Lauren Hartigan-Pritchard, Head of Restructuring and Insolvency at Higgs LLP, explains what misfeasance trading is and what happens if a claim is brought forward.

Are directors and shareholders liable in insolvency?

For many, the main appeal of a limited company is the limited liability status enjoyed by directors and shareholders. Generally speaking, the debts and liabilities of the company will not extend to the shareholders or directors, beyond their initial investment.

However, this protection is limited if the company should become insolvent, at which point the conduct of a director in the period prior to its insolvency can lead to claims against a director in misfeasance.

If a company enters an insolvency process such as liquidation, part of the liquidator’s duties under the Insolvency Act 1986 (“the Act”), is to investigate and assess the reasons behind the company’s failure. Part of this investigation will involve a detailed analysis of the decisions made by a director, whether that director took steps to protect the company’s assets and whether there were any transactions authorised by that director which made the position worse for its creditors.

What is misfeasance?

Misfeasance, in simple terms, means doing something wrong or improper in a legal context. When it comes to insolvency, misfeasance usually refers to the actions of directors or other company officers who have failed to fulfil their duties to the company and its creditors.

Section 212 of the Act specifically targets directors, company officers, and others involved in the management of the company who have misapplied, retained or become accountable for company money or property, breached their duties, or committed any form of misconduct that caused harm to the company or its creditors.

Common examples of misfeasance include:

1. Misapplication of company assets: This includes situations where company funds or property have been misused or wrongfully taken by a director or officer of the company.
2. Breach of fiduciary duties: Directors owe fiduciary duties to the company, including the duty to act in the best interests of the company and its creditors, particularly when the company is facing insolvency. A breach of these duties can lead to a misfeasance claim.
3. Failure to exercise due care: Directors are expected to exercise reasonable care, skill, and diligence in managing the company’s affairs. If they fail to do so, and this causes losses, they can be held personally liable for misfeasance under Section 212 of the Act.
4. Preferential treatment: If directors have given preferential treatment to certain creditors or engaged in transactions that are deemed unfair or detrimental to the company’s overall financial position, this may be considered misfeasance.

What happens in misfeasance claims?

1. Investigation: The liquidator will investigate the company’s finances and the conduct of its directors to identify any potential wrongdoing.
2. Claim: Misfeasance claims are generally brought by liquidators of the company and will only be available where the company has entered liquidation. No claim can be brought in misfeasance if the company is placed into administration, although alternative claims may exist by way of breach of fiduciary duties. Misfeasance claims may also be brought by the Official Receiver, a creditor or a shareholder of the company.
3. Court proceedings: If a settlement is not reached, an application can be made to the court. The court may examine the conduct of the director or officer of the company and make an order that they repay, restore or account for the money or property, with interest at such rate the court thinks fit; or the court can ask the person to compensate the company in respect of the misfeasance or breach of fiduciary duties.
4. Potential disqualification: More serious breaches in the context of misfeasance claims may also result in the Insolvency Service conducting investigations with a view to commencing disqualification proceedings on behalf of the Secretary of State. The consequences of a disqualification order can be severe, with bans ranging from 2-15 years. If a person that has been disqualified has been found to have breached the order, they may face imprisonment, a fine or sometimes both.

Summary

At all material times, directors must consider the implications of each decision or transaction that is authorised, with a view to assessing whether it is in the best interest of the company. This assessment becomes more pertinent if the company is facing financial difficulty, as the director must then assess and make decisions for the benefit of the creditors as a whole.

It can be tricky to navigate the decision process where the company is financially vulnerable. However, our team of expert solicitors provide a bespoke service offering Directors’ Protection Advice to help directors navigate that difficult decision-making process.

About the author

Lauren Hartigan-Pritchard is Head of Restructuring and Insolvency at Higgs LLP.

See also

Place an insolvency notice

Creditor duty: what directors need to know

What you need to know about director disqualification proceedings

Find out more

Insolvency Act 1986 (Legislation)

Images

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Publication date

25 September 2024

Any opinion expressed in this article is that of the author and the author alone, and does not necessarily represent that of The Gazette.