The Restructuring, Insolvency and Bankruptcy Group considers the English law position.
It is not unlawful in itself for a company to trade when insolvent. To avoid personal liability for any increase in deficit, directors should not cause the company to trade on once they know or ought to conclude that it cannot avoid an insolvent liquidation - unless they then take every step with a view to minimising the loss to creditors. Any activity which depletes the assets available for creditors can amount to “wrongful trading” for which the directors could be personally liable.
Critical payments and incurring new credit
It is important to note that every step must be taken if the above applies; usually this includes a block on non-essential payments and the incurring of new credit, in favour only of those payments or obligations critical to the company's current survival plan.
Shadow Directors can be made liable for the deficit caused by wrongful trading. The directors must be in the habit of deferring to the shadow director for instruction on what to do. A financier imposing requirements for its own protection, as a condition of continued finance, should have nothing to fear. A written record may help.
Personal liability for fraudulent trading is rare, but its reach extends to any persons who are knowingly parties to the carrying on of a company’s business with intent to defraud creditors.
Duties to Creditors
A director's duty to promote the success of the company for the benefit of the shareholders is expressly displaced by the Companies Act 2006 when the company is in the zone of insolvency. At that point the directors' duty is to the creditors.
If a company puts a creditor in a better position than would be the case on a liquidation, in the six months before formal insolvency, that benefit might be clawed back: but only if the directors were motivated by a desire to prefer that creditor. Legitimate, commercial reasons should be properly documented in board minutes or otherwise.
Transactions at an undervalue
“The directors resolved in good faith that the entry into the Agreement was for the purpose of carrying on the company’s business and there were reasonable grounds for believing it would benefit the company”.
Just reciting this in board minutes is pointless and won't prevent a challenge. Detailed board minutes or other documentary evidence specifying why a transaction was thought to be commercially beneficial will give much greater assistance to all concerned in defending any such challenge subsequently. Remember that the ability to reverse a transaction only arises if the company goes into formal insolvency within 2 years, and that the undervalue must be significant.
Breach of fiduciary duty and misfeasance
Directors can be made personally liable to compensate the company for any loss suffered as a consequence of a breach of fiduciary duty or misfeasance. Classic situations include misappropriation, or transfer of the company’s assets at an undervalue. If the transfer is to a connected party, the financier’s security should still attach to the assets, and Newco may, by operation of law, continue to hold the assets on constructive trust for Oldco.
Disqualification: Company Directors Disqualification Act 1986
Any of these types of activity could amount to “unfit conduct” leading to disqualification from acting as a director of an English company for up to 15 years.
Contribution Notices under Pensions Act 2004
A Type A Event is anything which has the effect of reducing a company’s ability to meet its obligations to the Pension Scheme. This would include the grant of new security for existing obligations. In that scenario, directors could be personally liable if a contribution notice was subsequently served on them by the Pensions Regulator in respect of any pension deficit.