Do you understand your legal obligations and liabilities as a company director?

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In tough economic climates, more companies tend to go into voluntary liquidation or be liquidated by a court on application by a creditor. The liquidators are now turning towards the directors of the company in order to obtain recovery of any losses, especially if those losses have been incurred on behalf of investors.

Even if a business is set up as a limited liability company, the directors can still be held personally liable if they have not fulfilled their legal obligations as a director.

The case of FXHT Fund Managers Limited (in liquidation) v Barry Finnegan & Boris Ven Delden as liquidators of FXHD Fund Managers Limited (in liquidation) shows that the days of silent directors (sometimes known as sleeping directors) are over.

In this case, the liquidators instigated proceedings against a silent company director who did not control the day to day affairs of the company. The silent was held liable for breaching section 135(b) of the Companies Act 1993 which deals with a director’s liability for allowing the business of the company to be carried on in a manner likely to create a substantial risk of a serious loss to the company’s creditors.

The silent director was also held accountable under section 137 of the Companies Act 1993 for failing to exercise powers or performing duties as a director to exercise due care, diligence and skill that a “reasonable director” would exercise in the circumstances.

The High Court ruled that the silent director had breached sections 135 and 137 by not requiring proper accounting and/or verifying information provided by the other director who had committed fraud by diverting the investors’ funds elsewhere. The Court ruled that by not requiring proper accounting procedures and questioning the director who had diverted the investors’ funds elsewhere, the silent director was equally responsible for failing in his duties imposed under section 135 and 137 of the Companies Act.

The High Court held that directors (silent or not) who are appointed to that role are to take responsibility for managing the affairs of the company, and are equally responsible to ensure the business of the company is carried out diligently to ensure that the risk to creditors was minimised. Directors are required under section 137 of the Companies Act to exercise due care and diligence expected of a director. This means that a silent director cannot escape liability for not taking part in active management of the company. The silent director appealed to the Court of Appeal. The Court of Appeal reaffirmed the position taken by the High Court.

This decision is particularly relevant to individuals who have gone into business with friends or family members. The scenario often arises in a family owned company where the spouse may be appointed as a director without any active involvement in the company. The spouse who is a director of the company is equally responsible for the affairs for the company.

If you are the director of the company, and are unsure as to your legal obligations and liability, or any other issues to do with commercial law, please contact Peter Smith by phone on 09 837 6882 or email peter.smith@smithpartners.co.nz