Update: commercial contracts

Many business people expect companies to be solely responsible for liabilities under commercial contracts. They struggle to see why directors or employees should be personally liable when companies, or shareholders, receive the profit and shareholders have limited, or no, liability. Indeed, the basic principle at law is that directors do not have personal liability (Ferguson v Wilson (1866) LR2 Ch 77). However, the exceptions are many. The following recent cases illustrate just how easily and frequently the law circumvents that basic principle.

Liability as a joint tortfeasor

In Boegli-Gravures SA v Darsail and Pyzhov [2009] EWHC 2690 (Pat), the High Court imposed personal liability on one of three directors for patent infringement by their company. It recognised that a director would not be treated as liable with his company as a joint tortfeasor if he did no more than carry out his constitutional role in the governance of the company. However, this director was jointly liable with the company because he had personally negotiated to sell goods knowing that that was an infringement. Moreover, he had made the decision to supply the patented goods alone, was personally involved in committing that infringing act and had gone beyond merely performing his constitutional role.

The decision relies on the judgment in MCA Records v Charly Records Ltd [2001] EWCA Civ 1441, that darling of intellectual property litigators, that: 'There was no reason why a person who happened to be a director or controlling shareholder of a company could not be liable with the company as a joint tortfeasor if'¦ the circumstances were such that he would be so liable if he were not a director or controlling shareholder.'

The really interesting conclusion is that directors who 'go beyond the exercise of constitutional control' are at risk of personal liability. While a director should not be too concerned when voting at a board meeting on a routine matter or acting in the ordinary course of his duties, once he is committing a tort in consequence of what he is doing on behalf of a company, he is at risk. In addition, at least on infringements of intellectual property, personal liability as a joint tortfeasor may arise where, in the words of Lord Templeman in CBS Songs v Amstrad [1988] AC 1013, the individual 'intends and procures and shares a common design that the infringement takes place'.

Misrepresentations by a company

The following case illustrates that M&A lawyers should heed that risk of liability for directors on share or asset sales. Indeed, the risk arises whenever a corporate entity gives warranties or representations or a signatory acts on behalf of an unincorporated entity or another person. In Invertec v De Mol Holding and Anor [2009] EWHC 2471(Ch), a sole director was personally liable for the fraudulent misrepresentations contained in warranties given by his company on a sale of all of its subsidiary's shares. He was the sole negotiator of the contract, he had signed all the transaction documents on behalf of the parent company and knew that the representations were false and dishonest. Consequently, he was personally liable for fraudulent misrepresentation. The judge noted that if the warranties had merely constituted negligent misstatements, there would have been no personal liability.

Deceit

One of the biggest risks lies in the tort of deceit. In Lindsay v O'Loughnane [2010] EWHC 529 (QB), the managing director of a company was personally liable in deceit for fraudulent misrepresentations which had induced the claimant customer to trade with the company and suffer a substantial loss.

The defendant was the managing director and majority shareholder of a company which converted currencies. The claimant occasionally instructed that company to convert sterling to euros. The company's terms declared a trust over monies received from clients but the company, to the defendant's knowledge, acted in breach of that trust by mixing clients' monies to purchase euros in bulk or to pay other creditors of the company. This caused delays to two of the claimant's trades. The defendant falsely blamed the company's bank. Before two subsequent trades, the defendant had met with insolvency experts and at no time did the defendant correct the impression that the earlier delays had been the fault of the bank, 'whereas the truth was that the delay was caused'¦ as the defendant had known'¦ [by the company being] hopelessly insolvent'. The claimant suffered loss on those last two trades. The court found that:

• in accepting the later trades, the defendant had knowingly and falselyrepresented that (i) the company was solvent and its business was being carried out properly and legitimately, (ii) the claimant's monies would beheld on trust, and (iii) the previous delays in payment were the bank's fault; and
• the claimant was induced by those misrepresentations to enter into the last trades '“ had he known the truth, he would not have traded with the defendant's company.

The defendant was therefore personally liable in deceit. The court brushed aside the defendant's protest that if he was liable then so would a multitude of directors or employees of insolvent companies in circumstances where any claim should properly be against the company.

Of course, as the court made clear, it was not the mere insolvency which allowed the court to find deceit, but the director's knowledge that the company would not act and had not acted properly and the claimant's reliance on the director's dishonest, false or fraudulent representations that it would and had.

And it is not merely directors who run this risk. In Wirecardv Scott [2010] EWHC 451 (QB), it was not just a director who was guilty (and not just for deceit). The defendants were the sole director, the company secretary and an employee of a company which sold tickets for sporting events. It failed to deliver any tickets it had sold for the 2008 Olympics. No one at the company had intended to acquire any tickets and the defendants had falsely represented that the tickets would be supplied by a third party. A provider of credit card processing facilities successfully sued the three individuals for its losses under the torts of deceit and conspiracy to defraud by unlawful means. In addition, as the employee was, within the knowledge of the others, disqualified from being a director and clearly involved in the management of the company, all three were personally liable to the claimant under the statutory liability for debts set out in section 15 of the Company Directors Disqualification Act 1986.

Procuring a breach of contract

It may not even matter if the company is not party to the contract in question. In Mayhew Lewis v Yeeles [2010] EWCA Civ 326, the Court of Appeal confirmed the personal liability of a director for his fellow director's unlawful decision as to how to remedy their company's rights.

The defendant's co-director at Strand Corporation Limited, Mr Benton, had agreed in his private capacity to transfer to Miss Yeeles a flat which he and Miss Yeeles had developed with the involvement of GTBC, a company closely connected with Miss Yeeles. Strand had entered into a second quite unrelated contract with GTBC for the redevelopment of another property. Strand and GTBC fell out.

Mr Benton, with the knowledge and advice of Mr Mayhew Lewis, sought to remedy Strand's rights against GTBC by refusing to transfer the flat to Miss Yeeles. Indeed, although it was contrary to his agreement with Miss Yeeles, Mr Benton sold the flat and divided the proceeds of sale between Strand and himself.

The Court of Appeal confirmed the defendant's liability, noting that he could be liable for procuring a breach, but only if he had committed some act ('an intentional causative participation', OBG Ltd v Allan [2007] UKHL 21) before the breach of contract by Mr Benton and was aware of the contract with Ms Yeeles. The court also stated Mr Mayhew Lewis had gone beyond the 'allowable area' of arranging for advice to be given about the contract and entered the 'prohibited pastures of persuasion and procurement'.

Finally, it was clarified that procuring a breach of a contract is a tort and that in general, an individual tortfeasor was personally liable for his own torts, even if he was a director; acting as agent for a company did not give this defendant a defence to personal liability for his torts.

Liability for duties to the company

Even if a creditor cannot sue the individuals concerned, the company itself might be able to establish liability on a director or manager. In QEB Metallics v Peerzada and Hafiz [2009] EWHC 3348 (Ch), a company in liquidation successfully sued a director and another person who was never formally a director, but was its controlling mind, for its failure to pay VAT. The court agreed that they each owed fiduciary duties of loyalty, honesty and good faith and were guilty of breaches of those duties, misfeasance, or an unlawful conspiracy to injure the company by failing to account for VAT (and were also liable under section 212 of the Insolvency Act 1986).

Reducing the risk

The above cases create do not create any significant new law but they illustrate the significant risks that directors and managers take in relation to commercial contracts. A more comprehensive examination would explicate all the streams of law in which they might acquire liability '“ tort, contract and statute (especially company, insolvency, competition and trading legislation) insolvency, agency and trust law and breach of directors' duties.

Practitioners (whether litigators, draftsmen or transactional) should:

• be alive to the possibility of such liability;
• ensure that it is clear for whom they are acting (and not acting);
• establish whether there have been any representations made outside the contract;
• check whether there has been any reliance on any behaviour which mightamount to a representation; and
• consider whether their instructions are such that they should consider, mitigate, confirm or attack such representations.

Businesses should consider the use of directors' and officers' insurance policies. In many cases, such liabilities can also be mitigated, or regulated, by judicious use of non-reliance or entire agreement clauses. However, the effectiveness of such clauses will be pertinent.