When Directors are exposed to lawsuits

Serving as a director on a company's board is often a mixed experience of rewards and anxieties. Paramount to the success of any corporation is the efficient functioning of a conscientious and knowledgeable board of directors. However, the task of attracting and electing directors of such calibre has grown increasingly difficult over time.
Historically, time constraints, business conflicts or other personal reasons have been cited by prospective directors for their reluctance to seek such a position. More recently, another reason is being offered. An increasing number of prospective directors have expressed concern over the potential personal liability exposure that may result from their actions as directors.
A number of high-profile corporate failures have recently made the news, adding to an environment of corporate cynicism and distrust. Along with the recent rash of corporate failures has come a rising tide of lawsuits seeking to hold directors personally accountable for corporate losses stemming from transactions entered into by the company.
In Malaysia, the courts have long decided that directors who execute an agreement for a company could not be made personally liable for any liability of the company, as the company, being a separate legal entity, has the capacity to sue and be sued in its own name. A company, being an artificial person, can only act through its directors, who are not thereby personally liable for the breaches or acts of the company in the absence of express provisions in the agreement or other documents to the contrary.
However, it was recently highlighted that directors who sign documents as part of corporate financing transactions may be open to personal liability. For purposes of illustration, an English High Court decision is used to demonstrate the issue addressed here. In Quest 4 Finance Ltd vs John Maxfield, John Carter and Michael John Chesney (2007) EWHC 2313 (QB), a company ran into financial difficulties. The directors of the company sought to bail out the company by seeking a "quick fix" financial assistance. The finance company, Quest 4 Finance Ltd, represented that no personal guarantees from the directors were required. All that was required was a warranty, which was put in place to cover the event of any fraudulent act being knowingly committed. The question was, were these warranties in actual fact personal guarantees?
The directors signed documents warranting that the company had complied, and would continue to comply, with the said warranties. Shortly thereafter, the company went into administration. Quest's case was simple. The event of the company going into administration was a breach of the warranty given by the company in the loan agreement.
Quest became entitled to terminate the loan agreement, and the loan together with interest became immediately repayable. The fact that the company was in breach of its warranty meant that the directors were also in breach of the warranty given by each of them. Quest therefore claimed the sums repayable by the company from the directors.
The judge decided that the directors' warranties were personal guarantees as the legal principle of a guarantee is that it is, in essence, a promise to see that a debtor performs his obligations to a creditor. Therefore, irrespective of its physical form, the directors' promise that the company (the debtor) would perform its obligations (complying with the warranties) to Quest (the creditor) was in substance a guarantee. However, the judge also decided that the representation in Quest's brochure that personal guarantees were not required was misleading, and the directors were therefore allowed to rely upon their assertion that they were induced to sign the warranties in reliance upon the misrepresentation.
Quest's case should serve as a warning to directors, who should be wary of being misled in respect of the extent of their personal liabilities. Most lenders tend to try to cover all the bases, which includes, where possible, having a right of recourse against individuals who may be under the misapprehension that they are infinitely protected by the corporate veil.
In the modern corporate environment, directors must be especially zealous in understanding the protection available to them in the execution of their duties, and the limitations of the protection. Having a basic understanding of the protection may help directors avoid personal liability stemming from their service on a board and may help prospective directors make more informed choices about where and whether to serve in such a capacity.
There is no single, clearly defined blueprint for taking preventive measures to avoid personal liability if one is sued. However, adherence to certain, well-established best practices by directors can help to significantly reduce the likelihood of personal liability.
As a general rule, directors must be aware that the position to which they have been elected carries serious responsibilities and that under certain circumstances, their actions, individually or as a board, may give rise to personal liability exposure. Directors must realise that they are subject to suit by persons who feel the actions of the company have caused them undue harm. The likelihood of such action may be miniscule, but becomes significantly more likely whenever directors permit or knowingly cause the company to operate contrary to law.
If you are sued in your capacity as a director, there are a number of steps you can take to protect your rights and help ensure the best possible outcome. These include:
Immediately retain legal counsel to assist you. The time to respond to a lawsuit is fewer than 15 days. It is therefore critical that you quickly retain legal counsel, who can assist you in determining when and how to respond to the lawsuit;
Retain independent and experienced legal counsel. Because the interests of the various defendants in lawsuits can and often diverge to some extent, it is important that you retain legal counsel independent of the counsel retained or employed by the company.
Understand the rights and protection available to you. A director may, subject to certain conditions, be entitled to indemnification and advancement of lawyer's fees and expenses in connection with the lawsuit.
Preserve documents. As soon as you are aware that a lawsuit has been or is likely to be filed against you, it is important that you take all necessary steps to preserve documents and other evidence that in any way relate to the lawsuit.