Personal liability

If you find yourself at risk of personal liability as a director in respect of a company’s affairs then it is vital that you seek urgent legal advice to mitigate your loss.

As a general rule, any claims for wrongdoings committed by the company should be brought against the company as it is recognized as a distinct legal entity, and is therefore separate from its shareholders and directors.

However, this protection is not absolute. The recent case of Wright v Chappell [2024] EWHC 1417 (Ch) is a stark reminder of the potential liability falling on a director personally. Two former directors of retail giant British Home Stores were ordered to pay equitable compensation of £110m ($140m) for wrongful trading and misfeasance.

There are instances in which directors can face personal liability, and it’s crucial to be aware of these situations to avoid potential pitfalls. This article examines the most common ways a director may be personally liable and provides practical advice to avoid such situations.

Wrongful trading and misfeasance

Once a director concludes, or ought to conclude, that there is no reasonable prospect of the company avoiding administration or liquidation, they have a duty to take every step that a reasonably diligent person would in order to minimize the potential loss to the company’s creditors. Directors may also be personally liable for misfeasance if they breach their duty to act in the best interests of the company’s creditors in an insolvent situation. A common example is diverting funds at an undervalue for personal use or unauthorized purposes.

The case of Wright v Chappell serves as a reminder that directors should seek advice on their legal duties as soon as there are any concerns in respect of the company facing financial difficulties. If the director is found personally liable for wrongful trading or misfeasance, the court can order the director to make an appropriate contribution to the company’s assets.

Directors can avoid wrongful trading and misfeasance by regularly monitoring the company’s financial health, seeking professional advice early, and taking action to minimize losses when insolvency is likely. Maintaining good corporate governance, acting in the company’s best interest, and documenting decisions are also essential.

Breach of directors’ duties

It is not only when a company is in financial difficulty that a director is at risk of personal liability. As is widely known, the Companies Act 2006 provides seven core statutory duties placed on directors:

• to act within their powers;
• to promote the success of the company;
• to exercise independent judgment;
• to exercise reasonable care, skill and diligence;
• to avoid conflicts of interest;
• to not accept benefits from third parties; and
• to declare interests in proposed or existing transactions.

If a director breaches one of the above duties towards the company, the company can take legal action against the director. There are also some breaches that are considered a criminal offence which could result in fines, disqualification, and imprisonment in in the most extreme cases such as embezzlement, forgery, or financial abuse.

To avoid personal liability directors should be fully aware of their legal duties and appropriate documentation should be carried out to document decisions. Most importantly, minutes of board meetings can be crucial in recording compliance with the above duties, such as the obligation to declare interests in proposed or existing transactions and documenting the reasons behind why a director would consider that certain decisions are in the best interests of the company.

In particular, if a big decision is being taken by the company that it is thought other shareholders or creditors may well challenge, it is crucial to set out in the minutes why a director took the decision they did. It should be remembered that the test for acting in the best interests of the company is a subjective test, that is the director has to be acting in good faith and in what they believe to be the best interests of the company.

The Courts will be far less likely to intervene if the director can show they exercised these powers diligently – showing a director’s thinking in exercising this duty can add considerable weight to any challenge that they were not acting within their duties.

Entering into personal guarantees

In certain circumstances, directors may willingly accept personal liability by offering personal guarantees, making themselves accountable if the company fails to meet its obligations. This is particularly common when securing financing or entering into material contracts. In these instances, pursuing an individual who has provided a personal guarantee is often easier than enforcing security against the company. In these situations, the director assumes personal liability if the company is unable to meet its obligations to the third party.

In the first instance, a director should not give personal guarantees without first getting legal advice. When a company is entering into a contract, directors should ensure that they are signing on behalf of the company and not within their personal capacity. However, if a personal guarantee is required, the scope of the guarantee should be discussed with your legal adviser and caution should be exercised to limit personal exposure.

Companies House filings

Whilst failing to keep Companies House updated with all relevant changes to the company may seem like an administrative oversight, it can lead to personal liability. Directors are responsible for ensuring that the company meets its statutory obligations, such as filing confirmation statements, annual accounts and notifications of changes to the company’s officers, registered office or people with significant control etc. These filing obligations will vary depending on the size of the company and whether it is public or private.

Late or inaccurate filings can result in fines, penalties, and potential personal liability, particularly if creditors suffer due to missing or incorrect information. Whilst responsibility cannot be avoided entirely, one way in which directors can mitigate liability arising is to delegate the preparation of such accounts to a financial adviser. But director approval must be sought prior to filing as knowingly or recklessly delivering false or misleading information to Companies House is a criminal offence and can lead to fines and/or imprisonment.

Conclusion

The circumstances where personal liability may arise are not limited to just those mentioned within this article, and even if a director is held personally liable there are ways in which to reduce or limit loss. In the first instance, if you find yourself accused of any of the aforementioned, it is vital to seek legal advice.