Can a Director Be Held Personally Liable in a Commercial Dispute?

Ask most company directors whether they can be held personally liable for their company's disputes, and the answer tends to be swift and confident: no. The company is a separate legal entity. Its debts are its own. Limited liability exists for precisely this reason.

They are not wrong. They are also not entirely right.

The principle of limited liability is one of the most powerful protections in corporate law - and one of the most misunderstood. While a company's obligations are ordinarily its own, directors who assume they are cleared when a commercial dispute arises can find themselves in a considerably more uncomfortable position than they anticipated. This article explains when that protection falls away, and why.

The principle of limited liability

A company is a separate legal entity, distinct from the individuals who manage it. Its debts and liabilities are ordinarily its own, and directors are not personally liable merely by virtue of their office.

However, that separation is not absolute. Courts have recognised circumstances in which a director’s personal conduct, representations, or personal commitments can give rise to direct personal liability.

Personal guarantees

The most common route to personal liability has nothing to do with misconduct. When a company borrows money or enters into significant commercial arrangements, lenders and counterparties will frequently require a director to provide a personal guarantee.

A personal guarantee is a contractual commitment: if the company fails to meet its obligations, the director becomes personally liable for the shortfall. This applies regardless of whether the company is solvent and irrespective of how the dispute arose. Directors should always take independent legal advice before signing a personal guarantee and ensure they understand the full extent of their exposure.

Breach of directors' duties

The Companies Act 2006 sets out a range of duties that directors owe to the company. These include:

• The duty to act in the way most likely to promote the success of the company
• The duty to exercise reasonable care, skill and diligence
• The duty to avoid conflicts of interest
• The duty to exercise independent judgment

Where a director breaches these duties, and there is a loss to the company as a result, they can face a personal claim for compensation. This becomes particularly relevant when a director's decision-making is scrutinised in the context of a dispute - whether they acted with adequate care, whether they had undisclosed conflicts, or whether they exercised proper judgment at a critical moment.

Wrongful trading

Under the Insolvency Act 1986, a director can be held personally liable for a company's debts if they allowed the company to continue trading when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency.

The test is objective: a court will consider what a reasonably diligent director in the same position should have done. If appropriate steps to minimise losses to creditors were not taken once insolvency became apparent, a director can be ordered to make a personal contribution to the company's assets. This is why early legal advice, when a company is under financial pressure, is so important.

Fraudulent trading

Fraudulent trading is a distinct and more serious allegation. It applies where a director has knowingly carried on business with the intent to defraud creditors. For example, incurring debt with no realistic intention of repayment. Unlike wrongful trading, fraudulent trading carries potential criminal liability, as well as civil consequences, including personal liability for the company's debts.

Misfeasance

In insolvency proceedings, a liquidator can bring a misfeasance claim against a director who has misapplied company assets, retained money in breach of duty, or caused loss to the company through misconduct. Common examples include using company funds for personal purposes or allowing assets to be transferred at an undervalue. A successful claim can result in the director being required to repay or restore the relevant amount.

What directors should do when a dispute arises

Where a company is involved in a commercial dispute, whether with a supplier, customer, creditor or shareholder, directors should take stock of their own position as early as possible. Key questions include:

• Have you signed any personal guarantees in connection with the contracts or obligations in dispute?
• Are you confident that the decisions you took leading up to the dispute were consistent with your duties under the Companies Act 2006?
• If the company is under financial pressure, have you taken proper advice about your obligations to creditors?

Acting promptly and with proper legal advice gives directors the best opportunity to protect their personal position throughout the life of a dispute.

For further information and trusted legal advice regarding director personal liability and commercial disputes, get in touch with us at Carlsons Solicitors.