions based on advice from financial and legal advisors when evaluating the corporation’s financial situation and recovery prospects, as well as determining the best course of action for the corporation. At this time in a corporation’s life, directors and officials must be aware that their exposure to personal liability is likely to increase. Furthermore, because the courts have not defined any limits to a claim of worsening insolvency, the possible responsibility of directors and officers remains unknown. In order to realistically evaluate the corporation’s condition, the risks connected with any proposed activities, the best course of action for the corporation to pursue, and the avoidance of liability for directors and officers, experienced financial and legal consultants should be engaged. In this regard, directors and officers should evaluate whether experts other than the corporation’s normal consultants should be involved in this process regarding the directors’ and officers’ personal liability.
Can a director be personally liable for company debts?
Because directors of private limited companies and limited liability partnerships are not personally liable for the company’s debts, many banks, suppliers, and landlords may refuse to offer credit or loan money to small firms without the owner’s personal guarantee.
If you signed a director’s personal guarantee on a loan, lease, or contract, you will be personally accountable if the company fails to pay. Personal guarantees are commonly requested on corporate vehicle or equipment loans, bank credit lines, and commercial leases.
In the case of a personal guarantee in liquidation, the circumstances change slightly. However, unless you have specifically pledged assets as security, the debt remains unsecured.
Is a board of director liable for company debts?
Directors of a corporation are jointly and severally accountable to the corporation’s employees for all debts not exceeding six months’ salary and up to 12 months’ vacancies pay under section 131 of the OBCA.
Directors may also be held personally liable for certain taxes if the corporation fails to remit source deductions (employee income taxes, Employment Insurance, and Canada Pension Plan contributions), as well as unpaid employee wages and vacation pay, as required by s.227(1) of the Income Tax Act, or fails to remit HST collected under s.323 of the Excise Tax Act.
The corporation, its owners, creditors, employees, and government authorities are all involved in these instances.
Directors may also be held personally accountable for damages resulting from their conduct or inactions, including but not limited to illegal acts that would violate their fiduciary or statutory obligations under the act.
In addition, directors may be held personally accountable for torts committed individually or on behalf of the corporation if they allow the corporation to act outside of its authority. Finally, directors may be held personally accountable if the corporation is used to commit fraud. The act of piercing the corporate veil is known as piercing the corporate veil.
Directors are accountable to employees for up to six months’ earnings if the company goes bankrupt or goes into liquidation, according to the Government of Canada’s Wage Earner Protection Program (WEPP). Employees who earned or became entitled to unpaid wages, vacation money, termination pay, or severance pay in the previous six months before a bankruptcy or receivership may be eligible for reimbursement under this scheme.
When an employee applies for WEPP payments, he or she agrees to authorize the Government of Canada to subrogate his or her claim up to the amount of the WEPP payment. When the assets of the insolvent employer are allocated through the bankruptcy and receivership process, the government will endeavor to reclaim the amount it has paid under the program from the estate or property of the insolvent employer.
Employees should be advised, however, that any claim must be filed within six months of the payment due date or within six months of any bankruptcy or liquidation proceedings. Directors will not be held accountable if allegations are filed beyond that time frame. Furthermore, a director’s obligation for unpaid salaries is limited to two years after he or she has ceased to be a director.
Every individual, including the corporation’s directors, who creates or assists in falsifying prospectuses or other public business disclosure papers is guilty of an offence under section 256(2) of the OBCA. On conviction, he faces a fine of not more than $2,000.00 or a period of imprisonment of not more than one year, or both; if the person is a corporation, he faces a fine of not more than $25,000.00.
The directors of a corporation are in charge of distributing funds to shareholders through dividend payments, share redemption, and buyback. Directors must verify that the corporation can pass two financial tests before making any payments to shareholders:
- When it comes to making payments to shareholders, the organization must be solvent, which means it must be able to meet its financial obligations and commitments on time.
- The Capital Impairment Test demands that the realizable worth of a corporation’s assets be at least equal to the sum of its obligations before any payment is made.
The rationale behind these restrictions is that payments to shareholders should not be made if they would be detrimental to the corporation’s creditors. If the shareholders are paid without the director being satisfied, the director will be personally accountable to the creditors for the amount owing, according to the reasonable belief test.
It’s vital to understand that legal directors aren’t the only ones who might be held liable. The concept of a “de facto director” has been incorporated into the legislation to determine liability. A ‘de jure director’ is a director who has been officially appointed to this post in line with the law. A ‘de facto director,’ on the other hand, is a director ‘in fact,’ who acts in the capacity of a director while not having been formally nominated to that role. Under tax law and other civil statutes, a ‘de facto director’ can be held liable.
A corporation may indemnify a director to the extent of their liability and seek proper insurance to safeguard directors and former directors from personal liabilities incurred as a result of their functioning as directors, according to certain Canadian corporation statutes. These exemptions are conditional on the director acting reasonably under his or her duty of care and in accordance with his or her fiduciary duties, and on the basis of his or her belief that his or her actions were legal and in the best interests of the corporation. The inclusion of director indemnity provisions in a corporation’s bylaws is widespread.
The main topic of directors’ personal duties or obligations is to strike a balance between the corporation’s needs and their own interests, as well as between the interests of shareholders and the corporation’s creditors. The liability that follows a breach of these duties is frequently in the form of remuneration, which reduces the incentive to break these obligations.
Because participating as a director of a business carries a lot of risk, you should contact a knowledgeable and experienced lawyer to help you understand your rights and duties under corporate law.
When can a director be personally liable?
Being a director carries a lot of responsibility, and it owes the firm a legal duty of care. The Companies Act 2006 establishes minimum experience and competence criteria for directors, as well as some crucial responsibilities. Many directors do as they are told.
Even the most meticulous and scrupulous directors, however, might run afoul of the law. Directors can often be held personally liable for legal troubles that arise purely as a result of their position as a director, even if the issue was created by someone else’s fault.
As a result of the rise in “blame culture,” litigation is increasingly focused firmly at directors, often unfairly. Even when there is no validity, legal disputes are often used tactically to try to compel directors into taking certain actions, in the hopes that they will wish to avoid an expensive and lengthy argument, especially when the firm, shareholders, or insurance are reluctant or unable to help.
The Companies Act 2006 outlines some, but not all, director responsibilities, which include supporting the company’s success, using reasonable care and skill, exercising independent judgment, and reporting interest in transactions, for example.
While breaches may be ratified by shareholder resolution, if they are not, a corporation can sue one of its own directors if the director has broken their duty to the company and caused it loss.
If a director benefits financially as a result of a breach, the director may be required to account to the company.
Directors are frequently required to provide personal guarantees on loans to persuade lenders that the debt would be paid if the firm is unable to pay for any reason. If this happens, the lender may be able to seize the director’s personal property and assets.
Entering a personal guarantee could result in conflicts of interest between the director and the company’s interests, necessitating cautious management to avoid a violation of duty. Because of his or her personal liability, a director may be perceived as biased.
The firm may employ shareholder agreements that stipulate that directors must contribute assets or provide security for the company’s debts in lieu of an express personal guarantee, for which directors are personally accountable. If any section is uncertain, seek legal assistance as soon as possible.
In the event that the company goes bankrupt and has to be wound up, the directors may be required to pay any outstanding share amounts for which they are personally accountable.
If a director makes a statement to another party that they know is inaccurate as a director and intends for that party to rely on the statement, and that party does so to their harm, the director may be personally liable for financial loss.
If it can be proven that the statement was made knowing it was untrue, without belief in it, or recklessly whether or not it was genuine, it is considered fraudulent misrepresentation.
If a director does not make it obvious that he or she is negotiating on behalf of the company in arranging a deal, and the other party believes the director is contracting personally, and a dispute ensues, the director may be held personally accountable.
If a company is involved in legal proceedings and the court orders the firm to do anything, and a director is aware of the court order but willfully disregards it, the director may be held personally accountable for contempt of court and face prison time.
If a company commits a data protection legislation violation and it can be proven that the breach occurred with the director’s consent or due to their negligence, the director may be held liable alongside the company. The ICO has the authority to impose a fine of up to lb500,000 on the director individually.
If a director commits a tort in the course of company business, such as deception (with the aim to defraud) or careless misrepresentation (a statement made negligently), the director may be personally accountable. If a director is involved in wrongful behavior by the company that amounts to a tort, the director may be held jointly accountable.
If a director has limitations on the authority with which they operate on behalf of the company, but abuses that authority and something goes wrong, the company may seek compensation from the director personally, even if the company is ultimately deemed accountable.
If a director continues to trade while knowing (or should know) that the company is manifestly bankrupt, the court may require the director to repay the corporation any assets unlawfully handled. In the event of insolvency, the director’s responsibility passes from the firm to the creditors.
If a director purposely and knowingly places the company’s assets out of reach of creditors, this may be considered fraudulent trade, with criminal consequences. Outside of a bankruptcy scenario, directors may be subject to fraudulent trading and criminal sanctions. For fraudulent trading, the maximum sentence is 12 months in jail if convicted on summary conviction, or ten years if convicted on indictment.
If a director causes their company to establish a cartel agreement that involves price-fixing, limiting production or supply, sharing markets, or influencing bidding processes, that director may face criminal charges. On conviction on indictment, a sentence of up to 5 years in jail and/or a fine may be imposed.
Directors who, via their cooperation or negligence, cause a corporation to break health and safety laws may face personal prosecution. Individuals convicted of health and safety violations might face up to two years in prison and/or fines in the millions of dollars. The severity of the issues is used to determine fines.
Depending on the circumstances, a director could be held personally accountable for discrimination or harassment committed against an employee, as well as the company itself.
A director may be held personally accountable if they personally committed an environmental offence while conducting company business, or caused it to occur with their permission or negligence.
If there was a sufficient duty of care between the director and the deceased, and a breach of that duty materially led to or caused the death, and the violation was found to be grossly negligent, the director could be charged with common law manslaughter.
Under the Bribery Act 2010, directors can be held accountable if they individually commit an offence of giving or receiving bribes. Conviction on indictment might result in up to ten years in jail and/or limitless penalties.
Many directors are overly reliant on insurance and believe they are adequately protected in the case of a disaster. They believe that either the firm, the shareholders, or insurance will bail them out; however, this is not always the case.
A company’s and insurance’s capacity to insulate a director from personal liability has limits.
The Companies Act of 2006 states that a company cannot indemnify a director for negligence, default, or breach of duty, but it does offer qualifying third party indemnity provisions (QTPIP), under which the company can indemnify the director for liability to a third party other than the company; however, this does not cover costs in criminal or civil proceedings where the director is convicted. Insurance provides some assurance, but it is far from perfect.
A director can obtain director’s and officers’ liability insurance (D&O), although this, too, may limit financial aid if there has been proven fraud or dishonesty, or if the litigation stems from an issue that occurred prior to the policy’s commencement date. Certain claims, such as those deriving from pollution or property damage resulting from bodily injury, may be expressly excluded. It is not safe to trust that insurance will save the day, and it is critical to get legal counsel as soon as possible.
It is obvious that directors could face personal liability for a variety of reasons. If you are a director dealing with an existing or potential dispute originating from the issues raised above, please contact us to see how we can help.
We’re perfectly positioned to handle business litigation and criminal concerns, including director liability issues, from offices facing the High Court in central London.
Are directors of limited companies liable?
A liability is a phrase used in business to describe a sum of money or other debt owing by a corporation. This could be in the form of a loan, a hire purchase agreement, or an overdue invoice. The capacity to operate as a limited corporation has long been touted as a significant benefit. But, exactly, what does “limited liability” imply? Simply defined, limited liability is an extra layer of protection between the firm and its directors. This means that if the corporation is unable to pay its debts, the directors cannot be held personally liable.
If you personally guarantee a company loan
If your firm has a bad credit history, is small, or isn’t well established, financial providers may ask for a personal guarantee before accepting a loan. When the time comes, if you are unable to repay or if your business fails, the creditors will turn to you for payment. You will be held accountable on a personal level. If you don’t have the necessary capital, your home and other personal belongings may be at stake if you go bankrupt. Here’s where you may learn more about directors’ personal guarantees.
If you have borrowed from lenders and they insist on a charge over your house in addition to a personal guarantee
When you take out a business loan, the lenders may be concerned that you will not be able or willing to repay the loan if something goes wrong, therefore they may request a charge on your home. Some lenders may be out of money if your firm goes bankrupt and additional creditor measures, such as calling on personal guarantees, are taken. In certain cases, the lender may require a charge on your property as additional security. This means that when or if the property is sold, it will be paid before other creditors.
Note: Any of the COVID recovery loans, such as the Bounce Back Loan or Recovery Loan, cannot be secured against the directors primary house.
If you have an overdrawn directors account
It is quite normal for directors to have a loan account that is overdrawn. This occurs when a director withdraws funds from the firm for personal use, yet it must be reimbursed and accounted for as any other transaction. The problem arises when the business fails and the loan is not repaid. Because you are a corporation debtor, the liquidator or administrator will pursue the money. Personal bankruptcy is a risk that could result in your home being repossessed.
If you are found to be guilty of wrongful or fraudulent trading
When the professional insolvency practitioner investigates the actions of the director(s) as part of the insolvency process, they may discover that you, as the director, have knowingly neglected creditor interests and knowingly heaped on debt that cannot be repaid. This is a significant violation of the Insolvency Act, and you could face personal liability for any or all of the company’s debt. Such proceedings against directors are uncommon, although they do occur.
So, if you acted as a director without any personal guarantees, didn’t trade illegally, and can repay your overdrawn directors account, you shouldn’t be concerned. Your home is not in jeopardy. If you’re unsure or need more information, contact one of our experts right away.
Are company directors jointly and severally liable?
The 2020 Finance Act ( “HMRC can hold company directors, shadow directors, or members of Certain Liability Partnerships jointly and severally accountable for the business’s tax liabilities under the Act, but only in limited cases including insolvency or possible insolvency.
Such liability arises, according to the Act, when an individual receives a Joint Liability Notice ( “JLN”) If a valid JLN is issued, the individual(s) and the company are jointly and severally accountable for the company’s tax obligations, unless the company ceases to exist, in which case the individual is exclusively liable. This type of notification is typically delivered on one of three occasions:
Tax avoidance and tax evasion cases
If a corporation has entered into tax avoidance plans or engaged in tax evasive activity, and the firm is insolvent or has a severe risk of becoming insolvent, HMRC may issue a JLN to an individual. Individual(s) responsible for the corporation joining the arrangement/engaging in the conduct, or individual(s) getting a benefit that the individual knew came as a result of the arrangement/engagement, are the only ones who can receive the JLN. Finally, the JLN can only be issued if the arrangement/engagement has resulted in, or is likely to result in, a tax liability, and there is a real risk that some or all of the liability will not be paid.
Repeated insolvency and non-payment cases
HMRC may also issue a JLN to a person who was ‘associated’ to two or more different companies, each of which was insolvent at the time they had a tax due or had otherwise failed to account to HMRC. Only if the individual is also related to another new firm that is engaged in a comparable trade or activity to the two “old” insolvent companies would they be liable to a JLN. HMRC will have to consider some extra time constraints and minimum value requirements before issuing a JLN, but in essence, this provision restricts directors’ ability to form new ‘phoenix’ firms to replace failing commercial operations.
Cases involving penalty for facilitating avoidance or evasion
HMRC can also issue a JLN if a penalty has been levied on a corporation under a number of specific rules related to tax avoidance or evasion. The Act specifies these specific provisions. If the company goes bankrupt or is in severe danger of going bankrupt, an individual can be issued a JLN if they were a director or shadow director at the time the conduct or omission that resulted in the penalty occurred and there is a considerable risk that the penalty will not be returned in full.
Those who receive a JLN have a limited right to file a review or appeal to the First-tier Tribunal if they do so within 30 days of receiving it. If a restructuring or insolvency proceeding is being considered, directors should get legal advice on their potential personal liability, as the impact of a JLN might be severe. Due to the broad scope of the Act, shadow directors, managers, shareholders, lenders, and other linked people could conceivably be held accountable, and should seek legal assistance if they are concerned about their company’s viability.
Who is liable for company debts?
That is to say, the company and its owners/shareholders are treated as a single legal entity. The company’s finances and its stockholders are seen as one and the same. As a result, the shareholders are legally liable for the company’s debts.
What happens to directors when company goes into liquidation?
A court decision determining that an insolvent firm should be wound up and liquidated is known as a winding up order.
After an unpaid creditor of the firm being wound up has successfully initiated a winding up petition against that corporation for the unpaid debts, the courts will issue a winding up order.
What Happens Next for Company Directors?
The courts first appoint an Official Receiver. The liquidation process is overseen by the Official Receiver.
The directors virtually lose their decision-making powers once the Official Receiver is appointed, albeit they will be obligated to cooperate with the Official Receiver in providing all necessary information and facilitating the liquidation process.
As a director, you should work with the Official Receiver to the utmost extent possible.
The Official Receiver will immediately begin an examination into the company in order to analyze its current situation. They must announce whether they intend to operate as the company’s liquidation or designate a separate liquidator within 12 weeks of their appointment.
Following the Official Receiver’s ruling, the liquidation will proceed in the usual manner. In summary, the liquidator, the Official Receiver, or both will be in charge of realizing the company’s assets and distributing the proceeds to creditors.
Official Receiver’s Investigation Into Directors’ Conduct
Prior to the winding-up order, the Official Receiver must investigate the acts of the company’s directors as part of the obligatory liquidation procedure.
Each director must meet with the Official Receiver for a two-hour interview during which they will be asked to produce a statement of the company’s affairs and outline the circumstances leading up to the company’s insolvency.
It is critical that you prepare properly for this interview as a director. To submit to the Official Receiver, you’ll need all appropriate information, including accounts and statements.
The Official Receiver has the authority to summon a director to court for questioning. This is an extremely rare occurrence, and it’s only employed in cases where the director is suspected of serious misbehavior.
As part of their investigation, an Official Receiver will be looking for three items in particular:
Unfair Preference
When a corporation takes particular activities that put a creditor in a better position than they would have been on an asset distribution during a winding up than they would have been otherwise. These activities had to be deliberate (but if the creditor is a linked party to the corporation (i.e. a director), it’s assumed they were).
Reporting to the Department of Department for Business, Energy & Industrial Strategy
After conducting their inquiry, the Official Receiver must submit a report to the Department of Business, Energy, and Industrial Strategy with recommendations on whether any consequences against the company’s director should be imposed (s).
The punishments for all three of the aforementioned offenses might result in the directors being barred from acting as directors for up to 15 years. There are also specific rights of action that can be granted to the liquidator, such as the ability to reverse any undervalued transaction or hold the directors personally accountable for the amount of the undervalue.
Though this may appear to be quite concerning, these sanctions are only applied in cases where there has been director misconduct and are in place to protect the company’s creditors. Sanctions are not lightly meted out, and they will only be imposed after a thorough inquiry.
Proceeds from the Liquidation
Any proceeds realized from the company’s assets will be paid to the company’s creditors as the company nears the end of its liquidation process.
Because the corporation was insolvent, the directors will not get any proceeds in their capacity as stockholders. A director, on the other hand, may be a creditor of the company in some other role. The amount of money recovered through the liquidation process, as well as their position in the pre-determined order of precedence for creditors, will determine whether they get payment on these debts.
Closure of the Company
After the proceeds have been distributed, the Official Receiver will convene a meeting of creditors and make a final report. They will also be relieved of their responsibilities, and the company will be closed down completely.
Can personal assets of directors be seized from a Ltd company?
Limited company directors occasionally contact us, afraid that bailiffs acting on the orders of enraged creditors may remove personal property from their business facilities.
Personal property is never included in corporate debt for limited company directors, as noted above. The above-mentioned issue of misfeasance is only considered after insolvency, therefore your personal belongings are fully outside limits during the baliffs stage.
Baliffs have no legal authority to seize personal property in any circumstance. They can take company assets, but only those that are owned by the company, and nothing that is on a hire-purchase basis.
Except for High Court enforcement agents with a warrant, no bailiffs have the authority to compel entry into a business.
Can you lose your house if you are a limited company?
A limited company director’s residence may be forfeited if the firm goes into liquidation. However, unless there is wrongdoing or a call on a personal guarantee, it is unlikely to happen immediately.
Are all directors of a company liable?
Becoming a director confers prominence and a direct influence on a company’s strategy and success. How much leeway does a director have to act on his or her own? What responsibilities and obligations should a director be aware of?
This is the third of four articles outlining the general responsibilities and potential liabilities of an English private company director (which is not in a group with a PLC).
A company’s day-to-day management is delegated to its directors by its shareholders. The shareholders appoint the directors at first, and they can normally appoint more directors up to the limit stipulated by the articles of organization.
The board of directors makes decisions on behalf of the directors collectively. Unless just one director has been selected, a director cannot operate as a director on his own. At board meetings, decisions are made by a majority vote or by a written resolution signed by all of the directors.
The position and abilities of the director are essentially described in the articles of incorporation and, if he is also an employee, in his service contract.
Ordinarily, a director’s appointment does not provide executive authority. Most directors, on the other hand, are also firm workers with specific rights allocated to them. A managing director is typically given broad authority to make daily decisions on behalf of the organization. Other directors, such as sales and finance directors, will have a less role to play.
Directors have a responsibility to the firm and, if insolvency is a possibility, to creditors (see Directors andinsolvency). Under the Companies Act 2006, certain fundamental director responsibilities have been made statutory (the “Act”). The corporation is owed these responsibilities. (For further information, see What are the responsibilities of a director? Part I: statutory responsibilities, and Part II: other general responsibilities).
A variety of other statutory obligations and limits apply to directors. These include a responsibility to keep accurate books and records, as well as prohibitions on engaging in certain transactions with the firm or accepting loans from it. Breach of these responsibilities and standards can result in a director’s disqualification from acting as a director, as well as personal culpability in certain situations (see below). Some circumstances of personal liability can be covered by insurance.
Personal liability
A director may be personally liable in addition to the scenarios listed above, in which he or she may be obliged to account for cash received or indemnify the firm against losses incurred:
- If the firm fails to comply with any of the requirements in The Companies (Trading Disclosures) Regulations 2008 and fails to make the trading disclosures required by those Regulations (Regulation 10 of The Companies (Trading Disclosures) Regulations 2008), the company may be subject to a fine.
- Section 51 of the Act prohibits him from signing contracts supposedly on behalf of the firm before its incorporation.
- if he manages the firm while disqualified or on the orders of someone he knows is ineligible (section 15 of the Company Directors Disqualification Act 1986);
- if he was previously a director of a company that went into insolvent liquidation and is now involved in the carrying on of business by another company under a name that is the same as or similar to the insolvent company’s name within 12 months before it went into liquidation (section 217 of the Insolvency Act 1986);
- If The Pensions Regulator has issued him a contribution notice on the grounds that he was a party to, or knowingly assisted in, an act or failure to act, one of the main purposes of which was to remove or reduce an employer’s requirement or ability to pay a debt due under section 75 of the Pensions Act 1995 on the winding up of a pension scheme;
- If someone makes a false or negligent misrepresentation in the course of negotiating a contract between the company and a third party, he may be held liable for damages.
- Section 19 of the Theft Act 1968 defines making a false statement about a company’s affairs with the goal of deceiving shareholders or creditors as a criminal crime.
- under the criminal offences of dishonestly making an untrue or misleading representation where the person making it knows that it is, or might be, untrue or misleading, and dishonestly failing to disclose to another person information that he is legally obligated to disclose, both of which require the intent to make a profit or cause loss or risk of loss to another person (sections 2 and 3 of the Fraud Act 2006),
- If he is knowingly a party to a firm carrying on its business with the intent to mislead creditors of the company or another person, or for any fraudulent purpose (section 993 of the Act), he faces up to ten years in prison or a fine.
- if he fails to make it apparent that he is contracting on behalf of the firm and not as an individual;
- a third party for damages for violation of an implied warranty of authority if he concludes a contract on behalf of the company but does so outside of his authority, allowing the company to set the contract aside; or
- in regard to the company’s illegal or fraudulent trading under the Insolvency Act 1986 (see Directors and insolvency).
A number of legislation state that if a firm commits a criminal offense, a director is additionally responsible if the offense was committed with the consent or connivance of the director, or was attributable to any negligence on the part of the director. ‘Consent’ in this sense refers to being aware of what is going on and agreeing to it, whereas ‘connivance’ refers to awareness combined with a negligent refusal to prevent it. ‘Neglect’ implies that no knowledge of the matters constituting the offence is required; rather, there is a failure to act when obligated to do so.
Corruption and Bribery
The Bribery Act of 2010 (“BA 2010”) took effect on July 1, 2011. It broadens the definition of bribery to include all transactions in the private sector (previously, bribery offences were confined to transactionsinvolving public officials and their agents).
- soliciting, agreeing to receive, or accepting a bribe (section 2) is a general offence.
- Bribing a foreign public official to obtain or retain business is a separate crime (section 6); and
- Commercial organizations that fail to prohibit bribery by persons acting on their behalf, when the bribery was intended to achieve or keep a business advantage for the commercial organization, are subject to strict responsibility (section 7).
When a company (rather than just individuals acting on its behalf) is convicted of an offence under sections 1, 2 or 6 (offering or receiving a bribe, or corrupting a foreign public official), the company’s directors may be held accountable. If it can be proven that they “consented” to or “connived” in the bribery, they will be exonerated. While the terms “consent” and “connivance” aren’t defined, they’re understood to signify things like knowing there’s a good probability bribery is going on but doing nothing to investigate or stop it.
The director must have a close relationship to the UK, such as being a British citizen, an individual normally resident in the UK, or a British Overseas citizen, in order to be held accountable.
A director who is convicted of any of these crimes faces a maximum sentence of ten years in prison and/or an infinite fine. A director who is guilty of bribery could be barred from holding a directorship for up to 15 years.
If a company employee bribes another person for the company’s profit, the corporation commits an offence, subject to the “appropriate processes” defense stated below. The term “affiliated” with the company shall be interpreted broadly. If a person conducts services for or on behalf of the firm, regardless of the role in which they do so, they are considered “affiliated” with the company. This could include agents, employees, subsidiaries, middlemen, joint venture partners, and suppliers, all of whom could potentially be held liable for the company’s (and its group’s) actions.
Furthermore, this is a case of strict liability. This implies that a motivation does not need to be proven. If the corporation is found to be in violation of this clause, it could face an unlimited penalties.
If the corporation can show it had “sufficient procedures” in place to prevent bribery, it will have a defense. The BA 2010 does not define “appropriate procedures,” however the Ministry of Justice has provided guidance (“Guidance”) on what acceptable procedures might entail. This guidance lays out six principles for businesses to follow, all of which are intended to help businesses understand the types of practices they should implement to prevent bribery within their organization. These are the following:
While this is a corporate offense rather than a violation by individual directors, the board must be satisfied with the company’s overall strategy to bribery prevention. In addition to a general risk assessment of the firm’s business, it’s likely that a review of the company’s current procedures, in conjunction with the Guidance, will be required in order to put in place measures that ensure the company has”adequate procedures” in place to prevent bribery.
Health and Safety
Individual directors do not bear responsibility for health and safety issues; instead, the corporation has accountability. However, if a ‘body corporate’ commits a health and safety violation with the consent or connivance of a director, or if the violation is related to his negligence, he may be prosecuted (section 37 of the Health and Safety at Work etcAct 1974). (In this context, consent involves being aware of the circumstances and risks, whereas connivance means being aware of the risks but doing nothing about them.) Neglect is defined as a willful breach of a duty of care.) If convicted, a director might face up to two years in prison and an unlimited fine (Schedule 3A of the Health and Safety at Work etc Act 1974), as well as being barred from serving as a director for a length of time (section 2(1) of the Company Directors Disqualification Act 1986).
One of the goals of the Health and Safety Executive’s (“HSE”) enforcement policy statement is to guarantee that directors are held accountable in the courts if they fail to meet their health and safety obligations. Inspectors from the Health and Safety Executive have been advised to pay special attention to the management chain and the role played by individuals in any health and safety violations. Each year, the HSE’s annual report will name organizations and people found guilty of health and safety violations.
The HSE and the Institute of Directors have issued recommendations on corporate directors’ health and safety obligations, suggesting that each board:
- acknowledge their mutual responsibility for the organization’s health and safety leadership;
- guarantee that each board member accepts personal responsibility and ensures that their actions and decisions at work promote the board’s health and safety messages;
- Ensure that all choices are made in accordance with the organization’s health and safety policy;
- urge all levels of employees to take an active role in health and safety; and
- maintain current on key health and safety risk management topics, and evaluate its health and safety performance on a regular basis, at least once a year.
Although the suggestions are not legally binding, prosecutors may consider whether or not to pursue criminal charges against a director in the case of an accident if they are not followed. Implementation of the guidelines, on the other hand, should allow directors to demonstrate that they have followed the law.
Manslaughter
The common law offence of manslaughter by gross negligence applies to companies and persons (including corporate directors and management) when (according to R v Adomako3 AllER 79):
- The violation was so egregious that the defendant’s conduct may be considered criminal and deserving of punishment because the defendant showed such contempt for the deceased’s life.
An individual’s conviction for gross negligence The maximum sentence for manslaughter is life in jail.
The Corporate Manslaughter and Corporate Homicide Act 2007, which replaces the common law offence of manslaughter by gross negligence for companies, partnerships, trade unions, and other organizations in the UK, creates a new offence of corporate manslaughter (also known as corporate homicide in Scotland). A company is guilty of corporate manslaughter if it:
- A person’s death is caused by the way its operations are managed or organized;
- the death is caused by the organization’s gross breach of a duty of care owed to that person; and
- The senior management of the company had organized or handled the company’s activities in such a way that it was a significant part of the breach.
Individuals are not covered by the Corporate Manslaughter and Corporate Homicide Act, but if found guilty, an organization faces an unlimited fine.
