Update: company

In an ideal world company directors would recognise when they were at risk of incurring personal liability. The reality is that the law in this area is intricate and not as director-friendly as they might suppose.

Two official reports last year commented on the duties and liabilities of company directors in the context of the Companies Act 2006. One was published by the Department of Business, Innovation and Skills, entitled Evaluation of the Companies Act 2006. It included an assessment of 'awareness of the codification of directors' duties', meaning the general duties set out in the so-called statutory statement (sections 171-177 of the Companies Act). The good news, to take this report at face value, is that awareness is high (79 per cent). If the proportion of those 'perceived to have responded' is lower (at 50 per cent) this is said to be unsurprising 'given the codification did not represent a change in the current law'.

The second report, a consultation paper issued by the Law Commission, Criminal Liability in Regulatory Contexts, discussed the merits of decriminalising a number of less serious offences. It noted that the Companies Act created some 20 new criminal offences alongside 69 re-enacted ones. The Act also altered the officers-in-default regime so that in relation to some contraventions a director is criminally liable if he fails to take all reasonable steps to prevent them.

A hypothetical director might find reassurance in these two reports. Even if he was among the 21 per cent not previously aware of codification it sounds from the first report as though not a great deal has changed. The second report will sound like potentially good news.

Surely, our hypothetical director mightsay, a director should not be burdened with liability of any sort unless he has committed serious wrongdoing, defined by the commissioners as 'principally deliberate, knowing, reckless or dishonest wrongdoing'. It is not as if even criminal behaviour necessitates a finding of mens rea (guilty mind). Take section 216 of the Insolvency Act 1986 (restriction on re-use of company names).

The claimant in Griffin v UHY Hacker Young & partners [2010] EWHC 146 (Ch) had been convicted in Richmond Magistrates' Court of the section 216 offence (and fined £1,000). He had also been held personally liable in respect of the new company's debts by virtue of section 217. When he sued his allegedly negligent advisers they applied to strike out the action pleading ex turpi causa ('an action cannot arise from a base or disgraceful cause'). Their application was dismissed.

For all the court knew Mr Griffin may have committed the section 216 offence innocently. He may have been advised that it was perfectly lawful to start a new business using the name of a company that had gone into insolvent liquidation, notwithstanding that he had been its sole director, provided that certain procedures were followed with all of which he may have thought he was complying. How that affected the advisers' liability was a matter to be decided at trial but it was irrelevant to the issue of Mr Griffin's liability.

A more exotic example '“ if it did not have extraterritorial reach '“ of strict criminal liability would be the US cartel offence: section 1 of the Sherman Act, Title 15, United States Code (prohibiting specific means of anti-competitive conduct). This offence requires proof of neither fraud nor dishonesty. It is the one to which two directors of Dunlop Oil & Marine Limited pleaded guilty in 2007 and to which Keith Packer (of British Airways) pleaded guilty in 2008. It is one of the charges on which Ian Norris, former chief executive of Morgan Crucible plc, was indicted. In a court in Philadelphia last summer, Norris was convicted of conspiracy to obstruct justice under Title 18, US Code (an appeal is pending).

A distinguishing feature of our cartel offence (section 188 of the Enterprise Act 2002) is that it does require proof of dishonesty. The Ghosh test applies. It is not necessary for the prosecution to prove mutual dishonesty on the part of both parties to a price-fixing arrangement (R v George [2010] EWCA Crim 1148).

Disqualification

Moving beyond the criminal realm, our hypothetical director may labour under the misapprehension that he will be safe from liability so long as he acts in the way he considers, in good faith, would be most likely to promote the success of his company (section 172). But failure to exercise reasonable care, skill and diligence may result in personal liability not only to compensate the company for resulting loss (section 174; section 212 of the Insolvency Act 1986) but also in appropriate circumstances to liability for wrongful trading should the company go into insolvent liquidation (section 214 of the Insolvency Act 1986). In that event, this can lead to disqualification as a director (section 6 of the Company Directors Disqualification Act 1986).

Something less than a breach of the duty of care may amount to unfitness for the purposes of disqualification, a fate which some company directors may find no less career-ending than a criminal record.

In Abbey Forwarding Ltd (in liquidation) v Hone [2010] EWHC 2029, the first reported case on section 174, Lewison J drew by way of analogy on Sansom and another v Metcalfe Hambleton & Co [1998] 2 EGLR 103 '“ a professional negligence case involving chartered surveyors '“ to propose that, particularly where a breach of the director's duty of care concerns the precise way in which a business is run, evidence of what is normal in the field of commerce in which the company in question operates will be of considerable relevance.

This will strike our hypothetical director as a tad more reassuring, especially when he learns that in that case, in the absence of such evidence, the claim against the director failed.

The wrongful trading case of Singla v Hedman and others [2010] EWHC 902 (Ch), however, sounds a different note. Peter Smith J was distinctly unimpressed with representations made to him in that case as to the normal standard of corporate responsibility in the film industry (which he characterised as, if true, 'remarkably low').

There is no special low standard for those operating in the film industry. The director in question had failed to act with reasonable care, conducting the company's business without regard to its impact on creditors and the company's solvency.

Unsettling

How much more unsettled will our hypothetical director be to learn that he may be found liable to repay an unlawful dividend in the absence of fault on his part? Some authorities suggest that liability is strict. The point remains unsettled even after extensive consideration in both the Court of Appeal in Paycheck Services 3 Ltd, Re; Revenue and Customs Comrs v Holland [2009] EWCA Civ 625 and the Supreme Court (at [2010] UKSC 51).

The reason is that directors, while not trustees, owe a like duty not to misapply the company's assets; for example, by paying unlawful dividends. All the general duties save the duty to exercise care are expressed in the Companies Act to be fiduciary (section 178(2)). The quintessential fiduciary duties '“ the no-conflict and no-profit rules (sections 175 and 176) '“ are absolute and inflexible. If they appear to work unjustly the justification lies in the deterrent nature of the rules (Lee v Futurist Developments Ltd [2010] EWHC 2764 (Ch)).

Section 170(1) says that a director's general duties are owed to the company (not to third parties). But that does not stop directors incurring personal liability to third parties under any number of heads, including patent infringement and procuring a breach of contract (qua joint tortfeasor), fraudulent misrepresentation and deceit.

One could add to this potentially very long list: (a) acting as a director while disqualified (Wirecard Bank Ag & Anor v Scott & Ors [2010] EWHC 451 (QB)) (or an undischarged bankrupt); (b) conspiracy, dishonestly assisting breaches of trust or fiduciary duty and knowing receipt (Law Society of England & Wales v Isaac & Isaac International Holdings Ltd & Ors [2010] EWHC 1670 (Ch)); and (c) failing to make it clear that one is signing a contract not so as to bind oneself personally but on behalf of a company (Smuts v Pearson [2010] EWHC 814 (QB)).

Recent cases remind us that directors may be ordered to pay anything from their company's unpaid class 1 national insurance contributions (Livingstone v Revenue & Customs [2010] UKFTT 56 (TC)) to the other side's costs of litigation '“ whether they are parties or not (Ashley-Carter & Anor v Hofmann & Mountford Ltd & Ors [2010] EWHC 2349 (QB)). The conditions of liability vary.

It is also true that a director may be relieved from liability for negligence, breach of duty or breach of trust if he has acted honestly and reasonably and, having regard to all the circumstances, ought fairly to be excused (section 1,157). All three hurdles must be surmounted (Gillespie Investments Ltd v Gillespie [2010] ScotCS CSOH 113).

Section 1,157 will not avail a director in the event of a third-party claim. Nor is it available in a claim founded on the tort of conspiracy (Murray Vernon Holdings Ltd v Hassall & Ors [2010] EWHC 7 (Ch)). And even if relief is available in theory it is virtually impossible to predict when it will be supplied in practice.

The judge at first instance in Paycheck Services and two of three Court of Appeal judges took the view that a director was entitled, on receiving a particularly unwelcome piece of news, to a few days' grace to collect his thoughts and, in that grace period, to relief from liability under what is now section 1,157. The dissenting Court of Appeal judge and two of the three Supreme Court Justices who directly or indirectly expressed a view arrived at the opposite conclusion.

Our law on the personal liability of directors is more demanding than someone familiar only with the statutory statement might suppose.