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Protecting directors against litigation

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15th Mar 2016
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Digitalisation has made the act of incorporation relatively straightforward. Indeed, the latest 2016 Companies House statistics state that 44,663 companies were incorporated in the month of January 2016, says Jennifer Adams.

Whatever the reasons for incorporation it is safe to say that many directors of those 44,663 companies will not appreciate the importance of the legal role they have taken on. In the course of carrying out these obligations directors could lay themselves open to litigation, the penalties for non-compliance being severe even possibly, criminal proceedings.

Disqualification from being a director could therefore be the least of their worries (courts can disqualify an individual from acting as a director or in any way being involved with the management of a limited company for anything up to 15 years. (see article on disqualification of directors).

Examples of personal liability

There are 147 clauses in the Companies Act 2006 that refer to situations whereby directors may be held personally liable for failure to comply. Obviously many do not result in financial recompense by the director although there are a fair number of what could be viewed as 'minor' transgressions that do. An example is s304 CA2006 – failure to call a company meeting. Under this section, if members present the directors with a valid request for a general meeting but the directors fail to comply within the days set, the members can go ahead and convene anyway. Any reasonable expenses incurred by the members must be reimbursed to them by the company and then the company must in turn recover those expenses from the directors personally.

A more serious breach of the act is to be found under s 213 CA 2006 - Illegal loans. This clause is relevant where a loan is made which infringes the rules and the company is entitled to compensation. Any director who receives an illegal loan, as well as any director who authorised its payment, is liable to account to the company for any gain they have made and – on a joint and several basis – to indemnify the company for any loss or damage it suffers as a result.

S121c of the Social Security Administration Act 1992 provides HMRC with the right to recover all unpaid National Insurance contributions due by a company from any company officer or manager instead and not just those sums relating to their own remuneration. 

Where a company commits an offence under s 60 and s61 VAT Act 1994 and it appears to HMRC that the company’s action is attributable to the dishonesty of a director then they may serve notice on that director to recover all or part of the penalty as if he or she were personally liable, the company being assessed on the balance. (See VAT dishonest factsheet). If there is no dishonesty, then the debt is written off.

It is the Insolvency Act 1986 where the liability of directors is most in point. Where a company is insolvent the law holds that directors’ need to defer to the company’s creditors rather than to the company itself although a company can bring a claim against a director for negligence, misfeasance and breach of statutory duty or of fiduciary duty under the common law.

There are a host of provisions in other acts that increase the exposure of directors to legal action personally. Inter alia there is the Theft Act 1968, the Health and Safety at Work Act 2004, the Fraud Act 2006, the Corporate Manslaughter and Homicide Act 2007, the Bribery Act 2010.

What is the company's position?

Many pre-CA2006 directors already have indemnity under Regulation 118 of Table A but it is only applicable if the company is solvent. A CA2006 company may incorporate this regulation into its own articles should it so wish.

A company cannot indemnify a director for any liability due to ‘any negligence, default, breach of duty or of trust’ other than in cases specifically brought by third parties (s232 CA 2006) and that third party indemnity cannot be for 'criminal or regulatory fines payable by the director'.(s234CA 2006).

However, a company is permitted to insure its directors against risks that either the company cannot indemnify against or chooses not to (e.g. instances where the company itself brings a claim - sS233 CA 2006). There are various restrictions, such as the insurance policy only being used for defence costs in proceedings where the director is acquitted. A company is allowed to provide a loan to a director in connection with a 'negligence, default, breach of duty or trust' claim and to defend himself against any investigation brought by a regulatory authority (s205-207 CA 2006.)

Under s239 CA 2006 a company may ratify the conduct of a director (including a former director), which amounts to 'negligence, default, breach of duty or trust' in relation to the company. The effect is that some acts of directors which would otherwise result in them incurring personal liability may be retrospectively approved by the company’s shareholders, thus relieving the directors of liability. Ratification is not possible for illegal acts or misappropriation of the company’s assets by the shareholders, a fraud on the company’s creditors, or on a minority of shareholders. Thus a director who enters into a profitable contract, the opportunity for which arose out of his position as a director, may have the contract ratified by the shareholders (in which case he may retain the profit) provided that he acted in good faith and the contract is not damaging to the company.

This section presents a technical problem for sole director companies. The rules state that where the members wish to pass such a resolution, the votes of the director (assuming also a member of the company) must be disregarded. As such the single director, if also a member of the company, is unable to vote on a motion to ratify his or her own breach.

Under articles 52 and 53 of the CA 2006 Model Articles the company is permitted to purchase insurance on the director's behalf against any liability incurred by a director (or ex- director) but it is not the director's benefit of right. A copy of the indemnity provision must be kept for inspection at the registered office for at least one year after expiry (s237 CA 2006) and must be disclosed in the directors' report.

Finally

There is always the potential for personal claims or proceedings against directors to arise from any decision made, or act carried out and whilst most corporate bodies are protected through public liability and other insurances, individual directors are often not, with far reaching implications.

Jennifer Adams is associate editor at AccountingWEB. A professional business author specialising in corporate governance and taxation, she has written for many of the leading specialist providers of legal, tax and regulatory publications.

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