The separate legal personality of a company protects those who run it — until the company fails and Part XVIII of the Companies Act 1997 is applied to their conduct.
Section 348(1) — when a director is exposed
(a) the company does not satisfy the solvency test, or becomes unable to satisfy it as a result of incurring that debt or debts including that debt; or
(b) there are reasonable grounds for believing that the company does not satisfy the solvency test, or will so become unable to,
and the director is aware that there are reasonable grounds for so believing, or a reasonable person in a like position would be so aware.
A director who takes no part in the decision but permits the company to keep incurring debt is within the section. Passivity is not a defence — which is consistent with section 115, requiring a director to exercise the care, diligence and skill a reasonable director would exercise in the same circumstances.
The closing words are the objective limb: “or a reasonable person in a like position would be so aware”. A director who did not look at the accounts is measured against a director who would have.
Note that “director” for these purposes carries the extended meaning in section 107 — including a person occupying the position by whatever name called and a person in accordance with whose directions the board is accustomed to act.
Section 348(2) — the order
(a) the section applies to a director or former director in relation to a debt owed by the company; and
(b) the creditor has suffered loss or damage in relation to the debt because of the liquidation; and
(c) the debt was wholly or partly unsecured when the loss or damage was suffered,
the Court may declare that an amount equal to the loss or damage may be recovered from the director or former director as a debt due to the company or the person, as the case may be.
The creditor may apply directly. The claim does not belong solely to the liquidator, and the recovery may be ordered as a debt due to the creditor rather than to the company.
Former directors are caught. Resigning before the collapse does not undo liability for debts incurred while in office.
The measure is the creditor’s loss, not the size of the debt, and only where the debt was wholly or partly unsecured. A fully secured creditor who suffers no loss has no claim.
The parallel provision for a holding company whose subsidiary trades insolvently is section 349.
Section 348A — failure to keep accounting records
If (a) a company in liquidation and unable to pay all its debts has failed to comply with section 188 (keeping accounting records); and (b) the Court considers that (i) the failure has contributed to the inability to pay all its debts, or has resulted in substantial uncertainty as to the assets and liabilities, or has substantially impeded the orderly liquidation, or (ii) for any other reason it is proper to make a declaration,
the Court may, on the application of the liquidator, declare that any one or more of the directors and former directors is or are personally responsible, without limitation of liability, for all or any part of the debts and other liabilities of the company as the Court may direct.
This is the most severe personal liability in the Act. Section 348 measures liability by one creditor’s loss; section 348A can make a director responsible for all or any part of the company’s debts and other liabilities, without limit.
And the trigger is not dishonesty. It is failure to keep proper accounting records — the obligation in section 188 to keep records that correctly record and explain the transactions, enable the financial position to be determined with reasonable accuracy at any time, and enable financial statements to be readily and properly prepared and audited.
The Court must not make a declaration against a person if it considers that the person —
(a) took all reasonable steps to secure compliance by the company; or
(b) had reasonable grounds to believe and did believe that a competent and reliable person was charged with the duty of seeing that the provision was complied with, and was in a position to discharge that duty.
Paragraph (b) is a delegation defence, and it has two limbs that must both be satisfied: a genuine belief on reasonable grounds that a competent and reliable person had the task, and that they were in a position to discharge it. Appointing a bookkeeper and then denying them access to the records answers neither. Compare section 116 on reliance generally.
Under section 348A(3) the Court may give any direction it thinks fit to give effect to a declaration, and under subsection (4) it may make a declaration even though the person concerned is liable to be convicted of an offence.
Section 350 — repayment of money or return of property
Where, in the course of a liquidation, it appears to the Court that a person who has taken part in the formation or promotion of the company, or a past or present director, manager, liquidator, or receiver, has misapplied, or retained, or become liable or accountable for, money or property of the company, or has been guilty of negligence, default, or breach of duty or trust in relation to the company, the Court may, on the application of the liquidator, a creditor, or a shareholder —
(a) inquire into the conduct of that person; and
(b) order that person (i) to repay or restore the money or property, or any part of it, with interest at a rate the Court thinks just; or (ii) to contribute such sum to the assets by way of compensation as the Court thinks just; or
(c) where the application is made by a creditor, order payment or transfer to the creditor, with interest.
Section 350 is a procedural shortcut. It does not create new duties — the underlying wrong is the existing one, whether breach of duty, negligence or misapplication of property — but it allows the claim to be dealt with in the liquidation, on the application of a creditor or shareholder as well as the liquidator. Under subsection (2) it has effect even though the conduct may constitute an offence.
Subsection (3) is striking: an order for payment of money under this section is deemed to be an Act of Insolvency within the meaning of section 21(1) of the Insolvency Act (Chapter 253). A director who is ordered to pay has, by that fact, committed an act on which a creditor may found a personal insolvency petition against them.
What this means for directors
- Keep the accounting records. Section 348A liability is unlimited and is triggered by record-keeping failure, not by dishonesty.
- Test solvency before each significant commitment once the company is under strain — and record the basis.
- Resigning does not help for debts already incurred: sections 348 and 350 both reach former directors.
- Watch guarantees. Paying a guaranteed creditor ahead of others exposes you under section 346 as well.
- Consider a compromise or an early liquidation. Continuing to incur debt while insolvent is precisely what section 348 penalises.
- Remember the criminal provisions run in parallel — section 423 on carrying on business fraudulently, and section 348A(4) confirms a civil declaration may be made even where an offence is also in play.
Sources
- Companies Act 1997 — ss 4, 107, 112, 115, 116, 188, 346, 348, 348A, 349, 350, 423
- Insolvency Act (Chapter 253) — s 21(1)
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.