Director Liability For Payments From A Company

Overview Of Director Liability For Payments From A Company

Director payments from a company is such an important issue because of the duties owed by Directors to Shareholders and creditors.

Payments to Directors from companies need to be proper because they are in control of the company’s property.

Checklist of Considerations On Director Payments From A Company

• Is the payment for the Director personally or the company?
• Is the payment in the best interests of the company from an objective vantage point?
• Can the company afford to make the payment?
• Is a full and proper record retained, identifying and evidencing the payment and purpose?
• Is the company already insolvent or of doubtful solvency?
• Has the payment been authorised by other directors?
• Has a personal payment to a director been ratified by Shareholders?

Misfeasance Principles For Director Liability For Payments

Section 212 Insolvency Act 1986 provides a summary remedy by which claims can be brought, including for breach of fiduciary duty by company directors.
A company director owes the general statutory duties set out in Sections 171 to 177 of the Companies Act 2006, including the duties to:

1. Act in the way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole: s.172(1); and
2. Exercise reasonable care, skill and diligence: s.174(1).
3. A duty not to cause the Company to enter into transactions with third parties, or persons associated or connected to the Company to the detriment of the Company.

Burden Of Showing Payments Are Proper

In the case of Manolete Partners PLC v Karim & Ors [2024] EWHC 2053 (Ch) the director’s burden of showing payments were proper was highlighted as follows:

Like all fiduciaries, directors are required to account for their dealings with trust property. This obligation means that, where a prima facie case is made out that a director has received company money or its benefit, then it is for that director to show that the payment was proper. Similarly, where credit entries are made to a director’s loan account, those entries will fall to the director to be justified. See Gillman & Soame Ltd v Young [2007] EWHC 1245 (Ch), [82]; GHLM Trading Ltd v Maroo [2012] EWHC 61 (Ch), [149].

That principle applies even when there are many payments or transactions in issue. Thus, even where there were 215 unexplained transactions, the Court of Appeal held that it was not necessary for the company to demonstrate that each transaction was illegitimate, but on the contrary that it was for the director to justify the payments: Ross River & Anr v Waveley Commercial Ltd [2014] 1 BCLC 545 at [120].

Creditor Duty

In circumstances of financial difficulty the focus of the duty under s.172 shifts to the interests of creditors. S.172(3) provides that:

The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

If a company finds itself in a position of doubtful solvency Re HLC Environmental Projects Ltd (in liquidation) [2013] EWHC 2876 (Ch) at [88] then the shift will have arisen. It is then unnecessary for the directors to have subjective knowledge that the company is insolvent or of doubtful solvency. The requisite knowledge is of the facts, which give rise to the relevant legal consequences (actual or potential insolvency): Re HLC at [95].

The duty owed to a company is a subjective one.  Jonathan Parker J at Regentcrest plc v Cohen [2001] BCC 494 at [120]:
“The duty imposed on directors to act bona fide in the interests of the company is a subjective one…The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind. No doubt, where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.”

The director’s conduct will be considered with particular care; reasons and motivations for the transaction in question might not be accepted, particularly when not appearing to be in the interests of the company – for the benefit of the director personally or connected persons.

The subjective test only applies where there is evidence of actual consideration of the best interests of the company. Where there is no such evidence, the test is objective, ie. whether an intelligent and honest man in the position of a director of the company concerned could, in the circumstances, have reasonably believed that the transaction was for the benefit of the company: Re HLC at [92b];

Reasonable Care

The duty of a Director is to exercise reasonable care, skill and diligence. This means (s.174(2)):

the care, skill and diligence that would be exercised by a reasonably diligent person with—
(a)     the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
(b)     the general knowledge, skill and experience that the director has.