This is the fourth article in a series on company directors’ duties and liabilities
What can directors do to reduce their chances of breaching their duties in the complex maze of legislation for which they may be held personally accountable? This article offers some practical guidance to directors to eliminate, or at least minimize, the risk of personal liability.
In order to aid the analysis, a risk assessment of the personal liability of directors needs to be made, even if at a basic level. An attempt is therefore made to first categorize the areas of law where risks of personal liability arise (by identifying the type of circumstances or scenarios that could potentially involve personal liability) and second to determine the level of the risk involved.
The risk assessment uses three measures: (i) the likelihood (frequency) of such breaches arising; (ii) the extent to which the observance of the relevant rule is within the control of the director; and (iii) the severity of the sanction (which can range from the imposition of a small fine to a term of imprisonment or to both).
The five categories of personal liability
Five broad categories of personal liability can be identified. The risk of liability increases from the first category through to the fifth category increasing in severity with each category.
1. Breach of general duties under the Companies Act
The general duties of directors under the Companies Act include the duty to act in the best interests of the company, the duty to act in good faith and loyally (and therefore to avoid self-dealing and manage conflicts of interest), the duty to exercise due care, diligence and skill and the duty to act in a manner that does not unfairly prejudice, oppress or discriminate against minority shareholders. A breach of any of these duties can potentially lead to the imposition of personal liability.
2. Liability for administrative fines under the Companies Act
Personal liability for fines may arise for breach of a wide variety of administrative duties under the Companies Act. For example, a failure to file, within the time-limits set out in the Companies Act, Form Ks, Form Ts, Form Hs, annual returns and audited financial statements etc. may lead to the imposition of fines both on the company and the directors personally.
3. Liability for administrative fines under specific legislation other than the Companies Act
Various administrative duties are also imposed on directors in the financial services sector by a variety of laws, including (but not limited to) the Prevention of Financial Markets Abuse Act, the Prevention of Money Laundering Act, the Banking Act, the Insurance Business Act and the Investment Services Act and regulations issued thereunder. A breach of these duties can lead to an administrative fine being personally imposed on directors.
4. Liability in a company insolvency scenario
Personal liability can also be imposed on directors in an insolvency scenario, in particular for fraudulent trading and wrongful trading.
5. Criminal liability
Criminal liability of directors can be of two types: direct liability or vicarious liability. Direct criminal liability may arise where the director violates certain specific provisions of the law, a breach of which would constitute a criminal offence (for example a breach of certain provisions of the Social Security Act or of the Banking Act). Vicarious criminal liability arises where a director is held criminally liable for an offence notionally committed by the company (for example a breach of certain provisions of the Employment and Industrial Relations Act or of the Value Added Tax Act).
Measures to mitigate the risk of liability
There are some general measures that can be taken that would help mitigate the risks of personal liability in each of the five categories. There are then some specific measures that apply to particular categories.
It needs to be emphasised that the extent to which the measures need to be implemented will of course depend on the size of the company and the nature of its business – it is one thing to be a director of a small family company that simply owns immovable property used by family members and it is another matter to be a director of a large insurance company or a bank or a listed company.
A person should not accept to be a director if he believes that the other members of the board are not competent or honest
General measures that apply to each of the five categories
Some general measures that should be adopted by directors of virtually all companies include the following:
- Consider carefully whether you should accept appointment as a director. One should conduct appropriate due diligence on the board he is being asked to join and seriously consider declining the offer to be appointed a director, especially of a company that operates in a highly regulated sector. In particular, a person should not accept to be a director if he believes that the other members of the board are not competent or honest.
- A director should as far as possible insist with the shareholders that the board is composed of directors who have the necessary blend of skills (depending on the nature of the business). Depending on the size and business of the company, it may be opportune to emphasise the need to have independent non-executive directors.
- A director should not allow a domineering chief executive officer or managing director or chairman to dictate matters concerning the company’s governance and management. An important role of a director is to challenge management. In practice, it has been proven that the presence within the board, of a domineering and highly influential personality makes the raising of any dissenting views unlikely and discourages the raising of any challenging questions or contrary view-points.
- A director must avoid being a “rubber-stamp”. The director will fulfil an important duty – and do himself and his fellow directors a favour – if he refuses to blindly follows what is dictated by the shareholder appointing him or by the “head office”.
- A director must resist the temptation of accepting a lucrative appointment as director merely for the sake of “fiscal strategic convenience” i.e. accommodating a board dominated by non-resident directors who require the additional presence of a local director solely for the purpose of adding additional local substance to the company, so as to optimise the company’s tax status under Maltese tax rules and regulations.
- A director should insist that the board meets regularly, that the board papers are comprehensive and circulated in good time before the meeting to allow directors to review them. If a director disagrees with anything fundamental that is being proposed, then his dissent should be recorded in the minutes. A director will, as a rule, be considered to have consented to any resolution passed or action taken unless his dissent is recorded in the minutes.
- The directors should seek legal and professional advice, including – where relevant – advice from engineers, appraisers, accountants and lawyers.
- If the company is sufficiently large or if the company operates in a regulated sector, the board should seriously consider engaging full-time in-house counsel. It is also good practice to ask a lawyer to attend board meetings, particularly if the company has engaged an in-house lawyer, unless one of the directors has a strong legal background.
- Directors should also be given regular training on subjects/matters that are relevant to the business of the company or to their role as company directors (for example training on occupational health and safety issues, handling of data protection, managing cyber security breaches, etc). Training sessions could be conducted by internal personnel or by engaging external experts. Attendance at relevant seminars should also be encouraged.
The above recommendations constitute principles of good corporate governance. Adopting good corporate governance should not be the objective only of listed companies. All companies should consider good corporate governance (with reasonable proportionality) as the first line of defence for a board of directors. In fact, although good corporate governance is often promoted as a sound policy that helps to safeguard the interests of the company and its shareholders, in reality, it also helps to protect directors from the risk of personal liability.
If all else fails, a director should resign. Resigning protects a director from liability for events that arise after the director resigns
Other measures that may be adopted by directors to lessen or guard against the risk of personal liability include the following:
- Directors may wish to consider entrusting particular duties to one or more of the directors. If this measure is adopted, only such director/s will be liable in damages (rather than all directors on a joint and several basis). This measure will however exonerate the other directors only insofar as liability under the Companies Act is concerned – it will not exonerate directors from personal liability imposed on them by specific legislation other than the Companies Act (for example, the Social Security Act).
- Where a director was not aware of any act of his co-directors, he can mitigate against the risk of joint and several liability by objecting to it in writing as soon as he becomes aware of it after its occurrence. A director should also be able to avoid liability if, knowing that the co-directors intended to commit a breach of duty, he takes all reasonable steps to prevent it.
- A director can mitigate the impact of personal liability by seeking an indemnity from the shareholder or shareholders appointing him. (It is not generally possible to seek an indemnity from the company itself).
- A director would also be well-advised to take out a good directors’ and officers’ liability insurance (a “D&O” policy) or, better still, insist with the company to take one out for the directors. A D&O policy must not however be regarded as a panacea. Insurers may deny liability or procrastinate in settling the claim or not cover the whole claim. A D&O policy is also not likely to protect against criminal liability as such cover may be regarded as contrary to public policy. A director will also need to ensure that cover will continue (in respect of any potential liability arising out of his conduct during his term of office) even after he is no longer a director. Directors should seek the advice of an experienced insurance broker to ensure that adequate cover is obtained.
- If all else fails, a director should resign. Resigning protects a director from liability for events that arise after the director resigns.
The next and final article in this series will look further into how directors of companies can avoid liabilities, particularly in relation to the five categories of personal liability discussed above.
Professor Andrew Muscat is a partner at Mamo TCV Advocates.
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