With rising numbers of practices either being run as private limited companies or owned by corporates, the need to be aware of the obligations that apply to being a company director has never been so important. In fact, more directors are finding themselves in hot water as authorities and the media put malfeasance firmly in the spotlight.
So, to highlight the ways in which directors can find themselves personally liable for company obligations not met, Improve Veterinary Practice spoke to two lawyers for their top causes of problems for directors.
Statutory declarations
Paul Taylor, a partner at City firm Fox Williams, sees directors who find themselves in trouble on a regular basis. Experience has taught him that there’s a myriad of ways a director can find themselves in the limelight.
The first issue Paul draws attention to involves statutory declarationswhich are made when a firm is heading for the buffers. He says that “if a company is in trouble, before it can enter into a members’ voluntary liquidation, the directors of the company must state that a company is able to pay its debts by way of a statutory declaration of solvency”. He adds that “this sets out that the company can pay all its debts in full within the next 12 months”. But if this declaration is made without reasonable belief in its accuracy, Paul says that directors can become liable for an unlimited fine or up to two years’ imprisonment.
‘If a company is in trouble, before it can enter into a members’ voluntary liquidation, the directors of the company must state that a company is able to pay its debts by way of a statutory declaration of solvency’
On top of that, he cautions that if the declaration is not registered within 15 days of being made, both directors and the company can also be fined for each day that it remains unfiled. But such declarations can be made in other circumstances and Paul gives another example – the discharge of a company’s security at Companies House. Again, he says that “if a declaration is made without reasonable grounds, again there can be personal consequences for such a director”.
Breaches in health and safety
Second on Paul’s list is the obvious matter of health and safety law breaches. He explains that “under the Health and Safety at Work etc Act 1974, a director can be found secondarily liable where an offence by a company is committed with their consent or connivance or is attributable to their neglect”.
The penalty? An unlimited fine or imprisonment for up to two years. Worse – Paul says that in cases “involving fatal incidents at work, a director can also be found criminally liable for involuntary or gross negligence manslaughter”.
He reminds that the Companies Act 2006 (CA 2006) sets out numerous general duties with which a director must comply; the one that applies in a health and safety context is section 172 – the duty to act in a way that promotes the success of the company for the benefit of its members. He says that “the Health and Safety Executive has guidance which sets out specific mechanisms by which a director can comply with its duties, for example, ensuring that effective monitoring and reporting systems are in place”.
Liability and tax evasion
Next comes vicarious and assumed liability. In detailing this, Paul tells how in an execution block involving a company there will often be the wording “For and on behalf of X Ltd” under the director’s signature. This phrase, he says, “is used to indicate that the signatory does not intend to be bound personally. Failure to insert the text may result in a director being deemed a party to the contract and therefore personally liable for any subsequent breaches.”
The problem for directors, as Paul puts it, is that “the court will always look to interpret the intention of the contracting parties in deciding who should be held liable. Hence, it is vital that a director sets out their deliberate intention to signify on behalf of the company rather than as an individual.”
‘It is vital that a director sets out their deliberate intention to signify on behalf of the company rather than as an individual’
Paul’s final concern is tax evasion. He tells how the Finance Act 2020 introduced a new form of liability for directors, whereby HMRC can hold directors jointly and severally liable for tax or tax penalties. He says that “this liability was introduced to ensure individuals are held liable for bad behaviour and to allow HMRC to recover the full amount of any tax liability or penalty where companies are affected by potential or actual insolvency”.
Paul says that HMRC can issue notices under the act, but only when the liability arises or is expected to arise from tax avoidance, tax evasion, repeated insolvency or a penalty for facilitating avoidance or evasion, and where the company begins insolvency proceedings, or is expected to do so, causing any of the tax liability to be lost to HMRC.
Wrongful trading
Zeena Asghar, a corporate solicitor at VWV, also sees numerous hazards for directors. She acknowledges the fact that a company has a separate legal personality and is thereby responsible for its own debts, property and actions. But like Paul, she too finds directors who have become personally liable because of their involvement in a company.
Wrongful trading is the first problem area she tackles. She refers to the Insolvency Act 1986 (IA 1986), noting that “a director of an insolvent company may become liable for wrongful trading if, at some point, before the start of liquidation or administration, they knew – or ought to have known – that there was no reasonable prospect the company would avoid insolvent liquidation or administration”.
Directors should be aware of red flags indicating insolvency such as creditor pressure, late filing of accounts, and numerous proceedings or statutory demands issued against the company
She says that directors should be aware of red flags indicating insolvency such as creditor pressure, late filing of accounts, and numerous proceedings or statutory demands issued against the company. That said, Zeena says that “a director may be able to raise a defence if [they] can prove that [they] took sufficient steps with a view to minimising the potential loss to the company’s creditors, after [they] became aware that the company had no prospects of avoiding insolvent liquidation or administration”.
However, to do this means taking professional legal advice, minimising debts and drawing up management accounts to establish the financial position of the company. Further, Zeena advises that “regular board meetings should be convened, and all commercial decisions of the directors should be reported in full in the company’s minutes”.
And from a director’s perspective, she says that their liability – meaning how much they might have to contribute to the company’s assets – will typically be measured against the increase in the company’s net asset deficiency. This runs from when the director first realised there was no reasonable prospect of the company avoiding failure up to when the company did fail.
Fraudulent trading
Zeena’s second area for concern is that of fraudulent trading. And she outlines what she means: “A director that knows the company is unable to pay its creditors, but continues the business of the company regardless, with the intention to defraud the creditors, can be found guilty of fraudulent trading.”
She comments that case law has set a high standard of proof required in proving liability and a two-stage test has been developed by the courts: “In essence, a liquidator or administrator must demonstrate the director’s subjective state of knowledge, and show that the director’s conduct was dishonest applying the objective standards of ordinary decent people.”
Fraudulent trading actions are rare due to the difficulty of establishing intent and are typically only brought against directors engaged in criminal conduct
If fraudulent trading is proven, Zeena says that “a director may be liable to make personal contributions to the company’s assets… the amount of contribution, however, cannot be punitive”.
In practice, however, she says that fraudulent trading actions are rare due to the difficulty of establishing intent and are typically only brought against directors engaged in criminal conduct.
Personal guarantees and maintenance of company records
Next on Zeena’s list, a common bugbear of directors – personal guarantees. The obvious problem here is that if the company defaults on a loan, a lender will be able to enforce the terms of the guarantee. And to make matters worse, she says that “in some circumstances guarantees are also supported by charges over the personal assets of the directors… and this could require them to sell their homes to repay the company’s debt or lead to them being declared bankrupt if they do not have the sufficient assets”.
For Zeena, it is important that directors understand the legal consequences and implications of entering into this type of guarantee. She recommends that directors “ask for the guarantee to be capped at a certain level and avoid giving security in support; certainly, a director should seek independent legal advice to satisfy any concerns beforehand”.
Zeena’s final risk factor relates to the failure to maintain company records. As she says, “these duties under the CA 2006 are often overlooked by directors but can attract significant fines and/or criminal sanctions against directors personally”.
The failure to maintain statutory registers is often only discovered when, for example, shareholders want to exit a company and the register of members needs to be produced and relied upon prior to completion of the sale
In overview, there are various records private limited companies are required to keep, including a register of members, directors and secretaries and charges and debentures. Zeena comments that “while maintaining yearly filings at Companies House is commendable, it is not always sufficient to comply with the requirement of maintaining statutory registers”.
The problem is that the failure to maintain statutory registers is often only discovered when, for example, shareholders want to exit a company and the register of members needs to be produced and relied upon prior to completion of the sale. In this situation, registers will need to be updated or reconstituted prior to completion which can cause significant delay to timings and incur additional costs.
Zeena further warns that “if there are no records then members of a company are not able to enforce their right to inspect a company’s statutory registers by giving the company 10 working days’ notice – less in certain circumstances. Therefore, the registers must exist!”
Summary
The reality is that there is only one way to forestall any likely troubles, and that’s for directors to be fully aware of their duties and obligations by taking good legal advice and not acting in haste only to repent at leisure.
