Directors’ liability in the event of refusal to pay: when is a director personally liable?

A director may be personally liable if he causes, or permits, a company to fail to pay a debt, whilst he should have seriously considered the likelihood that that debt would have to be settled in the near future. This applies not only to clear-cut ‘walk-away’ schemes, but also, for example, where a director allows a credit facility to lapse that was specifically intended to pay the creditor. A recent ruling by the Court of Appeal clearly illustrates this (ECLI:NL:GHARL:2024:7476).

What were the facts of this case?

A company had purchased an energy system but left the final invoice unpaid. The creditor initiated legal proceedings. In an interim judgment, the court had already ruled that the company was required to pay the claim, except to the extent that its defence of set-off would succeed. Following that interim judgment, something significant happened. The company terminated an existing credit facility, or at least allowed it to expire. That credit facility had been intended, in part, to pay for the energy system. Subsequently, new financing was arranged with another bank, but this could not be used to settle the outstanding claim. Furthermore, the company’s most important assets were encumbered by a mortgage. When the court later rejected the claim for set-off in its final judgment, it transpired that the company no longer had any assets against which the claim could be enforced. The creditor was therefore unable to be paid, despite the judgment. On appeal, the Court of Appeal considered the question of whether the debtor’s director could be held liable.

When does a refusal to pay lead to director’s liability?

In principle, a company itself is liable for its debts. A director is not automatically personally liable if the company fails to pay. This changes if the director has serious blame in causing this situation. This for example may be the case if the director:

• is aware of, or ought reasonably to have considered, a payment obligation;
• diverts financial resources or fails to make them available;
• frustrates the existing recourse options available to the creditor;
• fails to arrange reasonable alternative financing or a means of recovery;
• organises the company in such a way that the creditor is ultimately left empty-handed.

In this case, the Court of Appeal held that, from the date of the interim judgment, the director should have seriously taken into account the possibility that the full final invoice would have to be paid. It was precisely for this reason that the director should have ensured that the credit facility remained available, or that an alternative was arranged whereby the claim could still be settled.

A passive attitude on the part of directors can also be risky

What is striking about this ruling is that the director is not only held accountable for active conduct, such as siphoning off assets. The blame also lies in what the director failed to do. The credit facility had expired or was terminated; the director did not do enough to ensure that this financing remained available to pay the creditor. This too can result in the frustration of recovery.

This is an important point for directors to bear in mind. Frustration of recourse does not always have to involve an obvious asset-stripping scheme. Allowing relevant financing to lapse, replacing a usable credit facility with an unusable one, or encumbering key assets may, under certain circumstances, lead to personal liability.

What does this mean for directors?

Directors must take creditors’ interests into account as soon as it becomes clear that a claim is likely to have to be paid. A director who subsequently allows a relevant credit facility to lapse, encumbers assets or fails to arrange an alternative to enable payment runs the risk of being held personally liable.

The key lesson is a practical one: if payment becomes likely, the board must not stand by passively whilst the company loses its recourse options. Ensure that financing remains available, explore alternatives and carefully document the reasons for the choices made.