Is Ignorance Bliss?
In relation to corporate failure, there are some
common misconceptions about the liability of
company directors. Operating as a limited liability
company does provide a level of protection to
shareholders, however company directors can be
held personally liable for debts of the company if
they have breached their director’s duties. These
duties are set out in Sections 131 – 137 of Part 8
of the Companies Act 1993.
When a company is
placed into liquidation,
the liquidator will
examine whether the
have breached their
duties, including the
duty to avoid trading
recklessly, and the
duty to avoid incurring debt unless there were
reasonable grounds at the time to conclude that
those debts would be met by the time they fell due.
The objective test for reckless trading is if the
business has been carried on in a manner likely to
create substantial risk of serious loss to the
company’s creditors. This does not have to be a
deliberate intention. It can be through simple
carelessness, which is commonly demonstrated by
a director continuing to operate while insolvent.
When considering the duty to avoid incurring debt
that the company is unable to subsequently pay,
the question that needs to be considered is ‘were
the actions that the directors took (or neglected to
take) reasonable in the circumstances’? Directors
often neglect to meet this duty of care if they have
put their head in the sand and not closely
monitored the financial health of the company.
When weighing up whether to take an action
against a director, the liquidator will consider the
value of the loss (total amount of the company’s
creditors) compared with the value of the potential
gain (amount recoverable from the director
personally and potentially their associated trusts).
Failing to comply with ‘director’s’ duties leaves
directors exposed to financial claims and can result
in the loss of their personal assets or worse, being
adjudicated bankrupt. Any such claim is generally
capped at the value of the company’s total
If you are a director of a company, ignorance is no
excuse. You need to know your duties as you
could be personally accountable for the company’s
debts. If you know, or suspect, a company is
insolvent, always seek competent advice as to how
this may affect you.