Liability of US and UAE Directors for Fraud

Introduction

After the global financial crisis, there has been a growing need for companies in the US and UAE to develop stringent corporate regulations to ensure transparency and accountability. Many companies have adopted new corporate governance that ensures that directors and management perform their duties according to laid down rules and regulations. When a corporation is formed, it becomes a legal entity of its own because it can be able to sue and be sued.

A company is a separate legal entity that has legal rights of its own. Therefore, directors cannot be held accountable for the liabilities of the company. In both jurisdictions, directors act as agents of the shareholders. They must make their decisions for the best interest of shareholders. This raises a paramount issue about the veil of incorporation. The veil of incorporation states that a company has a separate personality of its own from the personality of shareholders and directors.

The veil of incorporation prevents shareholders and directors from being personally liable for the liabilities of the company. However, the veil of incorporation has raised heated debate over the personal responsibilities of the director when they commit fraud and mismanagement. Lord Neuberger while presiding over the case of Prest v Petrodel Resources Ltd argued that the veil of incorporation could not be used as a shield against the personal responsibilities of a director on fraud and mismanagement. To maintain clarity, the judge noted that companies must have a clear limit, which must be ‘as clear as possible’ to prevent directors from escaping personal responsibility for fraud and mismanagement.

The primary objective of this paper is to identify precisely the individual liabilities of directors in the US and UAE. This study seeks to provide critical analysis of potential liabilities of directors both in the US and UAE jurisdictions for the acts of fraud and mismanagement. Specifically, this study will focus on the personal liabilities of directors under both jurisdictions. The liabilities of directors can result from fraud, security law, insolvency law, Penal Code, and Anti-trust law. Finally, the study will critically analyze parties who are responsible for taking legal action against directors.

Personal responsibility of directors in the United Arab Emirates

Under the United Arab Emirates jurisdiction, the director is personally liable for fraud when he/she signs a document in the name of the company containing misleading information. The director is held personally liable and is subject to a fine or jail sentence as the judge may deem proper depending on the matter at hand. Andrew noted that the magnitude of liability is a matter of the court to decide which has a direct impact on the duration and fines imposed by the court.

Moreover, the judge must also consider the magnitude of misrepresentation and the intention of the director1. Moreover, a director can be held liable for giving false information especially if the director had prior knowledge that the information is false. Giving false information attracts similar charges to that of signing and issuing a document with false information. Also, directors can be held accountable for disclosing confidential information to their benefit or third parties that attract similar penalties.

Under the Penal Code, a director is personally liable for the embezzlement of funds, property, fraud, and legal rights. The Penal Code was introduced to prevent directors who might think of taking advantage of their position to abuse their powers for their benefit. Moreover, the UAE Penal Code explicitly states that when a director acts ultra vires by disclosing confidential information of a company they can hold personally liable and charged in court.

More specifically, the UAE Penal Code states that directors are criminally liable for drawing a cheque with prior knowledge that the company does not have enough money to meet that obligation. Under this liability, the judge must consider the knowledge of the director before drawing the cheque. The director can personally be charged in court or serve a jail term for less than five years.

A director is personally liable for making a public offer in a limited liability company. Under the UAE’s company law Act, a director cannot be allowed to make personally a public offer because it contravenes the Companies Act, which provides circumstance and procedure under which shares should be issues2. Moreover, a director can be held personally liable for misrepresenting a company’s value. This occurs when a director having prior knowledge of the value of the company decides to price the shares above or below their real value. UAE Capital Market Security law expects directors to act in good faith when valuing a company’s shares to ensure the price represents the true value of the business. If a director is found guilty, he/she can be charged in court for a maximum of two years in prison or a maximum of $27,000 in fine, whichever the judge may deem fit.

Under the UAE Insolvency Law, a director is personally liable for embezzling the properties of a company. This includes a deliberate action of a director during insolvency to enter into fraudulent agreements with creditors and suppliers of a company. This includes the act of false director misrepresentation of information and the company’s capital position to defraud the company. When a director receives money that is above what is stipulated under the Companies Act in the form of bonuses, compensation and false misrepresentation of a company’s debt, he/she is personally liable for misrepresentation and fraud. However, under the UAE, the law does not specifically mention the magnitude of liability that can be imposed on directors if they commit such acts.

Under the UAE Anti-Trust Law, the director can be held personally liable if he/ she induce unfair competition in the industry that harms other companies in the same industry. Specifically, if a director approaches an employee of another company (competitor) to acquire confidential information is personally liable. The law clearly states that if a director tries to acquire confidential information from a competitor whether for his/her gain or in the interest of the company, is personally liable, and that can attract a penalty of two years in prison. Similarly, is a director conspire in the distribution of deceptive good to deceive consumer attract the same penalty.

Also, a director is personally liable for damages caused by the publication or distribution of defamatory information about a competition that results in financial losses is personally liable for and attracts similar penalties. Nonetheless, to succeed in a defamation case, the competitor must be able to prove that the statements made by the director were defamatory and that the statements were directed to the company, which resulted in financial losses. In this case, the director issued under the law of tort for defamation.

Personal liability of a director for mismanagement in the UAE

Under the UAE Company’s Act, a director is personally liable for mismanagement for any action that leads to the deterioration performance of the company as a result of mismanagement. The UAE company law Act article 186 states that directors should be held personally liable for losses incurred by the company as a result of their decisions. Although this article does not specify the action that should be taken by a shareholder against the director, the act of mismanagement in itself attracts personal responsibility.

However, Article 111 gives any shareholder the right to sue directors for losses incurred because of the director’s neglect and misjudgment in decision-making3. For instance, if shareholders do not receive a share of the profit of the company due to management neglect, the can bring a lawsuit against the directors.

Under the jurisdiction of the UAE Civil Code, a director is personally liable to his/her action of resignation when the company is in a crisis thus resulting in huge financial losses. However, the director cannot be held liable if he had given a 6-month notice of his intention to resign. The company must also be able to prove that the losses resulted from the lack of special skills of the director. Moreover, they must prove that the director acted intentionally which resulted in financial losses.

Under Article 23 of the company’s Act, companies should not include any provision in the memorandum of association that exempts directors from personal liability as a result of fraud and mismanagement4. Indeed, Article 23 clearly states that any provision that exempts directors from personal liability for fraud and mismanagement shall be deemed rendered void and inapplicable. Both in the US and UAE, it is a common practice for companies to grant money in defense of a director, although it is treated as a loan which is later paid back. However, this provision has not been applied in the United Arab Emirates, and there is a doubt that courts will make any sense of this provision in the long run as they do with exception liability.

Under the law of insolvency, a director is personally liable for damages caused as a result of their failure to file bankruptcy within 30 days after the company losses half of its initial capital. Specifically, Article 289 stipulates that directors can be held accountable for losses incurred as a result of the failure of the director to file insolvency it is obvious. Article 289 requires directors to be responsible as the closely monitor financial statements to establish the status of the company.

Directors can also be held liable for breach of other laws mentioned above. In fact, in most cases, a director is liable in criminal law for all breaches of law that involve fraud and mismanagement5. Directors must ensure they have observed due diligence when dealing with company affairs to ensure they do not breach this law. Most of the laws that identify liabilities of directors for fraud and mismanagement overlap with criminal law, which exposes directors to high chances of being held liable for, mistake the commit when dealing with the organization.

In summary, even though this study does not effectively cover all aspects of the director’s responsibilities and liabilities for fraud and mismanagement is has raised critical instances when a director can be held personally accountable for acts of fraud and mismanagement. The director can be personally liable under the Penal Code, insolvency law, security law, and criminal law. Various stakeholders can bring a lawsuit against a director for personal liabilities. For instance, a shareholder has a right to sue directors for fraud and mismanagement if they incur losses as a result of the director’s decisions6.

However, for shareholders to be able to sue directors, UAE laws require that a shareholder be elected by other directors during a general meeting. However, if the company for fraud and mismanagement sues the director, any shareholder can be able to sue the directors for personal losses incurred as a result of their decisions. This lawsuit is specifically preferred when a company has failed to sustain a case against a director for fraud and mismanagement. However, only parties that have suffered financial losses as a result of the director’s action can be able to raise such a proceeding against the directors.

Personal liability of a director in the United States

According to the US Company’s Act, a director is personally liable for mismanagement as a result of negligence. According to Boyer and Tennyson, there is a concept in the US that directors are merely gratuitous has led to a growing perception that the responsibility of directors involves fiduciary relation. This relationship then imposes liability on directors if they break their duties to the shareholder. However, although this perception is held by many in the US, it is difficult for a stakeholder to be able to identify the equity of jurisdiction when this trust is invoked. Director is agents of shareholders, and they are expected to act in good faith to ensure they shareholders do not incur losses.

These losses can be as a result of mismanagement when directors act negligently without taking due care in major decision making. The liability for mismanagement arises due to the quasi-trusteeship that exists between shareholders and directors. Kevin noted that directors are personally liable for mismanagement, which is well stipulated in the case of Spring’s appeal in the case of Philadelphia bank7.

In this case, the director used all the resources of the company to try to save the company from going into receivership. The directors used the money in reckless and irrational investments such as giving out unsecured loans in anticipation they would gain huge profit to normalize the bank. The directors sacrificed loan collateral to save the bank from going into a financial crisis. However, their action was a reckless move that exposed stakeholders to huge losses. The directors were held personally responsible for their actions since it did lead to financial losses. However, on appeal, the judge overturned the first ruling when Justice Sharswood argued that no matter how absurd the director’s decision was, as long as they acted within their powers, it was their duty to ensure the bank does not go into receivership.

Under the US insolvency law, a director is personally liable for the deliberate action of a director during insolvency to enter into fraudulent agreements with creditors and suppliers of a company8. This includes the act of false director misrepresentation of information and the company’s capital position to defraud the company. When a director receives money that is above what is stipulated in the Companies Act in the form of bonuses, compensation and false misrepresentation of a company’s debt, it is personally liable for misrepresentation and fraud.

A director is personally liable under the Common law for fraud and misappropriation of organizational assets and other properties. This includes a deliberate action of a director during insolvency to enter into fraudulent agreements with creditors and suppliers of a company. This includes the act of false director misrepresentation of information and the company’s capital position to defraud the company. Peter argued that when a director receives money that is above what is stipulated in the Companies Act in the form of bonuses, compensation and false misrepresentation of a company’s debt, it is personally liable for misrepresentation and fraud.

The liability of a director is determined by the duties and responsibilities of directors. They include the duty of care, duty of obedience and duty of loyalty. If a director breaches any of the duties, they are held personally liable. Moreover, directors are expected to act in good faith as they exercise corporate responsibilities. For instance, in the US, a shareholder can raise a derivative action against directors on behave of the company against any director. In essence, the director depends on business practices and knowledge to make decisions. They use the business judgment rule as the best defense mechanism.

In this case, the business directors use the business judgment as to the presumption that they acted in the best interest of the company. However, judges in the US do not take into account the notion of business judgment. A shareholder can be able to sue directors when they mismanage the company leading to losses. However, a shareholder who raises such a case must be able to prove that suffered financial losses. Moreover, when these damages are awarded, they are recovered by the company and not the shareholder who sued the directors. For instance, in 2011, the Delaware Court ruled that directors were personally liable for mismanagement when they decided to sell Grupo Mexico to Southern Peru Copper. The directors were held liable for mismanagement, and they were charged $300 million that was awarded to the company.

In many instances, the US courts have held a director personally liable due when the results of their actions breach the duty of loyalty, due care and duty of obedience. For instance, David argued that in the case of Aronson v. Lewis, the presiding judge ruled that the director was personally liable for ratifying a transaction without due consideration. Under the United States law, a director can be personally liable for breach of the duty of loyalty.

Directors are expected to observe and practice ethical business practices in the best interest of the company. Directors should not use their position for their gains in usurping corporate opportunities that expose the company to a legal suit. For instance, directors should not approach any employee of another company to acquire confidential information from a competitor whether for his/her gain or in the interest of the company, is personally liable and that can attract a penalty of two years in prison. Similarly, is a director conspire in the distribution of deceptive good to deceive consumer attract the same penalty.

Conclusion

The extent to which directors can be personally held accounts depends on the jurisdiction of the country they operate. However, in most cases, directors are personally liable for fraud and mismanagement as a result of the quasi-trusteeship relationship. In the UAE, directors are liable under the Penal Code for embezzlement of funds, property, fraud, and legal rights. Moreover, a director can be held personally liable under the Civil Code by his/her action of resignation when the company is in a crisis thus resulting in huge financial losses.

Under Article 186 of the UAE, company law, directors should be held personally liable for losses incurred by the company as a result of their decisions. Although this article does not specify the action that should be taken by a shareholder against the director, the act of mismanagement in itself attracts personal responsibility.

In the US, a director is held responsible if he/she breaches the duty of obedience, trust, and due care. Directors can also be held accountable by the deliberate action of a director during insolvency to enter into fraudulent agreements with creditors and suppliers of a company. This includes the act of false director misrepresentation of information and the company’s capital position to defraud the company. In conclusion, directors can be personally held accountable under the Penal Code, insolvency law, security law, and criminal law. Moreover, various stakeholders can bring a lawsuit against a director for personal liabilities.

Bibliography

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Boustany, Mazen. “Combating Fraud And Money Laundering In The UAE – Criminal Law – United Arab Emirates.” Articles on Offshore – Criminal Law Including Law, Accountancy, Management Consultancy Issues. 2016. Web.

Hodgins, Peter. “Directors’ Liabilities and Insurance in the UAE: Clyde & Co (en).” Clyde & Co International Law Firm. 2016. Web.

Ibrahim, Ahmed. “Piercing the Corporate Veil Under the UAE Companies Law – When Can Shareholders Be Responsible? – Al Tamimi & Company.” Corporate Law Firm in Middle East, commercial Lawyers UAE-Al Tamimi & Company. 2016. Web.

LaCroix, Kevin. “Personal Liability for Corporate Officials Under U.S. Import Laws – The D&O Diary.” The D&O Diary. 2016. Web.

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Street, David R. “Director & Officer Liability: 8 Tips for Protecting Your Personal Assets.” Lerners LLP in Toronto & London, Ontario. 2016. Web.

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Footnotes

  1. Bainbridge, The Management of Limited Liability Companies and Directors’ duties in the UAE. Web.
  2. Boustany, Combating Fraud And Money Laundering In The UAE – Criminal Law – United Arab Emirates. Web.
  3. Ibrahim, Piercing the Corporate Veil Under the UAE Companies Law. Web.
  4. Hodgins, Directors’ Liabilities and Insurance in the UAE. Web.
  5. Smith, Directors’ Duties in the UAE – What Are the Potential Personal Liabilities. Web.
  6. Terblanche, UAE Company Law Overview – Corporate/Commercial Law – United Arab Emirates. Web.
  7. LaCroix, Personal Liability for Corporate Officials Under U.S. Import Laws. Web.
  8. Street, Director & Officer Liability: 8 Tips for Protecting Your Personal Assets. Web.