Resident's management company - Are the Directors at risk?

In the past a view has perhaps gained currency that being a director particularly an inactive Directors or non-executive Directors does not carry much risk. We now know this is no longer the position. Recent financial disasters such as those befalling Equitable Life and Split Capital Trusts (to name but two) have shown that directors are very much in the firing line when things go wrong whether they are executives or non-executives.

This becomes particularly important when we consider the new leglisation: The Commonhold and Leasehold Reform Act 2002 which came into law at the beginning of May this year and will come into force when a statutory instrument is made through the Lord Chancellor’s Department. Under the 2002 Act it is much easier to remove Managing Agents since it is no longer necessary to prove fault. However, an RTM company (short for Right To Manage company) is a company whose object is the acquisition and exercise of the right to manage and qualifying tenants are entitled to be members of such a company. Before seeking to exercise the right to manage the RTM company must give notice to all the qualifying tenants who are not already members inviting the Lessees to participate in the company and if Lessees become directors instead of being an opportunity to manage their own block it may become the proverbial bed of nails.

If the Management Company should go into liquidation, the directors will be investigated to see if they bear any fault. Certain actions of directors may also come under scrutiny if things go wrong even if the company remains in existence and an individual director can sometimes find himself at the receiving end of a financial claim if he has committed some negligent or wrongful act which has exposed the company to liability wherein the company may have dismissed him and taken the appropriate action. Even with the use of the new leglisation there are many management companies run by residents where directors play little part in the company perhaps delegating the day to day running of the block to Managing Agents without realising that the ultimate responsibility may well rest with them if anything goes wrong. For those who have other jobs to be concerned with this may not be something they wish to worry them at night. Without doubt it will become an increasing problem as more Residents’ companies take over the control of their own blocks.

Sometimes the Articles of Association of the Management Company contain provisions to protect directors excluding them from liability for negligent actions if they are not fraudulent but it is always difficult in advance to know whether a particular provisions will be sufficiently well drafted to protect a directors in the circumstances of a particular case. The other method of seeking to protect directors is by the Residents’ Company taking out a policy of insurance paid for by the Company to provide insurance cover should anything go wrong. The premium for this sort of policy depends usually on the number of flats, and it is reasonable to expect a sliding scale depending upon the amount of cover and the number of flats. One particular insurer would charge approximately £450 for £500,000 of cover in a 20 flat block. For a block of 100 flats and the same amount of cover the premium would be about £625. It is usual to find Resident’s Management Companies seeking cover of between £500,000 and £1 million. If the blocks have a large number of flats then the cover is usually higher. Taking a £1 million indemnity based on 100 flats a premium in the order of £850 might be expected. The Insured under such a policy includes all the directors and officers of the Company and can also include any spouse of such a director or officer, the estates of deceased persons who were directors and even the legal representatives of directors. The wrongful acts that are covered can include any actual or alleged act, error or omission committed by an insured person acting in their capacity as a directors or officer of the company. The policy will cover not just the loss which includes any damages, fines or penalties but also the reasonable legal costs of defending such a claim. It is worth remembering that employment law today gives rise to numerous claims and if the Management Company dismisses an employee then claim for unfair dismissal or discrimination needs to be considered. Of course, no policy will cover fraudulent or dishonest activity.

Even when the director has resigned and left a company as you would expect to happen if a director sells his or her flat and moves elsewhere there is still the risk of a claim arising for acts done whilst that person was a director. A suitable insurance policy can provide what is called run off cover to indemnify any such directors for a number of years after resigning their position. Directors leaving management companies should consider the need for this sort of cover.

Specialist insurance brokers can advise on what forms of cover are available in the market and the relative cost. It would be a foolish Board of Directors of a Residents’ Management Company that did not fully consider whether such insurance cover was necessary.

It is always worth considering as well whether it is possible to put in place directors of the Management Company who are not lessees and are more in the nature of professional directors. For example if there is a Managing Agent such Managing Agent might supply professional directors who would take on the responsibility and certainly there would be a degree of permanence about such an arrangement provided the residents were satisfied with the Agents and they were prepared to co-operate in this way. But short of finding what might be called “nominees” those Lessees who agree to accept the onerous burden of being a director of a Residents Management Company need to make sure at all times that they have sufficient protection against the risk of claims being made against them which can result not just from their own acts but from the acts of their co-directors.