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Liabilities of directors of firms in financial distress—15

2018-11-30 08:53:10

By Paul Kibuuka @isidoralaw

In this fifteenth part of our 30-part article series, we consider the legal duties of directors of companies under Tanzanian law where a company is in financial doldrums. Additionally, we identify ways in which the directors can become personally liable and the steps that they should take to mitigate that liability. This is crucial in view of the prevailing tight liquidity conditions which call for an understanding what directors ought to do to safeguard themselves and preserve enterprise value (EV).

Directors of a Tanzanian company are subject to certain legal duties to the company, and if the company goes burst, to its creditors. Those duties, codified under the Tanzanian Companies Act, 2002 (‘CA 2002’), include: the duty to act in good faith and in the best interests of the company (Section 182), the duty to have regard to the interests of employees (Section 183), the duty to exercise powers for proper purposes (Section 184), the duty of care, skill and diligence (Section 185), the duty to avoid conflict of interest (Section 209). Breach of these duties may lead to personal liability, or disqualification as a director.

Under Section 382 of the CA 2002 if, in the course of a winding up, anyone who has been concerned with or taken part in the promotion, formation or management of the company is found to have misapplied or retained, or become accountable for any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company, the court may, on the application of the official receiver, liquidator or any creditor compel him to repay, restore or account for the money or property or any part of it, with interest; or contribute such sum to the company's assets by way of compensation in respect of the misfeasance or breach of any fiduciary or other duty as the court thinks just.

Breaches of duties that are pertinent to the foregoing provisions might include a director’s involvement in the company undertaking a vulnerable transaction e.g. giving a preference or entering into an undervalue transaction within specified periods before its insolvency as a result of which an administrator or liquidator may apply to the court for an order that the company be put back into the position in which it would have been had it not undertaken the transaction, or require some other suitable remedy.

Directors can also incur personal liability following an application to the court by the liquidator for fraudulent trading (Section 383 of the CA 2002). The court can order that any party, who was knowingly a party to the carrying on of the business of the company with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, is liable to make such contributions to the company's assets as the court thinks just.

Fraudulent trading carries the risk of imprisonment, a fine or both; and it can arise when directors of a company allow it to incur debt when they know there is no good reason for thinking that funds will be available to repay the loan owed when it becomes due. 

Wrongful trading (Section 384 of the CA 2002) can lead to personal liability. It applies where a company has gone into insolvent liquidation and before the commencement of the winding up, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. The standard required here is that which would be known, or reached or taken by a reasonably diligent person exercising the duty of care owed to the company under Section 185 of the CA 2002.  

Moreover, where a director or former director is found to have engaged in conduct (e.g. fraudulent trading; late or non-filing of accounts at BRELA) which makes him unfit to be involved in the management of a company, he must be disqualified.

Mitigating the risk of liability for directors requires, inter alia, taking expert advice, recording the rationale for each decision in minutes of meeting, and checking if there is a directors’ liability insurance cover for possible legal costs. Finally, in a move aimed at combating corruption and bribery and cultivating an ethical culture, the government of Tanzania wants to see CEOs of private sector companies sign integrity pledge forms.

Paul Kibuuka is the managing partner of Isidora & Company Advocates, a corporate, commercial and financial law firm. This article was published in The Citizen on Saturday, 24 November 2018

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