Directors: Potential liabilities faced when issuing shares

In the life cycle of your company, there will be times when you need to recapitalize the business.

When would you need to issue shares?

A basic requirement of the Companies Act (the Act) is that the company remain a “going concern” (have enough funding to remain in business for the next 12 months). To satisfy this requirement, directors must regularly perform liquidity and solvency tests (liquidity tests if there will be sufficient cash to meet all obligations whilst solvency tests if assets in the business exceed liabilities). If these tests indicate funding will be needed, one avenue open to the company is to issue more shares.

Alternatively, a company may issue new shares when it plans a major expansion.

What is required of directors?

In terms of the Act, directors are responsible for issuing shares and must issue them for an “adequate consideration” which is to be calculated by the directors prior to the issuing of the shares.  

This section of the Act requires that directors apply their minds to determine what an “adequate consideration” is.  In this process, directors need to keep the best interests of the company in mind, cannot have a conflict of interest and must show the necessary “care, skill and diligence” when performing this task.

This can be a demanding process as for example, the market may dictate that shares be issued below market value or an “inadequate consideration”. In this scenario, the company might, for example, have issued shares in the recent past and shareholders may only be prepared to take up new shares at a discount. Directors need to be able to justify the course of action they take i.e. that the value/consideration is actually adequate in the particular circumstances.

If you as a director fail in this task…

Directors can be held personally liable if they do not issue shares for “adequate consideration” and may have to compensate stakeholders for any damages suffered in this process.

Thus while the Companies Act grants widespread powers, it also makes directors personally liable for losses sustained as a result of their actions. It is critical that you document your decisions so that you can withstand any scrutiny of them.