Feb 24
This is article 2 from a series of 10 written by Jonathan Mortimer, a Dispute Resolution Partner at Raworths. The guide is written from the viewpoint of where things may become contentious and involve legal proceedings. It presents a snapshot of the some of the legal issues which impact upon directors. It is not a substitute for taking specific legal advice on a particular set of circumstances.
The office of director comes with numerous responsibilities and legal consequences.
Here are five examples of traps which it is easy for a director to fall into even when acting with the best of intentions.
There are numerous statutory provisions which require not only the approval of the directors but also the shareholders. If you fail to get that approval, then the decisions may be declared invalid and have to be reversed. For example, if a director has a personal interest in a transaction or it is decided to provide a director with a loan then generally speaking the shareholders must agree.
Similar principles apply concerning the appointment of a director. Any service contract which lasts for more than 2 years must be approved by the shareholders.
If the intention is to later dispense with the director then the shareholders are required to agree to the removal and also to approve any compensation payment to the director concerned.
A director will usually also be an employee of the company. As a result, if you have insufficient grounds to dismiss the director, you could be faced with an unfair dismissal claim.
If you just terminate the contract of employment, the individual could remain a director and a shareholder unless you have you paperwork in order to cover this eventuality.
Some directors can be too keen to declare dividends for shareholders when turnover seems high or incorrectly declare dividends as a form of remuneration for themselves in an attempt to be tax efficient.
Directors frequently go wrong by declaring dividends when there is insufficient available profit to distribute and also not paying the dividends fairly to all shareholders leaving the directors exposed to having to repay the unlawful dividends paid.
This is known as a transaction at an undervalue and can potentially have serious repercussions for the director who may be seen as purposely diverting assets away from creditors.
As a result, a director, usually in the event of insolvency, can become personally liable for the company’s debts, receive a fine and even face a criminal prosecution. Whichever party received the asset in question may also need to hand it back.
If cash flow is tough and insolvency a possibility, creditors within the same class must be treated the same. If for example a director prefers to repay a loan to a family member, pay a particular lender to avoid personal liability on a guarantee or prefer to pay a creditor to secure an ongoing business relationship following insolvency the director may be in trouble.
Directors can face personal liability for the company’s debts and the party who was preferred can be made to return the advantage received.
A guide for directors: What you should know before accepting the appointment.
Links to other articles in the full series can be found here when they are published:
Jonathan Mortimer has significant experience dealing with contentious company matters including the issues covered in this guide. Jonathan can be contacted by email at jonathan.mortimer@raworths.co.uk or telephone 01423 566 666
Published on 8 February 2024
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