The Company Director's Desktop Guide

HOW DID WE GET HERE?

Until 1856, unless their company was created by an Act of Parliament and became a ‘statute’, company entrepreneurs (risk takers who wished to float and operate companies) were responsible for the debts of those companies should they fail. As the British Empire flourished and companies grew to take advantage of the opportunities presented by the expanding trade, so do did the potential liabilities of these entrepreneurial shareholders.

Pressure grew to protect the assets of the risk takers and the results were the Companies Acts of 1856 and 1862. These acts (a worldwide first, the principles of which have been copied in most countries) created a ‘legal persona’– the limited liability company – with virtually the same rights as real or natural persons. However, unlike real persons, the shareholding owners of such a company had their liability limited to the total value of the shares they had invested.

Once they had paid that, unless they had acted fraudulently, they had no liability to creditors of their companies should these fail. The limited liability company was born. It is fair to say that within a short time of this introduction of ‘limited liability for shareholders’, it was hailed as a ‘rogues’ charter’. The development was accused of being merely a means of devising the encouragement of speculation, overtrading and swindling.

These very real concerns were that some directors of such companies (who very often were the shareholders) could run the company into the ground knowing that they could walk away from a failed company with no liability to the unpaid creditors. Such observers were of course proved right and in a number of instances this is exactly what happened.

In addition, in some instances it was clear that although the directors’ names were known, in fact the companies were being ‘directed’ by persons whose presence was not acknowledged or disclosed. The directors’ actions were being manipulated by a kind of ‘eminence gris’ or ‘shadowy’ persona who actually had control of the company.

The price of limited liability protection is disclosure of information. Limited liability companies are required to ‘disclose’ information by lodging their details in the public arena. In 1844, the Registrar of Companies office was set up as a repository of information concerning companies, their ownership and control and direction and to provide a source of such information to which the public had access.

Information about limited liability companies was made available mainly to protect the creditors since they could inspect the financial results of the companies to which they were advancing credit. Amongst other data, directors’ details had to be lodged – but obviously the details of those pulling the strings of the board were not. The numbers of companies were quite small – under 100,000 at 1900 (when for the first time shareholders had the right to receive audited accounts from the directors) and under 500,000 by 1985.The explosion of numbers of companies has occurred since 1985 so that there are now 2.5 million.

THE CONTINUING LEGISLATIVE MOVEMENT

As is customary, once it is known there are legislative loopholes, subsequent legislation is introduced to attempt to plug the gaps. Since the mid-nineteenth century, every 15 to 20 years new company legislation has performed this function as well as adding considerably to the regulatory requirements placed on limited liability companies – and their officers.

From time to time – for example in 1948 and 1985 – there have been major rewrites of company legislation consolidating previous primary and secondary legislation. The 1985 Act was notable since not only did it consolidate all the legislation since the 1948 Act but in addition for the first time defined the ‘shadowy persons’ not acknowledged as directors at Companies House referred to above. Section 741 of that act states a ‘shadow director’ means ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act’.

THE INSOLVENCY ACT 1986

Linking with the 1985 Act and close on its heels, the Insolvency Act for the first time since 1855 placed liability on those actually running companies. The twin offences of ‘wrongful’ and ‘fraudulent’ trading were created. These require that directors (and others) who continue to run their companies when they knew or (the serious obligation) should have known that their companies were taking on credit which might not be paid on the due date – or within a reasonable time of that date – can be required to contribute personally to the creditors if their companies fail.

WHAT IS A COMPANY?

It must be said that there have not been that many prosecutions of culpable directors, mainly since the Department of Trade and Industry’s attitude is that unless there is a very good chance of success that it would not be appropriate to spend public money in such circumstances.

However, the responsibility for initiating proceeding and gaining potential recovery from wealthy directors who have broken the law in this way has now been passed to Forensic Investigation and Recovery Services (FIRS) who may generate more cases.

Fraudulent trading is proscribed anew in the Companies Act 2006. S993 states that any person who carries on the business of a company with intent to defraud the creditors (or anyone else) is guilty of an offence for which the sanctions are potentially imprisonment for up to ten years or a fine (or both) as well as personal liability for the debts.

THE NEW ACT

The above brought us to the mid-1990s. On 1 April 1997, Margaret Beckett, then the President of the Board of Trade, launched a consultation process that would eventually result, nine years later, in a completely new Companies Act ‘fit for the 21st Century’. The Companies Act 2006 received Royal Assent in November 2006 and will be fully in force by October 2009.The following text assumes its introduction, which is entirely logical since all parts (other than sections repealed which are detailed herein) of the 1985 Companies Act now appear in the new act.

As set out above, a company is a legal person – created by and operating under Company Law. It has an existence which is separate from its owners (shareholders, guarantors) and separate from its officers (directors, company secretary and managers). A company is brought into being via a process laid down under the Companies Act – and it can be wound up under the same act. Unlike real persons, however, a company, as a legal person, can not only ‘die’ but by decision of the Court can be brought back to life in order to face a liability claim.

The Companies Act does not permit shareholders to run companies – they appoint directors to do that. In essence, shareholders’ rights are restricted to appointing directors and, if they do not like the way their company is being run, removing them.

Recently in the UK there have been examples of shareholder power in the agreement of who should be (or continue to be) directors. A shareholder who does interfere with the running of a company runs the risk of becoming a ‘shadow director’ with potential liability as such.

A company as a legal person must comply with its legal obligations – not only company law, but all laws. If it breaks those laws, then the company can be made subject to the sanctions set out in those laws. However, in most cases the company acts via its agents – the officers – who can also be held personally liable for such actions. If the actions are very serious then imprisonment may be the sanction. A company cannot be imprisoned – but the officers can.

Taken as an extract from David Martin’s book, The Company Director's Desktop Guide. FDE readers can receive the full guide with a 33% discount by following on the link below and using the promotional code.

http://www.thorogoodpublishing.co.uk