Managing personal liability risks for directors during the continued economic crisis

In this article, Mike Pavitt and Lucy Andrews from the Corporate Restructuring and Insolvency Team at Paris Smith LLP explore the risks to directors of personal liability in the event that their companies fail, whether this happens whilst they are still running the company or not, and they offer some tips on how best to manage those risks.

Despite signs this month that the inflation crisis may finally be easing, growth in the economy has been non-existent for months, consumer confidence remains low, and the cost and security of supplies, materials and affordable refinance options across many sectors remains volatile and uncertain.

It is well documented that, with pretty much all the supports businesses had enjoyed in the aftermath of the pandemic having now been stripped away, and with HM Revenue and Customs issuing winding up petitions like they are going out of fashion, corporate insolvencies in Britain are now at levels not seen since the end of the so-called Great Recession in 2009.

These numbers are no longer reflective simply of the closing of the ‘insolvency gap’ (i.e. companies failing which would have been insolvent anyway and which had simply been propped up artificially by government intervention); they are now the result of genuine commercial distress in previously healthy businesses.

At the same time, the Secretary of State is clamping down on the disqualification of directors and seeking and obtaining high value compensation orders against directors of insolvent or dissolved companies in favour of creditors who have suffered losses to insolvent companies which can be traced to the acts or omissions of one or more individual directors.

As recently as September 2023 a director was ordered to pay more than £80,000 plus interest to customers of his travel company despite protesting that this would likely result in his personal bankruptcy.

It is perhaps unsurprising, therefore, that a high number of directors are choosing (or perhaps they feel they have no other choice but) to shut the doors of their companies and to either retire or seek paid employment.

But how secure is the director’s personal wealth if the company is shut down (it depends), and is there anything they can do before this happens to help reduce the risks of personal liability (almost always, yes)?

When can personal liability risks arise?

The starting point for any director wishing to manage their risks is to inform themselves of all the circumstances in which personal liabilities could arise.

Most directors know about the dangers of “personal guarantees” (which can sneak into trading relationships if you are not very vigilant) and that “trading whilst insolvent” can result in personal liability, although they may not understand until they are involved in a formal insolvency quite how many forms of behaviour in the run up to the failure of a company can be caught, how they can limit their exposure or even where such claims are likely to come from.

Directors facing claims from liquidators, creditors and other stakeholders soon learn that the circumstances in which the law will intervene in these circumstances cover a whole spectrum of behaviour, and can look at activities 2 years or more prior to formal insolvency.

There is, unfortunately, no shortcut to educating ourselves as directors firstly as to our common law (e.g. reported cases on duties of care) and statutory legal duties (mainly under the Companies Act and Insolvency Act).

Fortunately there are any number of self-help guides available for this, although the rule of thumb we recommend people to abide by is to treat your company’s suppliers and other creditors as if they were at least as important as shareholders or other investors.

Make sure you are as clear as you can possibly be about the terms on which you are trading, and if you are dealing with more than one company or business, make sure you know how to wear separate hats for your different roles and how to manage any perceived conflicts of interest between those roles.

How can Directors limit the risks before insolvency?

If cash gets tight or if you believe in the foreseeable future that the company’s true asset value may be outstripped by its liabilities, treat creditors as you would wish to be treated if the shoe were on the other foot.

If in doubt as to the company’s true financial state or options, work with your accountants to improve your visibility, bring in an insolvency practitioner accountant at an early stage, and if in doubt about how you should be approaching any critical decisions, bring in a solicitor with relevant experience.

Taking and relying upon appropriately qualified, licensed and regulated professional advice is one of the most effective ways in which directors can avoid or limit personal liability, although it is essential that you supply your advisors with all potentially relevant information.

The other vitally important thing is to document your decisions and the reasons behind them, ideally in formal board minutes, with which your professional advisors can assist if needed.

This will stand as reliable evidence with which you can defend yourself in the event that you are later criticised for the decisions you took.

Mitigating the risks: when the chips are down

If, having taken advice at an early stage, the range of options available nevertheless becomes more limited, for example if the advice you receive as a director is that your company should be contemplating a formal insolvency, make sure that you always have the interests of creditors front and centre in your thinking, and your personal interests out of the equation altogether – and that this is recorded in writing – and you cannot go far wrong.

If your fellow directors do not wish to take or follow appropriate professional advice and if you are unconvinced as to their reasons, you should consider resigning from the company, and recording your reasons for doing so carefully in writing.

The threat of personal liability upon directors for getting decisions wrong during this period is ever present.

The law regards a director’s ability to trade with limited liability as a privilege, and directors who fail to inform themselves of their responsibilities, do not take the correct advice when it is merited and/or who fail to heed that advice when it is given tend to find themselves facing the threat of a claim. Even at that stage, though, there is much they can do to limit their exposure.

Directors should, in particular, avoid admitting liability in respect of any claim without first taking their own, independent legal advice.

The Official Receiver, the Secretary of State, liquidators and solicitors acting for any of these are not immune to making mistakes.

They may have got hold of the wrong end of the stick, there may be evidence you could present – if appropriately advised – which would cause them to take a different tack, and if you admit something even just because you have no energy to fight it, you could find yourself having to meet a much larger liability than was strictly necessary.

Summary

The continuing economic crisis will doubtless claim many more casualties.

No business or directorship is without risk, but it is in all of our interests that directors of limited companies, who themselves are the life blood of the UK economy, know how to recognise and manage those risks, so they can act confidently so as to limit any damage to people’s lives and livelihoods.

By setting out the above tips we hope in some small way to have helped directors cut through any confusion about personal liabilities, so that they do not distract from the director’s main job of promoting the success of the company.

Should any reader of this article be facing any of the issues highlighted above, they are very welcome to contact the authors, Mike Pavitt and Lucy Andrews of Paris Smith LLP.

• https://parissmith.co.uk/

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