Directors’ liabilities in insolvency
The Directors of a company in financial difficulty must tread carefully if they want to avoid personal liability and disqualification as a director. Harry Pearson considers how to minimise the risk.
If you are a director of a company that is in financial difficulty, the actions you take now may be scrutinised in the future if the company goes under and could give rise to personal liability or disqualification as a director.
Is there any reasonable prospect that the company could avoid going under? If not, and you continue to trade the directors risk being found liable for wrongful trading. If personally contributing to the company’s assets and a potential disqualification order aren’t where you want to find yourself then read on.
Avoiding liability for wrongful trading
The courts typically find directors liable where they “closed their eyes to the reality of the company’s position” and continued to trade long after it should have been obvious to them that there was no way out.
Simply claiming that there was “light at the end of the tunnel”, or that the company’s bankers were “continuing to support the company” is no defence, unless you can show that the company’s bankers had expressly agreed to continue to support the company or that there was a genuine, realistic prospect of further significant investment in, or the sale of, the company.
To avoid personal liability you need to be able to satisfy the court that you took every step you ought to have taken to minimise the potential loss to creditors. Demonstrating that you have taken such steps can be difficult, but examples of good practice include:
- evaluating the viability of the business by assessing accurate and up to date financial information, determining cash flow needs, assessing the market and deciding whether the company should make disposals of non-profitable assets;
- ensuring frequent board meetings are held and detailed minutes kept of the proceedings, any decisions made and the reasons for them;
- discussing with the company’s bankers whether facilities are sufficient to meet the company’s cash flow requirements;
- informing major creditors of the financial condition of the company on a regular basis and, where appropriate, seeking their support for the continued operation of the company; and
- probably most importantly, seeking the advice of professional advisers (insolvency practitioners and solicitors) at the earliest possible stage. Don’t delay as directors are judged on when they knew or ought to have known that there was no longer a reasonable prospect of the company surviving.
One step on from wrongful trading is a deliberate intent to defraud creditors. Any actions you take which are deemed to have a fraudulent purpose can mean the more serious offence of fraudulent trading comes knocking at your door.
Whilst this offence is pursued less frequently because of the need to prove an intention to defraud, the consequences can be severe. You could be liable to contribute to the assets of the company, find yourself with a director’s disqualification order and you could also be convicted of committing a criminal offence.
With finances getting tight, creditors are likely to press for payment. With that comes the danger of you preferring one creditor over another (effectively putting someone higher up the pecking order than they would otherwise have been had the company gone into insolvent liquidation).
If a company gives a preference to any person, the court can do as it sees fit to restore the position to what it would have been had the creditor not been preferred.
To a certain extent it will be impossible for you not to prefer one creditor over another if you are being pressed for payment, but the company must be influenced by a desire to put that creditor into a better position for it to qualify as a preference. If it can be shown that the company had no option but to pay a particular creditor, for example to obtain essential supplies or services, then it will be difficult to argue that the necessary desire exists.
If you are a director of a company in financial difficulties then it is important that you tread carefully and, if you are ever in doubt, you should always seek professional advice.