Directors face increasing risk of personal liability and criminal prosecution

Amid the human tragedy of the loss of life resulting from the corona virus pandemic, some of the financial consequences of the crisis and new legislation brought in by the government in response to these problems have not received anywhere near the amount of press coverage and scrutiny that would have been expected in more normal times.

The speed with which the various financial reliefs had to be given following the first national lockdown in March 2020 did not allow a lot of thought to be given to the safeguards that needed to be put in place before funds were released.  Not surprisingly the various financial reliefs granted have been plagued by fraud.  However, the scale of the suspected fraud in relation to furlough scheme and the various corona virus loans is breath taking at an estimated £30 billion. To put this into context this is equivalent to the annual budget for Public Order & Safety services which include amongst other things the cost of the nations police force to catch criminals, the cost of the Crown Prosecution Service to prosecute these criminals and the prison service to lock them up.

In lieu of a mea-culpa, the government has recently introduced the Finance Act 2020 as its first shot to see if it can recover some of its money. The Finance Act gives HMRC extensive new powers to conduct criminal investigations and pursue directors by pressing criminal charges and issuing personal liability notices for a company’s tax liabilities. If this sounds a bit draconian it should be noted that furlough cheats are now on par with drug lords as HMRC has also been given the power to conduct dawn raids on homes and business premises under a warrant.

The political and financial pressures that have led to this development did not simply arise in the last year or so but have been brewing for the last 12 odd years since the Great Financial Crisis of 2008/2009 and its useful to see how we got here.

The central tenet of the Companies Act 2006 is that directors of companies have a fiduciary duty to exercise their powers with the objective of promoting the success of the company.  Furthermore, in doing so they are expected to exercise reasonable skill, care and diligence in performing their duties whilst avoiding conflicts of duty by exercising independent judgment. Nothing controversial here.

In good times, the benchmark for assessing a director’s conduct is a subjective test which runs along the following lines – did the director honestly believe that his act or omission was in the best interest of the company. Unfortunately, in bad times when a company is teetering on the edge of insolvency this is turned on its head.  Any concerns about the wellbeing of shareholders are shuttled to one side and the interests of creditors become paramount and the question is reframed as to whether an intelligent and honest man in the position of a director of the company could, in the circumstances, have reasonably believed that the transaction in question was for the benefit of the company.

More meat was put on the bones in the recent case of BTI 2014 LLC v Sequana SA (2019) which threw out of the window the concept of limited liability, at least as far as it applies to directors.  Apparently, the privilege of limited liability is not conferred on directors, that protection is only afforded to shareholders. What this means in practice is that if a creditors interest test is triggered and the director’s conduct is found wanting, there is a very real risk that they may be found to be personally liable for the debts of the company.  In simple terms the closer to the insolvency event a transaction takes place the greater the burden of the duty to creditors.

Which brings us to the Finance Act 2020.  This simply expands the scope of powers available to one creditor, namely HMRC, that believes it has unwittingly been the victim of the financial equivalent of domestic abuse- “tax abuse”.  In HMRC’s views this means that anyone involved in activities such as tax avoidance /evasion and phoenixism where a company goes into an insolvency process without paying taxes can be pursued.  The legislation has been broadly drafted to catch in addition to the directors any employees and professionals like accountants, solicitors and tax consultants who may have advised the company.

Apart from the twin threats of criminal prosecution and personal liability the third change introduced by the Finance Act puts skin in the game for HMRC.  This is the re-introduction in December 2020 after 17 odd years of secondary preferential status for all the company’s PAYE and VAT liabilities where companies go into an insolvency process.  The big change this time around is that there are no time limits on the how long the VAT and PAYE have been outstanding. For lenders with floating charge security these changes mean that the value of their security may potentially be worthless as HMRC will be paid in full in priority to them.

In 2021, as HMRC flexes its newly granted long desired powers it is more important that directors and promoters of companies seek appropriate professional advice to ensure that they do not fall foul of new legislation as they navigate through the most challenging and turbulent trading conditions in living memory.

by Nimish Patel

Partner, Re10 Restructuring and Advisory Ltd

Posted in Blog | Tagged , , , , , , , | Comments Off on Directors face increasing risk of personal liability and criminal prosecution

Comments are closed.