Everyone loves a title. Whether it’s self-aggrandisement, public recognition of good work done, or as a function of a role, titles are everywhere. But while some titles are honorific, others, such as that of company director, carry duties and obligations that are backed by legal sanction. And for good reason too.
Sadly for print, like many industries, it’s not hard to find examples of directors getting into trouble.
Back in March 2017, a former director of a Lincolnshire print company, Peter Henry Nicholson, was banned “from promoting, forming or managing a company for 10 years after breaching the terms of his bankruptcy.” This followed his appointment to another firm, Tandem Print Solutions, within a month of a previous 12-month ban handed down by the Insolvency Service.
Another high-profile print industry case involved Kevin Dunstall, who left a trail of bad debts at ventures including Prospect Mailing Services and Global MP (formerly St Ives Bradford). The Insolvency Service banned him from being a director for seven years after he made unexplained payments of more than £200,000 to himself, to the detriment of creditors.
So, with the background set, what exactly are the duties that the law places on directors?
Duties laid down
According to John Hamer, a partner at Walker Morris and head of corporate at the law firm, the Companies Act 2006 sets out seven duties of a director. Before listing them, he says it’s important to note “that up until the 2006 Act was passed, there wasn’t a code of directors’ duties, instead they had to be gleaned from a mixture of case law and various pieces of legislation.” He adds that the rationale behind the codification of these directors’ duties was to make the law easier to understand, particularly for new directors.
The statutory duties written into the Act are the duty to act within powers; to promote the success of the company; to exercise independent judgment; to exercise reasonable care, skill and diligence; to avoid conflicts of interest; not to accept benefits from third parties; and to declare any interest in a proposed transaction or arrangement with the firm.
Of course, when business is good, few tend to worry about their duties and obligations. But that isn’t the case when business turns sour. As Hamer outlines, the duties owed by a director to a company change in the lead-up to insolvency and “require directors to have proper regard for the interests of creditors. While it is clear that this rule comes in to play before the start of a formal insolvency process, precisely when it becomes relevant is less clear.”
The issue at heart is that directors should be conscious of the provisions of the 2006 Act and also the Insolvency Act 1986. These pieces of legislation can make directors personally liable as a consequence of their actions during the period before and on insolvency. Typically, these include wrongful trading, fraudulent trading and misfeasance. As Hamer has regularly seen, “the consequences of these actions are draconian and so advice should be taken early on to make sure that directors don’t face personal liability.” It’s precisely for this reason that he also advises recording all decisions so that these notes can be relied on as evidence in any subsequent inquiry or legal proceedings: “Showing that you were acting reasonably in the circumstances at the time will largely protect you even though hindsight may show that the decisions you made turned out to be poor ones.”
The key point here is that when a company gets into financial difficulties a director must ensure that the company does not continue to take on credit in circumstances where there is no reasonable prospect of it being able to repay its creditors. In addition, and this is particularly important says Hamer, “a director must seek to treat all creditors equally and not prefer any single particularly any creditor with whom directors or shareholders have some connection”. In other words, no sweetheart deals.
The state of the law
The problem with the law is that it can be a particularly blunt instrument, riddled with loopholes and open to interpretation. Indeed, it was Charles Dickens’ character, Mr Bumble who, in Oliver Twist, noted that “the law is an ass”.
Philip King, chief executive of the Chartered Institute of Credit Management, considers the biggest risk to firms – and the reputations of directors – to be that of phoenixism – where a firm fails only to be reborn, without the debt, often with the same managers and owners. “The changes to pre-pack administrations, and the introduction of the Pre Pack Pool following the Teresa Graham review have,” says King, “enhanced the level of transparency significantly.” That said, he says that engagement by creditors with insolvency practitioners and the insolvency process to be important, “as is the decision as to whether to trade with a business that has risen from the ashes of a customer from which a bad debt has been incurred.”
But in the event of a corporate failure, Dave Mullett, credit control manager at paper firm Elliott Baxter & Co (EBB), thinks that insolvency practitioners (IPs) will only ever be as effective in holding directors to account as cash allows: “If the insolvency occurs at a time when obligations far outstrip debt due, the funds available may be limited, and so an investigation into the conduct of directors may be cost-prohibitive.”
He adds that even if an IP is representing several of the largest creditors, they may feel more duty bound to investigate if there was any wrong doing, but again the investigation can depend on the funds available. Even so, he makes the point that “some IPs may have an appetite to pursue individual directors if they feel there is a case to answer, and if there is a strong likelihood of a successful outcome against those individuals, despite funds available for such action being limited.”
From a legal stance, Hamer thinks company law strikes the right balance: “We have limited liability companies in order to promote entrepreneurialism and it is inevitable that some businesses will fail with the founders often having invested considerable sums and losing it all.
“Creditors can be pulled down by these failures but ultimately credit risk is a business risk that every supplier must manage.
However, he notes that “there are people who ‘play’ the system and have multiple failures that they walk away from”.
This is why he supports greater powers (and public funding) to allow the Insolvency Service to pursue individuals who were directors of dissolved companies. It’s a timely point since the government is currently carrying out a review of insolvency legislation (which largely dates from 1986). As Hamer comments, “the review is seeking to address perceived shortcomings in corporate governance to put greater emphasis on the obligations of directors when companies are in financial difficulty.”
The review has a number of principal areas of focus including the interests of wider stakeholders when distressed sales of businesses occur; the reversal of inappropriate value extractions; enhanced powers for investigation of directors of dissolved companies; protection for company supply chains in the event of insolvency; and the strengthening of corporate governance in pre-insolvency.
Is there a saving grace?
The obvious question to ask is whether the actions (or directors’ mistakes) are deliberate, inadvertent or made through a genuine misunderstanding of the law (while trying to act honourably).
Mullett thinks that to answer the question requires recognising that some sleepwalk into directorships: “I feel sure there are many people in the position of ‘director’ who have worked hard for businesses and have been promoted into a position that the owners feel is a reflection of that individual’s efforts and loyalty over the years. Often, little will change for the individual other than title, and they continue without being fully conversant in the rules and responsibilities that come with such a position.”
With his lawyer’s hat on, Hamer suspects that most mistakes are inadvertent – “I don’t think there are many directors who deliberately breach their duties.” However, he does think that mistakes probably come about “through a lack of knowledge and understanding of their role as directors.” He also worries that inexperienced directors can sometimes be influenced by stronger and more experienced directors, as well as dominant shareholders, into making decisions with which they are not wholly comfortable. In such circumstances the advice is crystal clear: “They should seek to get independent advice as to the lawfulness of their decisions or actions.”
King takes the view that directors should be taught their craft, noting: “There is no requirement for training before becoming a director or running a company and no requirement to demonstrate competence or suitability – so there are myriad ways mistakes can be, and are, made.”
Mullett agrees: “Without wishing to stifle entrepreneurialism, I often wonder if, in order to become a company director, there should be some form of competency exam, for an individual to demonstrate they have an understanding of the obligations such a role demands.”
Even so, King warns businesses to remember who they’re trading with because the barriers to entry are low: “The only requirements to be a company director are that the individual must be 16 or over and not be disqualified from being a director.”
It’s just as important to remember that while some directors are dishonest and set out to exploit suppliers, many are just ill-advised and/or ill-prepared for the challenges of running a business and make mistakes often unknowingly.
In the shadows
Another complication to deal with is what are termed ‘shadow directors’ – individuals acting as a director but without the formal title or registration at Companies House. Both King and Hamer see problems as shadow directorships are hard to prove and the opportunity for abuse of process at a distance is always a possibility.
Hamer knows of circumstances where, in particular, a dominant shareholder exerts influence as a shadow director and other directors are not sufficiently robust to fight their corner – even though the law expects a director to do so.
King, on the other hand, says – again – that to combat the problem “it’s important to know who is really pulling the strings and controlling the activities of the business”.
As the old adage goes, Turnover is vanity, profit is sanity, but cash is reality. Knowing the customer and building relationships with the managers and directors is the only way to protect against the ‘rogue’ director and debt default.
For directors, not understanding or acting in accordance with the law can be very expensive. In the worst case, it can lead to an income-restricting directorship ban that can last 15 years as well as personal liability for company debts. And as a trawl of the web indicates, cases are brought, and directors are being disqualified. You have been warned.
Directors’ duties explained
Act within powers
It is important that directors always act in accordance with the company’s constitution and should only exercise their power within the boundaries they were given.
Promote the success of the company
Directors must act in a way that will promote the success of the company, for the benefit of all involved, for example, shareholders and employees. This means strategic planning, setting long-term goals to increase the value of the company, and making decisions that are appropriate and will navigate the company in the right direction.
The law demands a long-term view of all decisions; consideration of how decisions will affect employees; a view on how company relationships with clients, customers, supplier, etc. will be managed; a view on how the company will impact the environment and the wider community; a policy on maintaining the positive reputation of business conduct; and the understanding of the obligation to treat all members within the company fairly.
Duty to avoid all conflicts of interest
Directors must avoid any situation that may cause them to act in conflict with the company. This applies to information, exploitation or a possible opportunity (situational or transactional), even if the company could benefit from it. Examples include being a director of a competitor, shareholder, customer or company supplier; holding another advisory position within the company - for instance the accountant; and using the company’s information to make a personal profit. All of these apply to partners, spouses, children, parents or other members of a family. Conflicts must be declared.
The exercise of reasonable care, skill and diligence
The law says directors are required to have suitable experience, qualifications and skills to run the company successfully (including the filing of documents to Companies House and HMRC).
Duty to exercise independent judgement
Directors are required to act independently and confidently make their own decisions. This does not stop directors from acting within an agreement the company has entered into or the company’s constitution.
Not to accept any benefits from a third party
Directors must not accept benefits from third parties, for personal gain. This applies to gifts from customers or potential clients/contracts and any further exploitation of the business relationship. That said, each gift can be assessed and if it can be proven that it will not pose a conflict of interest the duty can be ignored.
Along with all the duties and behaviours directors will need to adhere to, there are a few filing obligations that will need to be completed. These will include company tax returns, confirmation statements, and paying corporation tax.
Declare all interest in proposed or current transactions or arrangement
Allied to former points, directors, directly or indirectly, who have an interest in a transaction, must declare the nature and the extent of their interest. If the contract has already been entered into, it must be declared as soon as possible. The same applies to transactions still to complete. Failures here are a criminal offence.
Directors and mistakes
Directors tend to make mistakes because they do not understand their fiduciary duties and fail to recognise the different interests and obligations of the company, its shareholders and its directors. Some directors take on the appointment without understanding the role. There is plenty of advice available from advisors and also the gov.uk website. Ignorance is no defence.
On being newly appointed
Newly appointed directors should take advice from a lawyer, accountant or business advisor about what is involved in becoming a director. Directors aren’t expected to know the law off by heart, just have an understanding of the general concepts and how they are applied in practice. It’s key to make sure the company has Directors & Officers insurance in place.
Suspicion of malfeasance
Directors who suspect that a colleague is in breach of the law and their duties should take legal advice at the first opportunity and act on the advice; turning a blind eye will usually land then in trouble in due course because they have a duty as a director to act.
If business turns sour
Here directors should communicate as early as possible with creditors who are often able and willing to support a business through difficult times if the long term looks positive. Breach of law cannot be ignored, and a director may become liable if they do nothing or take no action when they were aware of the issue(s).
If the company is in an insolvency situation the duty is towards the best interests of the company creditors. Where it is shown that the director should have realised that there was no possibility of avoiding insolvent liquidation and continued to trade to the detriment of the creditors she/he may be held personally liable for wrongful trading. She/he may have to personally contribute towards the assets of the company.
Where it is found that a director intended to defraud creditors she/he may be charged with fraudulent trading. Again, she/he would be liable personally to contribute towards the company assets and/ or face criminal charges.