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Wrongful Trading and Protection from the Abuse of Limited Liability
Luke Rawcliffe, University of Sussex, Brighton, UKIntroduction
The principle of limited liability was designed to allow company directors the ability to take risks for the benefit of the company in an attempt to maximise profits without being personally liable for any detriment those risks cause the company and its creditors. However the principle of limited liability is open to abuse and may result in directors taking risks beyond those which benefit the company, such as the continuation of trading once the company has become insolvent. The principle in section 214 of the Insolvency Act ('IA') aims to tackle issues of wrongful trading by 'greedy' directors however it has been criticised for being ineffective at preventing this abuse. This article considers how section 214 has protected the principle of limited liability from abuse by directors, how it helps prevent directors becoming 'greedy' and instead encourages them to seek help early before the company becomes insolvent. The article looks at just how effective the provision in section 214 has been and finally assesses how section 214 could be improved in order to prevent further abuse from directors who have nothing to lose.
Protecting directors and shareholders: the limited liability principle
The primary advantage of the incorporated company is the principle of the corporate personality, this principle means that the company has its own identity and is regarded by the law as its own person. Developed from the principle of corporate personality is the idea of limited liability, as a company has its own personality it also carries its own liabilities, this principle has been described as an: 'attractive weapon to enable company directors to take business risks and chances for the benefit of the company…'.
A company can be limited either by guarantee or by shares, the latter being the more common. Where a company is limited by shares its members are liable only for any amount unpaid on their shares. This acts as a veil, hiding away the directors (who are often shareholders too) of the company and preventing any creditors bringing a claim against them personally. The limited liability principle allows directors of companies to take business risks for the benefit of the company without the need to constantly justify their actions or worry that they may be sued as a result of any detriment their actions may bring upon the company. But what happens if directors take advantage of this principle and take unnecessary gambles after insolvency has occurred? After all they have 'everything to gain and nothing to lose'.
The growth of section 214: where did it come from?
In 1982, the Cork Committee published a report which reviewed all aspects of insolvency law in England and Wales and considered whether or not it was desirable for the law in this area to be reformed and harmonised. As part of their report the committee considered section 332 of the Companies Act 1948 which provided the provisions on fraudulent trading by directors. The committee found that the provision in section 332 was too strict requiring proof that the director acted dishonestly in his actions, they felt this requirement often discouraged liquidators from bringing a claim.
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