Directors Beware!

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We would like take this opportunity to consider the subject of Director’s responsibilities particularly when their company is experiencing financial difficulties.

Probably the most important thing to remember is that when there is a doubt as to a company’s solvency, the directors must act in the interests of the company’s creditors in order to minimise the potential loss to them.

What are the consequences of not acting as a responsible director?

Personal liability arising from wrongful trading

This applies where a company has gone into insolvent liquidation and before the winding up the director knew or ought to have known that there was no reasonable prospect that the company could avoid insolvent liquidation, and thereafter the director failed to take every step to minimise creditor’s losses. The court will consider the losses incurred by creditors as a consequence of continued trading in assessing the amount to be paid by the directors.

Personal liability arising from a breach of fiduciary duty

If, in the course of a winding up  a director  is found to have misapplied, retained or become accountable for any money or other property of the company a court may order the director to repay, restore or account for the money or property, with interest. Alternatively a director may have to contribute such sum to the company’s assets by way of compensation as the court sees fit.

Disqualification

Where a director is found to have engaged in conduct which makes him unfit  to be involved in the management of a company he will be disqualified  by a court order or have a disqualification undertaking accepted by the Secretary of State under the Company Directors Disqualification Act. He will not be able to act as a director or have any involvement in the formation or management of a company for a period of 2 to 15 years. What is unfit conduct? This would include the above offences of wrongful trading and breach of fiduciary duty. Also included is the failure to maintain adequate accounting records, and the late filing of accounts and other documents with Companies House. However by far the most common reason for disqualification is where a director allows the accumulation of excessive Crown debt, in effect using HMRC as a bank.

Practical guidance

This is a complex area and the stakes can be high. All the directors should meet as soon as possible to make a preliminary assessment of the position by reference to the company’s profit and loss account and balance sheet.

However remember that cash is king. A company’s financial problems will inevitably be revealed when there is insufficient funds to pay liabilities as and when they fall due.

If the directors are of the opinion that the company can survive then the assumptions made and the plan for recovery need to be thoroughly documented.

The directors may decide to continue to trade for a limited amount of time, with a view to turning the company’s financial position around. Alternatively time may be needed to try and sell the business as a going concern. Financial projections need to be produced to justify this decision. It is therefore very important that initially you seek advice from your accountant. Their knowledge of your business makes them a useful sounding board regarding your proposed survival plan.

Vulnerable Transactions

If, despite all efforts a company cannot be saved directors need to  be aware that if the company enters into certain types of transactions within specified periods before its insolvency, applications can be made to court  for an order to be made to reverse the transaction or to make some other appropriate remedy. Such transactions can also constitute a breach of duty by a director.

Let us look at a couple of examples:

- Repayment of an unsecured bank overdraft prior to insolvency.

If the overdraft has been personally guaranteed by the director then its repayment would extinguish the director’s liability to the bank. This could constitute a preference as it is an action made by the director that puts himself in a better position than if the transaction had not been made. Here the court has wide powers to put the parties back into the position they would have been before the transaction.  The monies recovered can then potentially be made available to the body of unsecured creditors.

- Creation of a floating charge after a loan has been made.

If it is likely that a company will become insolvent a director may try to move a loan up the pecking order for repayment in a liquidation by creating a floating charge. This again gives this particular creditor an unfair advantage over the body of unsecured creditors. Basically if the charge is created within two years of the winding up and after the loan was made, then the charge would be invalid.

When a company experiences financial difficulties directors must be aware that they are entering a mine field. Nobody has a crystal ball therefore judgements have to be made. As time passes decisions have to be revisited in the light of ongoing events. Remember to thoroughly document why you made these decisions.