It is interesting to compare the risk of personal liability for directors of U.K. companies against the risk for directors of U.S. companies. In the U.S., personal liability can exist for directors when they cause financial harm to the corporation, act solely on their own behalf and to the detriment of the corporation, or commit a crime or wrongful act. Causing financial harm to the corporation may result from (i) a breach of the duty of care to the corporation, (ii) a breach the duty of loyalty to the corporation, (iii) misappropriation of a corporate asset for personal use or use by another business, (iv) commingling personal and business assets, or (v) failure to disclose potential or actual conflicts of interest. Generally, officers and directors can be indemnified by the corporation against loss under the laws of the state of incorporation. For example, the Delaware Corporation Law permits indemnification “if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.”
In contrast, the risk of personal liability for directors of U.K. companies is much greater.
U.K. Companies Act 2006
Under the Companies Act 2006, the duties of directors in the U.K. were codified for the first time. Directors can be held personally liable for breaches of duties (discussed below). Moreover, the Companies Act restricts the indemnity that can be provided to the directors. Companies can indemnify directors in respect of third party claims, but not in respect of any liabilities to the company (or an associated company); any fines or penalties arising from criminal or regulatory proceedings; or any liabilities incurred by the director in defending criminal proceedings in which he is convicted or in defending civil proceedings brought by the company or an associated company in which judgment is awarded in the company’s favor.
The main duties owed to the company under the Companies Act are the following:
- Duty to exercise independent judgment
- Duty to exercise reasonable care, skill and diligence
- Duty to avoid conflicts of interest
- Duty not to accept benefits from third parties
- Duty to declare an interest in a proposed transaction or arrangement
- Directors must promote the success of the company having regard for:
- Long term consequence of any decision
- Interest of employees
- Need to foster new relationships with suppliers and customers
- The impact on the community and environment
- The desirability of the company to maintain a reputation for a high standard of business and conduct.
- The need to act fairly towards shareholders.
Shareholders have recourse against directors if they suffer loss as a result of the directors’ actions or inaccuracies in the company’s financial statements. A director who is honest but “reckless” can still be liable if the financial statements are inaccurate or misleading.
There are other statutory obligations of directors in the Companies Act. These include administrative duties, such as a duty to keep statutory records up to date and file annual reports. The liability for breach of these duties attaches to the company and all directors and officers. In the event of failures with regard to filings, directors can be convicted of an offense and fined.
U.K. Insolvency Act 1986
The Insolvency Act 1986 provides a number of grounds on which a liquidator of an insolvent company may pursue the directors personally to contribute towards payment of the company’s debts, and under which directors can also be subject to a 15 year ban.
Directors are guilty of “wrongful trading” if they allow the company to continue to conduct business and incur debts when there is no reasonable prospect of the company repaying the debt. There is no need to prove any element of intent for wrongful trading; the test is whether the director knew or ought to have known that there was no reasonable prospect of the company getting out of its financial difficulties.
U.K. Health and Safety at Work Act and employers’ liability
Directors can be personally liable and subject to criminal prosecution in the event that an offense is committed under the U.K. Health and Safety at Work Act or any other health and safety legislation. This would apply to dangerous practices started or continued with the director’s consent, or illness or accident attributable to a director’s negligence.
Other potential liability
Directors can also be sued personally for unfair dismissal, discrimination or unfair work practices. In addition, liability to a third party may arise because the director (either acting independently or when representing the company as its “mind or will”) does something (or refrains from doing something) which harms the interest of a third party with whom the company has a relationship; this would include suppliers and customers as well as employees and other directors.
Director liability can be covered by D&O insurance but many D&O policies in the U.K. have an “insured vs. insured” exclusion that may exclude from cover any claims brought by the company against its directors. Some policies also exclude losses arising from the “fraud or dishonesty” of the director.
Not surprisingly, U.K. corporations have a much harder time finding independent directors than U.S. corporations. It is also not surprising that the corporate secretary (there called “company secretary”) function is commonly outsourced in the U.K. to ensure that administrative matters are handled properly.