Company directors invariably litigate in the belief that if they lose the company will pick up the costs and they cannot be personally liable because the debt is owed by a limited liability company. However, there has been an increasing trend on the part of successful litigants to seek costs orders against directors personally and for the court to grant those applications. So directors need to be aware of the risks before embarking on litigation.
The criteria the courts use in deciding whether to make non-party costs orders against directors are:-
- Where a person has some management of the action, e.g. a director of an insolvent company, who causes the company improperly to prosecute or defend proceedings, or substantially controls the litigation or stands to benefit from it.
- Where a person has maintained or financed the action.
- Where the person has caused the action.
In most cases it is the personal funding of litigation by directors that most obviously exposes them to the liability. This need not necessarily take the form of paying the costs personally. Litigation could equally be funded by way of directors not drawing dividends from the company or otherwise financially supporting it in some way.
The degree to which the director controls the litigation is also relevant, so if he is the only person giving instructions and/or the company is effectively his alter ego then he is at more risk. Likewise if he is the one who stands to gain the most from the successful outcome of the litigation.
The merits of the claim being advanced are also a relevant factor. The more hopeless or speculative the claim the more likely the court is to find that the director should be personally responsible.
Trethowans has recently been involved in a case where it successfully obtained a costs order against the principal director and shareholder of a company who had brought a highly speculative claim. It was dismissed with an order that the company pay indemnity costs, only for the company then to be placed into administration. The court found that although the director had only personally funded a small proportion of the overall costs, nevertheless the director was the person who in reality controlled the company and that he was the one who had also caused the litigation because of the views that he held about the safety of his product (the litigation concerned the fitness for purpose of a product that had been adapted for use in the oilfield industry but which had been rejected on the grounds of safety). He had alleged that those who had come up with an alternative product to alleviate those safety concerns had been motivated by reasons that were spurious and in fact had acted in bad faith. If the claim had succeeded then the director was the one who stood to benefit since the money would have flowed through to him by way of salary or dividend. Therefore in all the circumstances it was just and proper to make the costs order sought.
One of the issues that the court had to consider was whether prior notice needed to be given to the director during the course of the litigation warning him of the intention to seek a non-party costs order. Recent authority, including the case that Trethowans were involved in, confirms that this is not a prerequisite. Therefore directors can get to the end of litigation, lose and find themselves being faced with an order that they pay the costs personally. They may not have been warned about this possibility by their legal advisors.
Generally a director is far more at risk of a personal costs order being made against him when he brings a claim which fails rather than defending a claim and the weaker the claim the greater the risk. The courts tend to consider it far more legitimate for a director to invest personally in trying to resist litigation, especially if there is a reasonable basis for that defence (obviously if spurious then the personal risk increases).
The cloak of protection that limited liability provides is not by any means fool proof.