When a company faces financial difficulties and becomes at real risk of insolvency, directors must act promptly and take appropriate action to comply with their legal duties and responsibilities to protect the company and its assets for the benefit of the company’s creditors. Failure to do so can have serious consequences for directors, including personal liability.
Directors’ Duties and Insolvency
Company directors have various duties imposed upon them by the Companies Act 2006, as well as under common law. Those duties include to promote the success of the company for the benefit of its shareholders. However, when a company is insolvent or at real risk of insolvency, directors’ duties shift, and the directors must make decisions for the benefit of the company’s creditors with a view to minimising creditor losses. Recent case law has applied a ‘sliding scale’ to the creditor duty, meaning that the greater the financial difficulty a company is in, the more paramount the interests of creditors is.
Key Steps Directors Should Take During Insolvency
Key steps which should be taken where a director becomes aware that the company is insolvent or at real risk of insolvency include:
- Preserve and Safeguard Company Assets
- Hold a Shareholders’ Meeting
- Hold Regular Board Meetings
- Seek Legal Advice
- Engage and attend upon an Insolvency Practitioner
- Report to Creditors
- Repay Overdrawn Directors’ Loan Accounts
- Minimise Creditor Losses
Personal Liability and Potential Risks for Directors
Directors are usually protected from personal liability due to the company being a separate legal entity. However, the actions and decisions of a director when a company is insolvent, or in financial distress, can expose directors to personal liability. Those individuals who act as directors but are not registered as such, and non-executive directors, are also at risk of facing personal liability. Directors can be found liable for:
- Wrongful Trading
If a director continued to trade when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency, they may be held personally liable for the company’s debts incurred during the period of wrongful trading.
- Fraudulent Trading
Where a company has entered liquidation or administration and the company’s business was carried on with an intent to defraud creditors and/or any other person, a director may be found liable for fraudulent trading.
- Antecedent Transactions
- Transactions at an Undervalue: directors could be ordered to compensate a company and its creditors for a loss suffered because of the company entering into a transaction at an undervalue. A transaction at an undervalue is where the company enters a transaction for which the company receives no consideration or consideration, the value of which is substantially less than the value of the consideration provided by the company.
- Transactions Defrauding Creditors: directors could be ordered to compensate a company and its creditors for a loss suffered because of the company entering into a transaction at an undervalue where the intention was to put the asset in question beyond the reach of the company’s creditors.
- Preferences: directors could face personal liability if the company enters into a transaction which places a particular creditor in a more favourable financial position than the other creditors than otherwise would have been the case upon an insolvency event.
- Personal Guarantees
Directors can face personal liability where they have given personal guarantees for the company’s debts.
- Misfeasance
Directors who breach their duties to the company may be required to compensate the company for any losses suffered by the company as a result of those breaches.
- Director Disqualification
As part of the insolvency process, Insolvency Practitioners have a duty to report to the Insolvency Service on the conduct of each of the company’s directors, including any who held office during the preceding three years. If misconduct is found or the director’s conduct is deemed unfit, a director can face disqualification for a period of up to 15 years.
How Nelsons Can Help
If you are concerned about your company’s financial situation, it is vital to seek professional advice at the earliest opportunity. Proactively addressing insolvency risks can help mitigate potential liabilities and ensures compliance with directors’ duties.
At Nelsons, our restructuring and insolvency specialists can provide expert guidance on companies navigating financial distress, complying with directors’ duties, and minimising risk.
Our restructuring and insolvency specialists can also provide legal advice to directors who are facing legal action for breaching their duties as a director of a company which is now in an insolvency process. Whether you require advice on restructuring, compulsory or voluntary liquidation, or director liabilities, we are here to help.
Abbie Fotheringham is an Associate in our expert Restructuring & Insolvency team.
If you have any questions in relation to the subjects discussed above, please contact Abbie or another member of the team in Derby, Leicester or Nottingham on 0808 258 0461 or via our online form.