Can a director be liable for the debts of a company?

In uncertain economic times people often ask whether trading as a limited liability company really stops directors being responsible if creditors are owed money. The case of Roberts v Frolich & Spanner [2011] EWHC 257 (Ch) serves as a useful reminder that limited liability is a not always a complete shield to personal liability.

A company was set up to develop 30 industrial units. It conducted its activities entirely upon borrowed money. It acquired the site in June 2004. A contractor was engaged on a letter of intent on a costs plus basis so work could begin whilst a lump sum contract was negotiated. The loan from the Bank contained certain terms including that the building work was to be done under a fixed price contract.

Things did not progress smoothly. Negotiations did not result in a lump sum contract being concluded. Inevitably the company had difficulty paying the contractor which resulted in the contractor commencing adjudication proceedings to get paid and was awarded £1.6m. Two days later the directors called in Administrators who sold the site off.

The proceeds of sale paid the bank loan leaving a number of unsecured creditors, the main one being the contractor.

The case looks at various duties that directors have to the company and to creditors and the circumstances in which the corporate veil can be lifted to attach personal liability to the directors who continue with a commercial venture knowing that the company is insolvent – that is they continue to allow creditors to carry out work when they knew or ought to have known that the creditors would not be paid for the goods or services supplied.

In addition, Section 214 of the Insolvency Act 1986 applies where if, in the course of the winding up of a company, it appears that:

• the company has gone into insolvent liquidation;
• that at some time before the commencement of the winding up of the company, a person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation;
• and that person was a director of the company at that time

In those circumstances the court may declare that that person is to be liable to make such contribution (if any) to the company's assets as the court thinks proper.

The directors were found to be in breach of their duties to the company and creditors in that the directors had permitted the company to trade wrongfully using credit supplied to it by suppliers. This case highlights that directors cannot simply be wilfully blind to the financial position of their company and any optimism that the company can trade out of a precarious financial position must have some credible foundation.

If in any doubt directors should seek professional advice from their lawyer and/or accountant.

In the event that you would like to discuss any of the issues raised in this article and how they might affect your business, whether you are a director or a creditor, please contact Richard Millard.