In the current climate, where asset values have diminished and directors’ decisions are increasingly under the microscope, it is in a director’s personal interests to be fully aware of what planning should be implemented within their company generally (regardless of how well it may be doing), and the necessary steps to take in advance of or upon a company becoming insolvent, in order to avoid any future criticism. Here we explore the legal duties and liabilities that are encumbent upon directors, perhaps more importantly, the personal risks that you might want to consider mitigating.
The 2006 Companies Act (Sections 171-177) sets out a range of duties which a director must adhere to, reflecting 150 years of case law dictating what is expected of a director. The principle duties, and associated directors’ liabilities, are explained below:
- A director has fiduciary duties (in other words, a legal duty of care/trust) to the company, its shareholders, its employees and its creditors; and, he or she also owes non-fiduciary duties to, amongst other groups, the public at large.
- Any breach of a fiduciary duty may be grounds for a claim against that director personally, for such compensation or loss arising from that breach. Alternatively, directors may often be liable for any harm caused by the company whilst they were appointed (regardless as to whether this harm arose from within their department or they were aware of it); this risk is heightened where a company subsequently enters into any insolvency proceedings.
- Perhaps the most important director’s duty is found under Section 172 of the Companies Act 2006, which states that directors have a duty to “act in the company’s best interests”. This usually relates to the company’s financial success, and thus the interest of shareholders, unless the company exists for other purposes.
- However, a related sub-section underlines that this is subject to change, for example, as set out by the Insolvency Act 1986 or the Company Directors Disqualification Act 1986, when directors are then required to act in creditors’ interests instead. In such circumstances, once the directors know or should have known (hence the need for all directors to closely scrutinise financial information) that a company is insolvent, they have a fiduciary duty to act in creditors’ interests.
Let’s now consider the legal definition and circumstances around insolvency. There are two measures which determine whether a company is insolvent:
- Where a company is unable to pay its debts as they fall due (section 123(1)(e) of the Insolvency Act 1986); or
- Where the value of the company’s assets is less than the amount of its liabilities (section 123(2) of the Insolvency Act 1986).
A company may be placed into liquidation by an unsecured creditor filing a winding-up petition. Alternatively, a company could be placed into a voluntary liquidation by the company’s members, or the company could be placed into Administration by the company, its directors, a secured creditor or on application to the Court (these are collectively referred to as an “Insolvency Event”).
Directors’ Personal Liability
Once an Insolvency Event occurs, there are various mechanisms where directors can be made personally liable for part or all of the company’s debts. Unless the director has a wealth of other personal assets, it is quite common for such liability – at worst – to lead to the loss of the family home and bankruptcy. However this risk can be mitigated, by either obtaining early advice or seeking advice once you have been notified of a claim or potential claim.
Although this article cannot cover all of these risks in detail, a summary of the main types of risk faced by directors are as follows:
(i) Claims for misfeasance/antecedent transactions
Directors can be personally liable where assets are removed from a company up to 2 years prior to an Insolvency Event and either nil or below market value consideration is paid, or where such assets are used to repay a creditor(s) in preference to other creditors. The recipient of such transactions can also be subject to a claim for recovery of these sums (even if receiving them by way of repayment of a valid debt).
(ii) Wrongful/Fraudulent trading
A director can be personally liable where he either deliberately continued trading the company, or negligently continued trading the company, where an insolvent liquidation was unavoidable. This has broad-ranging consequences; to repay the loss to creditors caused by the continued trading and, in the case of fraudulent trading, may be subject to criminal proceedings.
(iii) Breach of fiduciary/non-fiduciary duties
Both pre- and post-insolvency the company can bring a claim against directors where it can be demonstrated that they breached any of their fiduciary duties to the company. In insolvency, the appointed liquidator or administrator can issue such proceedings on behalf of the company. Alternatively, a similar claim can be brought by third parties for breaches of fudiciary and non-fiduciary duties, by way of a personal claim against directors.
(iv) Personal Guarantees
It is often the case that once a company enters into an Insolvency Event this will trigger liability under the terms of any personal guarantee offered by directors to secured lenders or otherwise.
(v) Director Disqualification
Within 6 months of an Insolvency Event the appointed administrator/liquidator is required to file a report with the Secretary of State for Business, Innovation and Skills (“the Secretary of State”) on the conduct of directors. This may lead to further investigations by the Insolvency Service (acting on behalf of the Secretary of State) resulting in the issue of proceedings to disqualify the director from being involved in the management or control of any other companies. These proceedings may not be issued until 2 years after the Insolvency Event, and it is almost always the case that the directors’ response to initial enquiries (perhaps provided some time ago) is used in disqualification proceedings.
The above claims are often issued on the basis of factual circumstances which may have appeared very different at the time (the benefit of hindsight). These claims represent a very real risk to directors’ personal assets and future ability to act in a similar capacity. It is vital therefore that directors deal with such risks head on by introducing a suitable professional to review the company’s circumstances in an objective fashion.
This blog post was kindly written by Stephen Downie, Senior Associate at Francis Wilks & Jones LLP.
Image by: Zoramite
Topics: Business strategy, Preserving value