The collapse of construction giant Carillion led to the government ordering a fast-track investigation into the conduct of the directors at the time of the company’s failure, highlighting the responsibilities that directors have in the face of insolvency.
This news came at a time when the government is planning to introduce new reforms to create a stricter corporate governance regime for privately-owned businesses incorporated in the UK, aligning this more closely with the governance rules which already apply to listed public companies.
Also significant is the government’s proposal that public and sizeable private companies will be required to disclose how their directors are fulfilling their statutory duties, and whether or not they are acting in a way that promotes the success of the company and takes into account the interests of employees, suppliers, customers, the community and the environment.
What are the duties of a director?
Under the Companies Act 2006, company directors have a duty to:
- act within their powers as a company director
- promote the success of their company in good faith for the benefit of the members
- exercise independent judgement
- exercise reasonable care, skill and diligence
- avoid conflicts of interest
- not accept benefits from third parties
- declare any interest in proposed transactions or arrangements with the company
A director’s duty to creditors
Although the directors of a limited company are not normally held personally liable for the debts of a company, there are circumstances where a claim can be pursued against directors by an administrator or liquidator in circumstances where they are in breach of their duties.
Once a company has become insolvent, the director’s statutory duty to promote the success of the company shifts towards the creditors of the company. The directors must demonstrate that they have taken reasonable steps to minimise the potential loss to creditors collectively and we would recommend that in these circumstances, a director seek independent advice as early as possible to limit their personal exposure.
The court will consider whether the director, having known that the company could not recover, should have discontinued trading and a director should not take any action that would lead to the company’s debts increasing. In addition, a director must not favour any one supplier or creditor. If they fail in their duties, they face personal liability and potential disqualification from acting as a company director. This duty also extends to shadow and de-facto directors.
When could a director be held personally liable for his conduct as a director?
If it can be shown that a director has behaved in any of the following ways, then a director can be personally liable for the company’s debts: this is not intended to be an exhaustive list, but illustrates the most common scenarios that give rise to a claim against a director:
- Using fraudulent methods to raise the funds needed to pay creditors, such as obtaining finance using misleading or inaccurate information, or taking payment for goods and services that could not be delivered
- Paying dividends to shareholders when there is no profit to distribute or when the company is insolvent
- Disposing of company assets at an undervalue or at no value (this includes the transfer of company property to new trading vehicles or to the directors/shareholders or related parties personally)
- Entering into a personal guarantee, then breaching its terms
- Using company funds for non-business activities
- Creating an overdrawn director’s loan account. This will be repayable during an insolvency process because the loan account is a company asset
- Preferring one creditor over another creditor where there can be no commercial justification for doing so
- Allowing the company to trade beyond the point when it was unable to pay its debts as and when they fell due (i.e. when the company was insolvent)
An insolvency practitioner will be responsible for considering whether the company is in a worse position because of the directors’ conduct and where it is, whether there are grounds to pursue a claim against directors personally. They will want to see as a minimum, evidence that the directors prioritised the interest of creditors collectively from the point that the company was unable to pay its debts.
The duty to act honestly and reasonably
Cullen Investments Limited & Ors  EWHC 1586 (Ch) provided welcome clarification as to when a director can be relieved of liability for breaches of their statutory duties on the grounds that they behaved honestly and reasonably.
In this case, two brothers and directors of a company - Julian and Quentin – had breached their duties as directors by diverting a commercial opportunity that should have been offered to their company, for their personal benefit. Both brothers claimed that they should be relieved from liability on the grounds they acted honestly and reasonably.
In short, the court accepted that Quentin had honestly believed that his brother had disclosed his interest in the opportunity and received authorisation for it. However, it felt that Quentin had not acted reasonably in failing to disclose his own interest.
This case is a timely reminder to company directors to ensure their compliance with their duties to the company, their company’s creditors and where in doubt, to always seek specialist advice.