The concept of limited liability is something embedded in legal systems across the world. As a result of this, business owners frequently see this “limited liability” as a form of insurance that enables them to trade without the threat of personal liability. What they fail to realise, however, is that more and more situations are arising that allow institutions and individuals the ability to scrap this limited liability and bring actions against the decision makers within a business. Outlined below are just a handful of situations where personal liability can occur.
A director must make informed decisions as to whether or not the business is solvent. It is a difficult decision to end the life of a company and, in turn, extinguish a livelihood. However, if the company continues to trade whilst insolvent then the director will fall foul of Section 214 of the Insolvency Act 1986. If it can be shown during a winding up that a director continued to trade knowing that the company was insolvent, it is likely that he will have to contribute to the company assets. There is also the possibility of criminal sanctions if there is evidence that such a liability arose fraudulently.
If a company goes insolvent then the decisions made by the directors will be scrutinised and there is every chance that they may have fallen foul of law. Section 212 of the Insolvency Act 1986 provides a statutory remedy for misfeasance which enables a liquidator or creditor to bring proceedings against a director if there is evidence that the director may have contributed to the liquidation of the company. If it can be shown that the director failed to discharge his duties or misapplied company funds, then it is likely that he/she will be required to contribute funds to creditors.
Many people believe that they can rescue their business by liquidating the company and incorporating a new company with the same or similar name. They can’t. This is commonly known as a phoenix company and is prohibited by Section 216 of the Insolvency Act, unless certain criteria can be fulfilled. A breach of this section of the Act is punishable both in the criminal and civil courts.
Historically, breaches of this Section of the Act did not incur any penalties. However, creditors are increasingly pursuing actions under Section 216 and even using the threat of notifying the Insolvency Service as leverage to get their debts paid. Creditors are also recognising the opportunity to purchase otherwise unrecoverable debts for a minimal consideration, with a view to pursuing the directors personally. It is in this context that a breach of Section 216 is most likely to come to light.
It is not just statutory remedies that provide the opportunity to pierce the limited liability shield. If you make promises as a director to pay suppliers when you know you cannot afford to pay, you may well find yourself liable to a claim of deceit which is a tortious liability developed in the courts as a form of fraud. Unlike a negligence claim, a person liable for deceit is personally liable for all losses flowing directly from the deceit, even if those losses are not foreseeable.
Directors will therefore note that, although they may think they are free from potential litigation because of the “LTD”, this is far from the truth. Decisions that are made in business can affect you personally. What is clear is that if you are up front and honest as a director, the law should provide you with limited liability. If you are dishonest or try to beat the system it is likely that the law will provide you with unlimited liability.
SMEs are the fulcrum of the British economy and it would not be right for business owners to be frightened to make business decisions. In situations where you are a director or shadow director and your company is facing financial problems, you need to take legal advice immediately. Do not wait until the liquidation has commenced as it could be too late to protect yourself and you will end up going from MD to HMP.