A guide to misfeasance claims against directors

Directors of insolvent companies sometimes find themselves under investigation by a liquidator or administrator for misusing company funds, breaching their duties as a director, or putting their own interests before those of creditors.

These investigations often take the form of misfeasance claims.

What is misfeasance?

The term ‘misfeasance’ refers to the negligent, improper or careless execution of a legal duty. In the context of corporate insolvency, it refers to situations when directors have not correctly fulfilled their legal duties to a company and its shareholders. This can be misuse of company funds and assets or breach of statutory duties.

Misfeasance claims against directors are often brought by liquidators or administrators who wish to have the court determine whether a director acted properly in the lead up to a company’s liquidation or administration.

The legal basis for a misfeasance claim

Misfeasance claims against directors are brought under section 212 of the Insolvency Act 1986. Section 212 applies where it appears that a former director, non-executive director or shadow director has:

• Wrongly used or kept company money or property;

• Been responsible for handling company money or property;

• Breached their duties to the company, its shareholders or its creditors.

Typically, directors have a duty to the company and its shareholders and must maximise value and returns for them. However, when they know (or ought to have known) that the company is at risk of insolvency or bordering on insolvency, that duty switches to a duty to minimise losses for creditors. Section 212 provides a mechanism to act against directors who have not met those duties.

Who can bring a misfeasance claim?

A misfeasance claim can be brought by the official receiver, the liquidator, an administrator, a creditor, or, with the court’s permission a shareholder, or other person who may be liable for the company’s debts.

Who can face a misfeasance claim?

As well as directors, misfeasance claims can be brought against those involved in the formation of a company and de facto or shadow directors – those who are not named as directors but wield the same power and influence over the running of the company.

In some instances, a non-executive director may also find themselves at risk of a misfeasance claim, despite having limited involvement in the day to day running of the business.

Common examples of alleged director misfeasance

Allegations of misfeasance in insolvency situations are often centred around issues such as:

• Making unauthorised payments or withdrawals from company funds for their own benefit;

• Using company money or assets for a non-business purpose;

• Receiving pay, benefits or dividends that the company could not afford or could not be justified;

• Having a significantly overdrawn director’s loan account;

• Transferring company assets to a director or related business for below their value;

• Failing to disclose a conflict of interest or personal gain;

• Keeping poor financial records.

Investigating and proving misfeasance

After a company goes into an insolvent process for example liquidation, the insolvency practitioner (liquidator or administrator) may ask directors to explain decisions they made or transactions they authorised. They may consider evidence such as:

• Bank statements, payments and payroll records and dividend vouchers

• Management accounts and statutory books

• Directors’ loan accounts

• Minutes from board meetings

Through reviewing the evidence, they will be seeking to answer the following questions:

• What duty did the director owe, and to whom?

• Did any of the director’s acts breach that duty?

• What transactions, money or property were affected?

• Did the company and its creditors suffer a loss?

• Was that loss caused by the director’s actions?

As part of the insolvency practitioners’ investigations, they will prepare a D report to the Insolvency Service regarding the conduct, or misconduct of a director, which may trigger a director disqualification investigation by the Insolvency Service, the director may receive a director’s conduct questionnaire. It is important to seek expert legal advice before completing this as answers to the questionnaire can be relied on during the liquidator/administrator’s investigations as well as the Insolvency Service.

Potential remedies for director misfeasance

If the misfeasance claim against the director succeeds, the court may order them to return money or property to the company.

Section 212 applications are civil rather than criminal proceedings and separate criminal proceedings may be brought against the director if the evidence supports it.

Personal liability of directors

A key benefit of the limited company structure is that it has a distinct legal identity from its directors, which means that they are typically not personally liable for the company’s debts. However, this limited liability does not always protect a director from personal liability arising from a breach of their duties in the fact of insolvency.

Where a misfeasance claim succeeds, the director will likely need to make a repayment or meet a compensation order from their own funds.

Director disqualification proceedings

If a misfeasance claim succeeds, it will not automatically impact a director’s ability to manage a company. However, the same underlying conduct which led to the success of the misfeasance claim may also be grounds for the Insolvency Service to investigate the director’s misconduct as a whole and to bring separate director disqualification proceedings.

This can, of course, have a significant impact on a director's future, personal assets and livelihood, so you should seek urgent legal advice. Contact our director disqualification solicitors for help.

Responding to a misfeasance investigation

Your first step on receiving correspondence from a liquidator, administrator, the Insolvency Service or the court should be to take expert advice. You should never ignore correspondence as strict procedural deadlines will apply.

To support your defence, you should ensure that you preserve any evidence to support your position, such as accounts, bank statements, relevant correspondence, board minutes, contracts and summaries of any legal advice you received before taking a decision. You must not destroy, alter or retrospectively create records.

An expert in misfeasance claims can help you put together your defence. Available defences to the investigation might include:

• The director did not breach their duties

• All transactions were properly authorised

• Neither the company nor director gained a benefit from any wrongdoing

• The actions of the director did not cause the alleged loss

• The director based their actions on professional advice

Even if it is not possible to defend the claim in its entirety, you may be able to apply for relief under section 1157 of the Companies Act, sometimes a route under which directors can excuse themselves from some liability in certain circumstances.