RECOVERIES FROM DIRECTORS AND OTHER COMPANY OFFICERS

PART 4

November 2011

RECOVERIES FROM DIRECTORS AND OTHER COMPANY OFFICERS 

31.4B.66 Recoveries from directors – general

There are a number of different circumstances where a director of a company may be liable to recoveries by the liquidator or creditors of a company.  In summary, those circumstances may be categorised into three areas: 

 

31.4B.67 Recoveries from other persons

Recoveries are not necessarily limited to the director of a company.  In certain circumstances other persons may be found liable.  See, for example paragraphs 31.4B.85, 31.4B.88D and 31.4B.88i.

 

31.4B.68 Actions by the company

It is possible for a company to bring a claim against a director for negligence, misfeasance, breach of statutory duty or breach of fiduciary duty under the common law.  The Act provides a mechanism for these types of claims to be brought by creditors, contributories, the official receiver or the liquidator [note 1].  So far as concerns those types of actions, this Part will cover only the procedure for the official receiver to bring actions under the Act although, invariably, many of the considerations will be the same for claims brought by creditors, etc.

 

31.4B.69 Importance of investigating potential recoveries and seeking evidence of breach or debt

The official receiver when investigating the affairs of a company [note 2] should be aware of any potential recoveries that may benefit the company where there has been a breach by the director or where there is a debt owing to the company from a director.  The official receiver, as liquidator, will need to establish that the director(s) has committed a breach or owes the company money and attempt to establish the amount of compensation or debt that is due.  The official receiver will also need to check that any breach has not been sanctioned by the company (see paragraph 75.130).

The evidence that is likely to be appropriate will vary from breach to breach and from company to company and it is not easy to give specific guidance.  Studying the examples of breaches and comparing the actions of the director to the requirements the law should assist (see paragraphs 31.4B.73 and 31.4B.74).

 

31.4B.70 Recoveries – general

Unlike other forms of antecedent recoveries (see, for example, preferences and transactions at an undervalue – see Chapter 31.4A), recoveries of the type covered by this Part are not ‘recoveries’ at all in the strict sense of the word, as the court does not necessarily seek to restore the company to a position that it would have been in had a transaction not have taken place; rather the court will seek to have the director (or other liable person) pay compensation for the loss to the company caused by his/her action/inaction.  It is not intended that the payment should be punitive (that is, to punish the director) [note 3].

 

31.4B.71 Recoveries for a breach of duty/misfeasance, etc. - general

A director has a duty to act in the best interests of the company and not, for example, to seek personal profit when carrying out his/her role as director.

Where a director has misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary duty (including a duty of care [note 4]) in relation to the company [note 5], the official receiver, as liquidator, can bring a claim in the court, for the court to examine the director’s conduct and compel him/her –  

  • to repay, restore or account for the money or property or any part of it, with interest at such rate as the court thinks just [note 6], or 
  • to contribute such sum to the company’s assets by way of compensation in respect of the misfeasance or breach of fiduciary or other duty as the court thinks just [note 7].

These provisions apply equally to any officer of the company (including a shadow director [note 8] and a de-facto director) [note 9] [note 10] or a company secretary, and the order for compensation may be apportioned between the directors as the court sees fit [note 11]. 

 

31.4B.72 Dealing with a recovery from a director

Assuming that there is evidence supporting the fact that a recovery/claim may be made against a director of the company (see paragraph 31.4B.71), the official receiver may pass the matter to The Service’s antecedent recovery contractor (see Part 1).

 

31.4B.73 Directors’ duties

The Companies Act 2006 provides a statement of a director’s duties, which are split between general duties and specific duties, as follows:

General duties

To promote the success of the company (see paragraph 75.90)

To exercise independent judgement (see paragraph 75.92)

To exercise reasonable care skill and diligence (see paragraph 75.93)

To avoid conflicts of interest (see paragraph 75.94)

Not to accept benefits from third parties (see paragraph 75.97)

To declare an interest in a proposed transaction or arrangement with a company (see paragraph 75.98)

Specific statutory duties

To declare an interest in existing transactions or arrangements (see paragraph 75.103)

To have the company approve a substantial property transaction (see paragraph 75.108)

To have the company approve loans or quasi-loans (see paragraphs 75.110)

To have the company approve a payment for loss of office (see paragraphs 75.120)

To obtain a trading certificate (see paragraph 31.4B.88F)

In connection with the company’s purchase of its own shares (see paragraph 31.4B.88E)

Whilst this list is not exhaustive and other actions of a director may constitute a breach, it should give some indication of the areas in which the official receiver should direct his/her enquiries (see paragraph 31.4B.69).

 

31.4B.74 Examples of recoveries for breach of duty/misfeasance

The following are examples of behaviour the commission or omission of which could be classed as misfeasance or a breach of duty: 

  • The director has received monies or other consideration from the company (other than the proper remuneration for services provided) which has resulted in a material loss to the company [note 12]. 
  • The director has authorised payments or other dispositions of property to himself/herself (or to connected persons – see paragraph 31.4B.30) which has resulted in a loss to the company [note 13] [note 14]. 
  • The director has been responsible for the improper investing or payment of the company’s money [note 15] [note 16] [note 17]. 
  • The director has been responsible for the payment of dividends out of capital (illegal or ultra-vires dividends/distributions – see also paragraph 31.4B.83) [note 18] [note 19 
  • The director has been responsible for the non-disclosure to the company of any contracts, dealings or other transactions in which use was made of the company’s assets or property (including goodwill) and which has resulted in a material loss to the company [note 20]. 
  • The director has failed to disclose an interest in a property purchased by the company [note 21] [note 22]. 
  • The director has been responsible for any material loss to the company occasioned by the sale, assignment, transfer or property other than in the normal course of business [note 23]. 
  • The director failed to introduce a proper accounting system into the company [note 24] 
  • The director paid redundancy to an ex-employee when none were due and overpaid redundancy to another [note 25]. 
  • The director failed to read a proposal for insurance before signing it [note 26].

 

31.4B.75 Breach of duty/misfeasance following professional advice

Where a director is subject to an application for recovery, the court may grant relief (allow a lesser amount of some/all of the compensation to be paid) if the director was shown to have acted on professional advice [note 27] [note 28], though the court would be unlikely to grant relief to the director if to do so would leave a position where he/she benefitted from the loss caused to the company or creditors [note 29].

It is open to the director to personally seek a contribution from any professional advisors in these circumstances [note 30].

 

31.4B.76 Recoveries for a breach of trust – general

A director of a company is considered to be a trustee for property of a company that comes under his/her control [note 31].  A director who has misapplied, retained or otherwise become accountable for property of a company must make good any resultant losses to the company and/or any personal gains [note 32].

 

31.4B.77 Claims for misfeasance/breach of duty and the right of set-off

An amount to be ordered by the court to be paid by a director (see paragraph 31.4B.72) cannot be set-off [note 33] against sums owing by the company to that director [note 34].

 

31.4B.78 Recoveries following specific statutory misconduct

The official receiver, as liquidator, may seek a recovery from a director following misconduct defined in the Act, namely:

 

31.4B.79 Fraudulent trading

If it appears that any business of the company has been carried on with intent to defraud creditors of the company or of any other person, or for any fraudulent purpose, the court may, on the application of the liquidator, declare that any persons (not just company officers) who were knowingly parties to the carrying on of the business in the manner mentioned above are liable to make such contributions to the company’s assets as the court thinks fit [note 35].

For a successful recovery action under the provisions relating to fraudulent trading, it is necessary to demonstrate that there was an intent to defraud [note 36].

Fraudulent trading is also a criminal offence [note 37].  Information on fraudulent trading as a crime can be found in Chapter 38 of the Enforcement Investigation Guide.

 

31.4B.80 Wrongful trading

Where a director, former director or shadow director [note 38], knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation, and took the decision to carry on trading, the court, on the application of the liquidator, may declare that the director is liable to make such contribution to the company’s assets as the court thinks proper  [note 39] [note 40].

Simply allowing the company to continue to trade when insolvent would not put the director in contravention of these provisions.  It must be shown that he/she ought to have known, or concluded, that there was no reasonable prospect of avoiding insolvent liquidation [note 41].

Information regarding wrongful; trading as a matter of unfit conduct can be found in Chapter 38 of the Enforcement Investigation Guide.

 

31.4B.81 Wrongful trading – conditions in which the court will make an order

The court will not make an order requiring a director to make a contribution to the assets of the company in connection with wrongful trading if it is satisfied that the director, knowing that there was no prospect of avoiding insolvent liquidation, took every step with a view to minimising the potential loss to the company’s creditors as he/she ought to have taken [note 42].  In reaching this conclusion, the court will take into account the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as that director [note 43] and the actual knowledge, skill and experience of the director [note 44].

In addition, the court must be satisfied that the company’s position was worse as at the date of liquidation than it was when there was knowledge of insolvency to make an order for contribution [note 45].  It is possible that not all directors could be found liable as each individual’s role and knowledge will be separately assessed by the court [note 46].

 

31.4B.82 Wrongful trading following professional advice

Where a director takes the decision to continue trading, the court may grant relief (allow a lesser amount of contribution to be paid) if he/she were acting on professional advice [note 47].

 

31.4B.83 Recovery in relation to directors’ remuneration – including pension contributions and benefits in kind (amended April 2013)

Remuneration might be in the form of a straight salary, or might be benefits in kind such as a company car, health plan or pension contributions. 

It has been held that if there is the power of a company to award remuneration to its directors, remuneration cannot be challenged solely on the basis that it was not to the benefit of the company [note 48].  The court, however, did give examples of general circumstances where a challenge might be appropriate: 

  • The remuneration is so excessive as to contribute a fraud on creditors;
  • Although the director could receive payment simply for holding office, if the payment was above the amount which might be reasonably paid to the director in question, it might be held to be a gift out of capital. 

Paragraph 31.4B.83a provides advice to the official receiver to assist him/her in establishing if remuneration may be considered to be excessive or unreasonable.

 

31.4B.83a Remuneration considered to be unreasonable or excessive (added April 2013)

Generally, excessive remuneration is remuneration which goes beyond what is reasonable in all circumstances.  Reasonableness might be measured in terms of what the company could afford [note 48a] [note 48b] and, whilst this is a useful rule of thumb it should be applied with care and without an over-reliance on hindsight.

Reasonableness cannot be measured by the remuneration that the director and his/her family need to live on [note 48c], and does not necessarily equate to the market rate for a director [note 48d].

The director should have reasonable grounds for believing that the company can or will be able to (see paragraph 31.4B.83b) afford the remuneration (whether on its own or through a third-party).  If not, the remuneration should be deferred or taken as loans (see paragraph 31.4B.84).

 

31.4B.83b Decision to fix remuneration (added April 2013)

The decision to fix remuneration rests with the company where it operates under Table A of the Companies Acts 1948 or 1985 [note 48e] [note 48f] (see Chapter 75, Part 6).  Where the directors allow or fail to stop the company paying unreasonable remuneration, this might be a matter of misfeasance leading to a civil recovery.

Where the company operates under Table A of the Companies Act 2006 [note 48g], it is the directors who fix the remuneration.  Any remuneration fixed that is unreasonable might similarly be considered misfeasance, for which a recovery might be appropriate.

Remuneration that is reasonable when the decision is taken to fix it might become unreasonable following a change of circumstances (for example a change in the company’s financial position) [note 48h].  If so, the remuneration should cease, or the company should stop trading [note 48i].

 

31.4B.83c Retrospective remuneration (added April 2013)

Directors often draw money from the company and only at year end decide whether to account for the drawings as dividends (see paragraph 31.4B.88i), loans (see paragraph 31.4B.84) or remuneration.

When deciding whether remuneration fixed retrospectively is reasonable, it is necessary to take account of the ascertainable facts when the director took the decision to fix the remuneration and not the position of the company during the period to which the remuneration relates.

 

31.4B.83d Remuneration and tax liability (added April 2013)

Remuneration cannot be justified, and would be considered to be excessive, if the company cannot afford to pay the tax due on that remuneration. 

 

31.4B.84 Debts owed to the company by a company officer

Where a company officer owes money to the company under a contract or other arrangement (such as an overdrawn loan account), this should be pursued through the normal channels for debt recovery (see Chapter 31.1, Part 3) and not, for example, as a matter of misfeasance [note 49].

In addition, the official receiver should consider if any other company officers may be liable under a breach of duty if the loan was not made with the consent of the company (see paragraph 75.110).

 

31.4B.85 Personal liability following use of a prohibited name

Where a company uses a prohibited name (see paragraph 31.4B.87), a person will be personally responsible for any debts incurred when he/she was involved in the management of the ‘new’ business and/or incurred at a time when he/she was acting or willing to act on the instructions of the person restricted from using the name (see paragraph 31.4B.88) [note 50].

Where only part of the business was conducted under a prohibited name, the person will be liable only for those debts incurred under the prohibited name [note 51].

The person will be jointly and severally liable for the relevant debts with the company [note 52], and liability is automatic – there is no need for a court order or conviction.  Where the official receiver is liquidator of the successor company, he/she should seek a recovery from those liable (see paragraph 31.4B.88). 

 

31.4B.86 Restriction on re-use of a company name

When a company goes into insolvent liquidation, the Act [note 53] provides that any person who has been a director or shadow director of that company in the 12 months prior to the making of the winding-up order [note 54] is not allowed to use (see paragraph 31.4B.88) the name (known as a prohibited name – see paragraph 31.4B.87) of the company for a period of five years from the day the company went into liquidation [note 55].

 

31.4B.87 A prohibited name

A company name becomes a prohibited name if [note 56]: 

  • it is a name by which the company in liquidation was known at any time in the in the period of 12 months prior to the making of the winding up order (note that it does not just apply to the registered name), or 
  • it is name which is so similar to a name used by the company as to suggest an association with that company.

 

31.4B.88 Use of a prohibited name

The person is considered to be using a prohibited name (see paragraph 31.4B.87) if he/she [note 57]: 

  • is a director of a company that is known by the prohibited name, or 
  • is in any way, whether directly or indirectly concerned or takes part in the promotion, formation or management of any such company, or 
  • is in any way, whether directly or indirectly, concerned with or takes part in the carrying on of a business (not a company) under the prohibited name.

 

31.4B.88A Exceptions to restrictions on re-use of a company name

Apart from the person restricted from re-using a prohibited name (see paragraph 31.4B.85) obtaining the permission of court to re-use the name [note 58] [note 59], there are three cases where a director will be able to use the name without incurring personal liabilities: 

  1. Where the new business/company acquires the whole, or substantially the whole, of the business of an insolvent company, under arrangements made by an insolvency practitioner acting as liquidator, administrator, administrative receiver or supervisor of a voluntary arrangement, and gives notice to the insolvent company’s creditors following the procedure in the Rules [note 60] (see paragraph 31.10.87).
  2. If the director applies to the court for permission (see paragraph 31.4B.88B) to use the prohibited name (see above) within seven days of the making of the order, he/she may continue to use the name for a period of six weeks from the date of the winding-up order or until the date that the court deals with the application for permission, whichever is sooner [note 61].
  3. Where the ‘new’ business/company has been known by the prohibited name for a period at least 12 months ending on the day of the winding-up order [note 62].

 

31.4B.88B Applications for permission to re-use a prohibited name

An application for permission to re-use a company name must be served on the Secretary of State at least 14 days before the hearing [note 63].

Such applications are dealt with by Intelligence and Enforcement Directorate (http://intranet/IES/Intelligence%20and%20Enf/Intelligence%20and%20Enf.htm) who will contact the official receiver in relevant cases to seek any views on the application.

 

31.4B.88C Considerations in respect of an application to re-use a company name

Clearly, where a director wishes to re-use the name it is likely that the name will have some value to the director and the official receiver should consider transferring the goodwill in the name for consideration.  For further information on the sale of  goodwill see paragraphs 31.10.83 to 84.  Such a transfer could be conducted on an informal basis – by an exchange of letters – if the purchasing director were content to proceed in that way.  The Secretary of State can advise the court of any prospective sale and the court may make the granting of permission conditional on the payment being made.

 

31.4B.88D Liability when acting whilst disqualified

Where a person is: 

  • in contravention of a disqualification order, or whilst an undischarged bankrupt, without leave of court is involved in the management of a company, or 
  • involved in the management of the company, and he/she acts or is willing to act on instructions given without leave of the court by a person whom he/she knows at that time to be the subject of a disqualification order or to be an undischarged bankrupt, 

That person will be liable for any debts incurred when he/she was involved in the management of the company and/or incurred at a time when he/she was acting or willing to act on the instructions of the disqualified person [note 64].

The person will be jointly and severally liable for the relevant debts with the company [note 65], and liability is automatic – there is no need for a court order or conviction.  The creditor(s) may pursue the person for settlement of his/her debt.

Where the official receiver is liquidator of a company where there has been a breach of a disqualification, he/she should seek a recovery from those liable (see paragraph 31.4B.72). 

 

31.4B.88E Liability when company has purchased own shares

(Amended August 2014)

Where a private company wishes to purchase its own shares, the company’s directors must make a statutory declaration specifying the amount of permissible capital payment for the shares in question and stating that there will be no grounds on which the company could be found unable to pay its debts, and will carry on business for at least a year [note 66].

If the company is wound up within a year of re-purchasing shares out of capital, and the aggregate amount of the company’s assets is not sufficient for the payment of its debts and liabilities and the expenses of winding-up, any director who signed the declaration may be liable to contribute to the assets of the company [note 67].

The directors are jointly and severally liable with the shareholders whose shares were repurchased for the amount received as consideration on the repurchase [note 68].  A director may be able to avoid such a liability if he/she can show that he/she had reasonable grounds for forming the opinion set out in the statutory declaration [note 69].

In circumstances where the director is obliged to make a contribution under these provisions, the official receiver should pass the matter to Clarke Willmott (see Part 1).

 

31.4B.88F Trading certificate under the Companies Act

A company registered as a public company (plc) on its original certificate of incorporation must satisfy the Registrar of Companies that it meets the requirements for share capital for such a company before it may commence trading [note 70].  The company does this by sending a Form SH50 (http://www.companieshouse.gov.uk/forms/generalForms/SH50_application_for_trading_certificate_for_a_public_company.pdf) to the Registrar containing a statement of compliance signed by a company officer [note 71].  If the Registrar is satisfied with the information provided, he/she will issue a certificate – often known as a trading certificate [note 72].

A company re-registering from a private company to a public company does not have to apply for a trading certificate.

 

31.4B.88G Personal liability in connection with failure to obtain a trading certificate

If a company does business or exercises any borrowing powers without obtaining a trading certificate (see paragraph 31.4B.88F) and then fails to comply with obligations in connection with that activity within 21 days of being called to do so, the directors of the company are jointly and severally liable to indemnify the other party to the transaction in respect of any loss or damage suffered by him/her by reason of the company’s failure to comply with those obligations [note 73].

 

31.4B.88H Recoveries by creditors following insolvent liquidation

It is possible for those disadvantaged following breaches of statutory provisions by directors of a company to seek redress for their losses from the director personally.  Particular examples of this are as follows: 

 

31.4B.88i Illegal (ultra-vires) dividends/distributions (amended April 2013)

A company can declare a dividend only if it has sufficient distributable reserves, as defined by the Companies Act [note 74]. Any unlawful dividends are repayable by the shareholders in receipt of the payment [note 75].  In deciding whether the distribution is unlawful, it is irrelevant if the company was solvent at the time of the distribution [note 76] and ignorance of the law is no defence [note 77].

Where the directors authorise or fail to stop an unlawful dividend payment being made, this would be misfeasance in respect of which a civil recovery may be made [note 77a].  

 

Back to Part 3 – Avoidance of charges] [On to Part 5 – Avoidance of dispositions of property]