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Director and parent company liability

Liability

Under what circumstances can a director or parent company be held liable for a company’s insolvency?

Director liability

A director can be held liable for a company’s insolvency where:

  • the company has carried out insolvent or fraudulent trading;
  • fraud has been committed in anticipation of winding up, with the intent to defraud the company’s creditors or contributories, in the 12 months preceding commencement of the winding up; 
  • creditors or contributories (ie, persons liable under the Companies Winding-Up Amendment Act to contribute to the assets of the company in the event that it is wound up and every holder of a company’s fully paid up shares) have been defrauded in the course of the winding up; or
  • misconduct has occurred in relation to the company’s liquidators in the course of winding up, including material omissions to a company’s statement of affairs. 

A director may be exposed to claims of negligence if he or she has breached his or her duty of care and skill to the company, or may be held personally liable if he or she has provided a guarantee to a creditor in relation to the company’s debts. 

At common law, a director has a fiduciary duty to act in the best interests of the company. If the director acts in breach of this duty, he or she could be liable to the company for damages in relation to that breach. 

Parent company liability A parent company will not ordinarily be liable for the debts of its subsidiary, because it is considered a separate legal entity. Therefore, unless an agreement has been made that it will be liable for the subsidiary’s debts, a parent company cannot be liable for the subsidiary’s insolvency. 

However, the parent company can be held liable if it can be established that the subsidiary is a façade or sham seeking to avoid or conceal the parent company’s liability. In these circumstances, or where the parent company could be said to exercise such a degree of control over the subsidiary that the subsidiary is acting as its agent, the court may pierce the corporate veil.

Defences

What defences are available to a liable director or parent company?

The following defences are available to a director or parent company:

  • There was no intent to defraud the company’s creditors or contributories.
  • The director disclosed the relevant information concerning the company to its liquidators, to the best of his or her knowledge and belief.
  • There was no intent to conceal the state of affairs of the company or to defeat the law.
  • The director did not know – or could not have concluded – that there was a reasonable prospect that the company could avoid being wound up by reason of insolvency at any time before commencement of the winding up.
  • After the director first knew – or ought to have concluded – that there was a reasonable prospect that the company could avoid being wound up by reason of insolvency, he or she took every step reasonably available to minimise the loss to the company’s creditors.

Due diligence

What due diligence should be conducted to limit liability?

In order to limit liability, directors should ensure that they take every reasonable step to minimise potential losses to the company’s creditors as soon as it becomes apparent that there is no reasonable prospect that the company will avoid being wound up by reason of insolvency. 

Directors should also ensure that the steps taken are within the scope of that which a director of a company ought to know or ascertain, and that the general knowledge, skill and experience that may reasonably be expected of a director carrying out the same functions are exercised. 

The test of the general knowledge, skill and experience of a director is generally that which a reasonably diligent person would have known, ascertained, reached or taken.

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