Directors of companies which are insolvent or are in financial difficulties face a number of issues.
Often directors will be concerned with how they can keep the company in business. However, directors must be careful to avoid some of the risks that may arise with allowing the company to trade whilst it is insolvent.
It is often a difficult balancing act for directors to determine when they should cease trading. Furthermore, if they do decide to cease trading, the directors may need to consider which insolvency route the company should follow (see the section that deals with where your company is in financial difficulties).
Our Insolvency and Restructuring team is experienced in advising directors on their duties and responsibilities in connection with insolvent businesses. Some of the concerns for the directors of an insolvent company include :
⢠Personal guarantees
Generally, the directors of a company are not personally liable for the debts of a limited company. However, if a director has given a personal guarantee in respect of the liabilities of the company, personal liability on the part of the director may be introduced by that guarantee.
Briefly, a guarantee is a promise by the director to ensure that the company fulfils its obligations and is a promise that the director will fulfil those obligations if the company fails to do so. Therefore, in the event that the company becomes unable to pay its debts, a director who has given a personal guarantee to the company's creditors may be personally liable to pay those debts.
We regularly advise individuals in relation to personal guarantees they have given to lenders and/or trade creditors of the business.
⢠Wrongful trading
Once directors of a company conclude (or should have concluded) that there is no reasonable prospect of the company avoiding liquidation, the directors have a duty to take every step which a reasonably diligent person would take to minimise potential loss to the company's creditors. This may include, for example, bringing the affairs of the Company to a close and/or ceasing to trade.
If the directors fail to comply with this duty, it is possible for any subsequently appointed liquidator of the company to seek an order from the court for the directors to make a personal contribution to the company's funds or assets, so that there is more money available for the company's creditors.
Determining when there is no reasonable prospect of a company avoiding insolvent liquidation is difficult. For example, the directors may believe that the company is capable of "trading outâ of its current financial difficulty. However, if this does not occur, the directors may face allegations of wrongful trading.
⢠Fraudulent trading
Fraudulent trading is a criminal offence and may be punished accordingly.
If, in the course of the winding up of a company, it appears that the business of the company has been carried on with the intent to defraud creditors, or for any other fraudulent purpose, the liquidator of the company can seek an order from the court that requires that anyone who was knowingly party to the fraudulent business make a personal financial contribution to the company's assets so that there is more money available to the company's creditors.
Anyone who is knowingly a party to carrying on the business with intent to defraud may be liable for fraudulent trading. Therefore, unlike the offence of wrongful trading (above), it is not only directors of the company who may be liable for fraudulent trading.
In order to establish a successful fraudulent trading claim, it is not enough to show that the company continued to run up debts when the directors knew that it was insolvent. The liquidator must show that there was "actual dishonestyâ on the part of those concerned. As a result of this high evidential burden, it is common for many liquidators in these circumstances to pursue claims for wrongful trading instead (see above).
⢠Misfeasance or breach of fiduciary duty
Directors are in a position of trust and confidence in relation to the Company and owe duties to the Company, its shareholders and its creditors. If the director acts in breach of this trust and/or these duties, in particular in relation to the company's assets, this is known as misfeasance.
If a company enters liquidation and it appears that a director has misapplied or retained any money or other property of the company, or has been guilty of any misfeasance or breach of any fiduciary or other duty, the court may order the director to repay or restore money or property, with interest. The court may also order the director to pay compensation to the company.
⢠Breach of common law duties.
Where a company is insolvent or on the verge of insolvency, the directors owe a duty to act in the best interests of the creditors of the company.
Directors cannot, for example, cause an insolvent company to repay shareholders' debts or make distributions to shareholders out of profits if no proper provision has been made for the company's creditors.
We regularly advise individuals with regards to the above matters and any potential liability that may arise.
Our team also has significant experience of advising directors in relation to Director Disqualification proceedings, as well as in relation to claims made against directors by insolvency practitioners.
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