When we incorporate PCNs or GP practices, one of the most common questions from concerned GPs relates to the liability they might pick up if they become a director of the incorporated company. In this blog, we look at how real the risks are to company directors, and whether or not you need be concerned.
At a very basic level, it is worth remembering that liability is limited in companies but is unlimited in partnerships. So, if a partnership has assets of £60,000 and £100,000 of creditors, then the partners have personal liability for the shortfall. If a company has assets of £60,000 and £100,000 of liabilities, then the directors can liquidate the company, whereupon the £60,000 of assets are sold and the proceeds distributed to the creditors, leaving the creditors short by £40,000. In other words, in a partnership structure the partners lose out if there are insufficient assets, whereas in a company structure the creditors lose out. This is the very essence of limited liability and is why limited companies come with more onerous rules than unlimited partnerships.
In the above scenario, the shareholders of the company will have no liability: if shareholders could be liable for a company’s debts then neither stock exchanges nor pension funds would exist. Directors could theoretically have liability for some or all of the shortfall, but in practice this is extremely unlikely. However, the likelihood of a partner being held liable for the shortfall in a partnership is 100%.
Directors can incur personal liability to creditors in certain circumstances if the company is insolvent, but such liability only arises in situations which go beyond negligence and into the realms of recklessness or crime. One of those circumstances is fraud, which speaks for itself. The other is wrongful trading, which occurs when a company continues to trade when it has “no reasonable prospect” (which wording sets quite a high bar) of avoiding going into insolvent liquidation or insolvent administration. An example of this in a normal trading company might be continuing to take customer orders and customer money when there is no realistic chance of the orders being met because the company is insolvent. Again, the liability which a director would have in such circumstances is no greater than a partner of a partnership would have in identical circumstances, whilst the hurdles which a creditor would have to overcome to enforce a claim against the director would be considerably higher than in enforcing them against a partner.
By moving trading activity from a partnership of which you are a partner to a company of which you are a director, you are invariably reducing your risk of personal liability very significantly.
Breach of fiduciary duties
So what other liabilities might a company director be opening themselves up to? In law, there are seven fiduciary duties set out in statute:
- to act within powers;
- to promote the success of the company;
- to exercise independent judgment;
- to exercise reasonable care, skill and diligence;
- to avoid conflicts of interest;
- not to accept benefits from third parties; and
- to declare any interest in a proposed transaction or arrangement with the company.
To a director who is familiar with these duties in the context of a partnership, these hardly seem onerous and, most significantly, the duties are owed to the company itself, rather than to third parties. It would be the company itself, either through a majority of directors or through minority shareholder action, that would have to sue a director for breach of fiduciary duties. Whilst this is conceivable in a large, listed company, in a small private company which is run and owned by the same people, and in which decisions are made by majority, it is hard to conceive of a situation whereby it might occur.
When it comes to clinical negligence, a company can be liable for the actions of a director, but it is rare for a director to be capable of being held liable for the actions of the company unless the director has themselves done something negligent, in which case the liability arises by virtue of the director’s action rather than by virtue of them being a director. Corporate manslaughter is an exception to this principle, but for a director to be liable in respect of corporate manslaughter it would have to be established that the way in which the activities of the company were managed or organised caused someone’s death and amounted to a gross breach of a relevant duty of care owed to that person. Again, it is hard, if not impossible, to conceive of circumstances where a director of a company had more liability in identical circumstances than a partner of a partnership.
What steps can be taken to reduce the risk to directors?
A question we are often asked related to directors’ liability concerns directors’ and officers’ liability insurance (D&O Insurance). D&O Insurance first started to feature in the public awareness as a result of the various government-commissioned reports into corporate governance in the 1990s: the Cadbury Report, the Greenbury Report and the Hempel Report. These reports led to an increase in the number of non-executive directors being appointed by listed companies. As these non-executive directors usually had very limited supervisory roles, usually concerned with audit and director remuneration, but could potentially incur the same personal liability as ‘ordinary’ directors, they invariably insisted on companies taking out D&O Insurance on their behalf before they would accept appointments - simply by virtue of the enormous numbers involved in such companies. D&O Insurance in respect of a small private company, such as a PCN company or an incorporated GP practice, would be unusual as the directors invariably have a much greater understanding of the operations of a much simpler business. If however you are concerned about this residual directors liability you should speak with a specialist insurance broker about the risks more generally in primary care.
In summary, when you move trading activity from a partnership to a company you invariably end up reducing your potential personal liability. It is no surprise that well over three quarters of all businesses in the UK trade as limited companies, and the majority of the remainder trade as very small sole practitioners. Partnerships have their advantages, but reducing personal liability is not one of them.
If you have any questions on the topics covered in this blog or on any other legal issues, please contact Nils Christiansen on 01483 511555 or email [email protected].