While limited liability companies are considered a separate legal entity, directors can still become personally liable if they breach their duties.

These duties have become increasingly important in light of the recent financial downturn. When there is financial uncertainty, and investors or creditors suffer losses, directors are more likely to make decisions which may be challenged. Recently there have been numerous reports of the Securities Commission taking proceedings against directors of finance companies for misleading investors. Under the Securities Act these directors face fines of up to $500,000.00 in civil proceedings, and up to five years imprisonment or fines of up to $300,000.00 in criminal proceedings. Therefore all directors need to be aware of their obligations to their company.

The key duties under the Companies Act 1993, found in Part 8, sections 131-137, include the following:

  • The duty to act in good faith and in the best interests of the company.
  • The duty to use their powers for the purpose for which they were conferred and not for any ulterior motive.
  • The duty to act in accordance with their obligations under the Companies Act 1993 and the company’s constitution.
  • That a director must not agree to cause, or allow the company’s business to be conducted in a manner that is likely to create a substantial risk of serious loss. To determine this the Court will look at what an “ordinary prudent director” would have done in the same circumstances.
  • The duty not to take on any obligations unless it is believed on reasonable grounds that the company will be able to perform those obligations when required to do so; and
  • The duty to use the reasonable care, diligence and skill that a reasonable director would exercise in the circumstances.

Directors must actively ensure that they are meeting their obligations. The recent case FXHT Fund Managers Limited v Oberholster held that directors who are not actively engaged in the company or “sleeping directors” can also be liable. In that case the inactive director was held liable for a breach of his duty of care even though it was his co-director who defrauded investors. Initially he was not aware of his co-director’s dealings, but as soon as he became aware he reported the matter to the authorities, however he was still held liable.

Similarly in Lewis v Mason & Meltzor the directors relied on a manager and did not exercise sufficient control over the company’s financial position or the day to day running of the company. It was found that reliance on a manager does not excuse a director from liability and the directors were ordered to contribute to the company’s debts.

The above cases show the need for directors to take positive steps to discharge their obligations under the Companies Act, and be proactive directors who are aware of and adhere to the duties imposed on them.