The main idea behind the creation of a limited liability company is that those investing in it can limit their risk to the loss of the capital they contribute. As well as the risk for investors being limited, the directors of the company will not normally be liable for the company's debts should it fail.

However, the latter is not always the case. The directors of a company owe a duty both to its shareholders and to its creditors, and, if the interests of either are imperilled, the directors are expected to take steps to minimise losses as far as reasonably practicable. When a company is in financial difficulty, the interests of creditors will take preference over those of the shareholders. If the directors fail in their duty or behave in a way that is improper, the protections that apply to them may fall away, leaving them liable for the company's debts.

This is precisely what happened in a recent case. A company had retained builders to carry out work on a property it leased. The property was the UK residence of the company's sole director and shareholder, who leased it from a second company owned by his brother. The brother was the key decision maker and funded the building works, both directly and indirectly.

When the relationship between the builders and their client soured and funding the works became an issue, the builders' invoices went unpaid and their contract was terminated, which was a breach of contract. The client company was placed in liquidation. When further funds became available, the brother's company gave the project to another firm of builders to complete.

The company that had originally placed the contract was a shell company and without assets. It was clear that the original builders would receive nothing. They therefore took legal proceedings against the director of that company and his brother. The builders claimed that the two had induced the company to breach its contract and had entered into an 'unlawful means conspiracy' to prevent the builders receiving the payments lawfully due to them.

Both men were found liable for a variety of reasons. Chief among these was that the financial arrangements they put in place to complete the project were ruled to be the cause of the breach of contract. The two brothers were ruled to have colluded in an unlawful conspiracy to permit the company to avoid its legal obligations.

Attempting to use a corporate structure to avoid paying debts often fails. We can advise you how to minimise the risk of any contract you wish to enter into and how to proceed if people you are dealing with are attempting to avoid their responsibilities or if you as a director are on the receiving end of claims. Please contact Leanne Schneider Rose or Preena Lal on 0121 698 2211.

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