Articles

Introduction

Company directors play a crucial role in corporate governance, making decisions that affect the business and its stakeholders. The general legal rule is that a corporation or company is considered a “legal person” distinct from its members, meaning directors are usually shielded from personal liability. However, this legal protection has sometimes led directors to act arbitrarily, knowing they have this shield.

In certain circumstances, courts may lift the corporate veil and hold directors personally liable for a company’s actions. This typically occurs when:

• The company is used as a vehicle for fraud or illegality.
• There is deliberate misrepresentation or concealment of financial information.
• The directors act recklessly, leading to significant losses for creditors and stakeholders.

This legal overview explores these situations in which directors may face personal liability under Kenyan law.

Legal Framework Governing Directors' Liability in Kenya

The primary laws governing director liability in Kenya include:

• The Companies Act, 2015 – Establishes directors' duties and liabilities.
• The Insolvency Act, 2015 – Addresses liability in cases of company insolvency.
• The Capital Markets Act – Regulates director accountability in publicly listed companies.
• The Penal Code and Anti-Corruption Laws – Cover criminal liability for fraudulent or illegal activities.
• The Ethics and Anti-Corruption Commission Act – Governs investigations into corruption-related offenses.

Situations Where Directors May Be Personally Liable

1. Breach of Fiduciary Duties

• Directors owe fiduciary duties to the company, including acting in good faith, promoting the company's best interests, and avoiding conflicts of interest.
• Personal liability arises if a director acts dishonestly, misuses company funds, engages in self-dealing, or enters into transactions that benefit them personally rather than the company.
• Case Example: In Samuel Kamau Macharia & Another v Kenya Commercial Bank Ltd & 2 Others, the court held that directors who misuse company assets for personal gain may be held accountable.

2. Fraud and Misrepresentation

• If a director provides false information, misleads investors, or engages in fraudulent activities, they can be held personally accountable under both civil and criminal law.
• The Companies Act, 2015 penalizes directors involved in fraudulent business practices, and directors may also face prosecution under the Penal Code and Anti-Corruption and Economic Crimes Act.
• Case Example: In Republic v. Githongo & Others, directors of a company were charged with fraud after misrepresenting financial statements to investors.

3. Failure to Exercise Due Care and Diligence

• Directors have a duty of care to act prudently in company management.
• If negligence leads to financial losses, regulatory violations, or harm to third parties, directors may be personally liable.

4. Insolvency and Reckless Trading

• Under the Insolvency Act, 2015, directors can be held responsible if they continue trading while knowing the company is insolvent.
• Wrongful or fraudulent trading may result in civil penalties, disqualification from holding directorships, or criminal prosecution.
• Case Example: In Westmont Power (K) Ltd v. Commissioner of Income Tax, the court ruled that directors who knowingly operate an insolvent company can be personally pursued for debts.

5. Non-Compliance with Tax and Regulatory Obligations

• Directors can be held accountable if a company fails to pay taxes, comply with statutory filings, or violates labor and environmental laws.
• The Kenya Revenue Authority (KRA) can pursue directors for tax evasion, and regulatory bodies can impose fines and other penalties for non-compliance.
• Example: Directors of Nakumatt Holdings faced personal liability claims for tax non-compliance and failure to settle supplier debts.

6. Personal Guarantees for Company Debts

• If a director provides a personal guarantee for a company loan or obligation, they may be liable if the company defaults.
• Lenders may pursue the director’s personal assets to recover outstanding debts.

7. Criminal Liability for Corporate Misconduct

• Directors may face criminal charges for corruption, bribery, money laundering, and other offenses under Kenyan law.
• The Ethics and Anti-Corruption Commission (EACC) and the Directorate of Criminal Investigations (DCI) investigate and prosecute such cases.

Preventative Measures and Best Practices for Directors

To minimize personal liability risks, directors should adopt strong corporate governance principles, including:

• Ensuring compliance with all statutory and regulatory requirements.
• Keeping clear records of all board decisions and rationale behind them.
• Avoiding conflicts of interest and ensuring disclosure of related party transactions.
• Seeking legal and financial advice before making major company decisions.
• Implementing strong internal controls and risk management policies.

Defenses Available to Directors

• Acting in Good Faith: Demonstrating that decisions were made honestly and, in the company’s, best interests.
• Delegation and Reliance on Experts: Directors may rely on professional advice where necessary.
• Due Diligence: Maintaining records of compliance and due diligence efforts can help avoid liability.

Conclusion

While corporate structures generally shield directors from personal liability, certain actions can expose them to legal consequences. Directors must exercise their powers responsibly, uphold corporate governance principles, and ensure compliance with statutory requirements. Courts and regulators continue to scrutinize director misconduct, emphasizing accountability and transparency.

To avoid personal liability, directors should implement best governance practices, seek legal counsel proactively, and ensure full compliance with corporate laws. For expert legal guidance on director liability, corporate governance, and regulatory compliance, consult B.I.K Advocates LLP, your trusted legal partner in business law.

We welcome your feedback and inquiries and look forward to assisting you with your legal needs. For any questions, please reach out to us at info@bikadvocates.com

Disclaimer

This article is for informational purposes only and should not be construed as legal advice.