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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?

In cases of fraudulent trading, the Companies Act grants the court the power to impose liability on the wrongdoer with no limitation for all or any of the debts or other liabilities of the company, as the court may direct. Fraudulent trading arises if, in the course of winding up a company, it appears that the business of the company has been carried out with the intention to defraud creditors of the company or creditors of any other person, or for any other fraudulent purpose. In such cases, the court may declare that any persons who were knowingly parties to the carrying on of the business in such manner be personally responsible, with no limitation of liability for all or any of the debts or other liabilities of the company, as the court may direct. The relevant provisions may be invoked against any person, including directors, shareholders or any other persons knowingly involved in the fraud.

In cases of wrongful trading, directors (including shadow directors) of a company which goes into insolvent liquidation may be ordered to make a payment towards the company’s assets, as the court sees fit. The provisions on wrongful trading apply where “a director of the company knew, or ought to have known prior to the dissolution of the company that there was no reasonable prospect that the company would avoid being dissolved due to its insolvency”.

Certain laws, such as the Income Tax Management Act, also impose personal liability on directors for certain debts which would in the normal course be due and payable by the company.

With respect to the parent company, the general principle which flows from the notion of separate juridical personality is that the holding company is not liable for the acts of its subsidiaries. However, there may be instances in which a holding company will incur liability on the basis of general principles of law and independently of the fact that a holding-subsidiary relationship exists. These include situations of:

  • agency;
  • liability in tort; and
  • the grant of a guarantee by a holding company in favour of the creditors of the subsidiary.

Defences

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

This will largely depend on the factual matrix of the case. In cases of wrongful trading, the action will not succeed if the court is satisfied that the director knew that there was no reasonable prospect that the company would avoid being dissolved due to its insolvency and accordingly took every step that he or she should have taken with a view to minimising the potential loss to the company’s creditors.

Due diligence

What due diligence should be conducted to limit liability?

Where a director has not been present or active in the company since its registration, only thorough due diligence may serve to potentially limit liability. If due diligence uncovers matters which may give rise to personal liability, it is unlikely that any person would be willing to take on a role within the company and potentially expose himself or herself to such liability. Generally, the standard of diligence required of a director is that of a bonus paterfamilias

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