Insolvency considerations for directors: Misfeasance

What is misfeasance?

Misfeasance claims operate under Section 212 of the Insolvency Act 1986, to allow a liquidator or an administrator (and certain other parties) to bring a claim that belongs to the insolvent company that could have been brought before it entered insolvency proceedings.

Directors can be liable if they are found to have misapplied or retained company money or property, for breaching their duties owed to the company, or if they have otherwise been guilty of misfeasance (i.e. misconduct).

Establishing a breach of duty by a director is essential for a misfeasance claim, and this will largely be informed by sections 171 to 177  of the Companies Act 2006 (CA 2006), which codifies the broad range of duties that directors must comply with.

These duties regulate how a director can and should exercise their powers and are designed to protect the interests of the shareholders of the company. In summary, the general duties that apply to directors under the CA 2006 include:

• 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
• To declare an interest in a proposed transaction or arrangement.

For more information about the duties of directors under the CA 2006, see our overview here.

Who else can be held liable for misfeasance?

As directors are bound by the most wide-ranging set of duties, misfeasance claims are typically made against them. They can also be brought against any person who has assumed responsibility to act as a director, but has not actually been officially appointed to the role (i.e. a “de facto” director).

Former directors, current and past managers and company secretaries, or anyone else who is or has been concerned with the promotion, formation or management of the company, may be subject to claims for misfeasance.

Claims can also be brought against any person who has acted as a liquidator or an administrator.

Who can bring a claim for misfeasance?

Insolvency practitioners are legally obliged to investigate the decisions made by the directors in the period running up to insolvency, primarily so they can recover money for the benefit of creditors if there has been any foul play.

Misfeasance claims are therefore typically brought forward by the appointed administrator, liquidator, or official receiver. However, they can be brough by individual creditors as well, and in certain rare instances, a creditor can bring a claim for misfeasance against the insolvency practitioner, for example if a liquidator wrongly paid out a liability.

Ultimately, for a misfeasance claim to succeed, the claimant will need to demonstrate that a quantifiable loss has been sustained, and that was caused by a breach of duty.

What are the potential consequences of misfeasance?

If misfeasance is proved, the Court may order a director to:

• Repay or account for any misappropriated money or property to the company, with added interest
• Compensate the company by making a contribution to the company’s assets
• Be disqualified from acting as a director of a limited company for up to 15 years.

How can misfeasance claims be defended?

A  director may request relief from liability by relying on the defence contained in section 1157 of the CA 2006, which excuses them when they prove to the satisfaction of the Court that:

• The director acted honestly and reasonably; and
• The circumstances of the case mean that it is fair to excuse the director from the liability.

Another technical defence that might apply is based shareholder ratification; this can make the misfeasance an act of the company, rather than a director individually, to prevent a claim from being made for misfeasance. However, its application is not always straightforward and a director looking to rely on this principle as a defence will need to demonstrate that (amongst other things) the relevant misfeasance or breach of duty was actually ratified by the shareholders.

Misfeasance trading

There has been an important development from a recent case involving a claim by liquidators against the former directors of British Home Stores group. The directors were found liable for wrongful trading, but also what the court described as misfeasance trading. This related to the directors’ breach of duty under Section 172 CA 2006, by failing to consider the interests of the company’s creditors when entering into risky transactions while the company’s solvency was in doubt.

The court found that the breach of duty caused the company to continue to trade, and increase the net deficiency for creditors, so as to leave the directors liable for the increase in the net deficiency.

The creditor duty, to have regard to the interests of creditors, rather than just shareholders, comes to the fore when a company is financially distressed and formal insolvency becomes more likely.

It is worth noting that potential liability for breach of the creditor duty in the context of trading misfeasance may occur at an earlier point than the point at which a director might first become susceptible to a claim for wrongful trading (which is where a director allows a company to continue trading when there is no reasonable prospect that it will avoid going into insolvent liquidation or insolvent administration). It follows that a misfeasance trading claim might apply, where a wrongful trading claim would fail.

Final thoughts

Misfeasance claims can be legally, factually and procedurally complex. They are broad and cover a number of different types of claim, and every case will turn on its own particular circumstances.

Misfeasance claims can be brought to recover unlawful dividends, transactions at an undervalue, preferences, damages and compensation for breach of fiduciary duty or tortious duties of care. Another common risk arises from the operation of directors’ loan accounts to fund personal spending, which are not properly regularised.

Directors also need to be aware of the duty to take into account the interests of creditors when the company is insolvent, or bordering on insolvency; the risk of misfeasant trading opens a new potential avenue for liquidator recoveries.

Directors should be mindful of their duties, therefore, and take timely professional and legal advice aimed at reviewing whether insolvent liquidation is inevitable or whether there is some way of resolving or mitigating the company’s financial difficulties. A cautious approach is well advised as your actions are likely to be scrutinised if your company enters a formal insolvency process.

If you have any questions about the topics raised in this article, please get in touch.