What legal liabilities could directors incur?

This a large and complex area of law and only an outline can be given here. Reference should be made to one of the leading reference works on company law for a fuller account.

Directors' legal duties fall into the following categories:
(1) general fiduciary duties imposed by the branch of the common law known as equity;
(2) the duty to observe care under the common law of negligence;
(3) duties under the Companies Acts, the Insolvency Act 1986 and related legislation, including for fraudulent and wrongful trading;
(4) duties imposed by the company itself;
(5) duties imposed by other legislation and common law provisions.

(1) General fiduciary duties
Directors are subject to general duties imposed by equity. They are in a fiduciary relationship with the company and as such are bound to act bona fide, in what they consider to be the best interests of the company. There are many different aspects to these fiduciary duties, e.g.

Directors as quasi-trustees
Directors are entrusted with custody of the company's money and assets and are bound to use their own discretion in taking care of them. It is no excuse that the director was regarded as a nominee and acted on the instructions of another: Selangor United Rubber Estates v Cradock [1968] 1WLR 1555.

Unauthorised profits
A very blatant example of this was shown in Boston Deep Sea Fishing Co v. Ansell (1888) 39 Ch D 339. A director who received personal payments from suppliers when placing orders on behalf of the company was held liable to account to the company for the payments.

But see also Regal (Hastings) v Gulliver [1942] 1 All ER 378. Here the company owned a cinema. It wished to acquire two further cinemas but was unable to raise sufficient money. A second company was set up in which Regal bought a majority of the shares and the directors of Regal (and the company's solicitor) bought the rest. The second company bought the two cinemas. Later the two companies were taken over. All shares in Regal and the second company were sold to another company. The directors were replaced. Regal sued the ex-directors for the profits they had made on their shares in the second company. Held: The directors' profits arose from their functions as directors of Regal and had not been authorised by the company. As such they were liable to account to the company for the profits. The principle that a director may not keep unauthorised profits is too important to allow any exceptions to be made.

Corporate opportunities
Directors may not take advantage of opportunities, information, etc. which belong to the company. See IDC v Cooley [1972] 2 All ER 162.

Proper purpose
Directors must use their powers only for the purposes they were granted:

Hogg v Cramphorn [1967] Ch 254.
In this case there was a take-over bid for the company. Directors worried that a majority of the shareholders may accept the bid. The directors set up a trust for the benefit of employees with themselves as trustees. The company made a loan to the trust with which the trust bought newly issued shares in the company. The directors then had sufficient shares under their control to defeat the takeover bid. A shareholder challenged the whole operation. Held: The whole scheme was void. The directors' main purpose had been to defeat the takeover bid. This was an abuse of their powers to allot shares, the proper purpose of which is to enable the company to raise finance.

Duties owed to the company
Directors' duties are owed to the company, not to the individual members of it: Percival v Wright [1902] 2 Ch 421. Generally only the company may sue (rule in Foss v Harbottle (1843) 2 Hare 461).

(2) Duty of care
Directors owe the company a duty to take care in the course of their duties. The standard is that of the reasonable person who has that particular director's degree of skill, knowledge and experience: Re City Equitable Fire Assurance CO [1925] Ch 407. This is an aspect of the general common law of negligence.

The articles of a company cannot exempt directors from liability for negligence, but the company may purchase insurance indemnifying directors against liability for negligence: CA 1985, sec310.

(3) Companies legislation
The Companies Acts 1985 to 1989, the Insolvency Act 1986 and related legislation lay down a regulatory framework for the management and conduct of companies. Many sections of these Acts require companies to send information to Companies House, hold certain meetings, or to do or refrain from certain actions in particular circumstances.

Much of this legislation imposes potential liabilities for non-compliance on the company and, usually, 'on every officer in default'. Directors, along with the company secretary, are the officers who are potentially liable for any such default. Prosecution for regulatory offences (not filing information at Companies House, etc.) is rare, though not unknown.

Potentially more serious are the liabilities which may be incurred on a director personally when a company has become insolvent and it appears that there has been fraudulent or wrongful trading.

Fraudulent trading
Fraudulent trading is where any business of the company has been carried on with intent to defraud creditors or for any fraudulent purpose: Insolvency Act (IA) 1986, sec213. This includes where debts have been incurred by a company knowing that they cannot be paid. Note, however, that fraudulent intent must be shown.

Possible court orders:

Any person knowingly a party to the fraud may be made liable to contribute to the company's assets: IA, 1986, sec213(2);
May be convicted and imprisoned and/or fined: CA 1985, sec458;
Directors disqualification order up to 15 years: Company Directors Disqualification Act (CDDA) 1986, sec4

4. Wrongful trading
This is where a company has gone into insolvent liquidation and it appears to the court that any person who has been a director of the company knew or ought to have known that this would occur and failed to take all reasonable steps to minimise the loss to the creditors: Insolvency Act 1986, sec214.

Keeping a company in a situation where it is trading at a loss, so increasing the deficit to creditors, rather than ceasing to trade or putting the company into liquidation, is clear failure to take such steps. No fraudulent intention is required.

If wrongful trading is established the court may order:
Director liable to contribute to the assets of the company: IA 1986, sec214.
Directors disqualification order: CDDA 1986, sec10.

See also CDDA 1986, sec6: The court may make a directors disqualification order against any person who has been a director of a company which has gone into insolvent liquidation and who appears not to be a 'fit person' to be concerned in the management of a company.

(5) The company may impose duties on its directors by its memorandum and articles and by delegation by the board of functions to particular directors.

(6) General Law
Directors are responsible for seeing that the company is run lawfully, i.e. in accordance with the general law.

Related topics

• Who can be a director?
• Are directors employees of the company?
• What powers do directors have?
• What legal liabilities could directors incur?
• What is the legal position of a managing director?
• What is the position if a director has a conflict of interest?

The Insolvency Service website provides valuable information on the Company Directors Disqualification Act 1985, and the full text of the Insolvency Act 1986 and related legislation. Click here for a link to this site.

See also the Guidance Booklets available on the Companies House website. Click here to link to this site.