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Director and parent company liability
Under what circumstances can a director or parent company be held liable for a company’s insolvency?
A director has a fiduciary duty to act in the interest of the creditors as a whole if the company is insolvent and must not take any action which is detrimental to the company’s creditors. The circumstances under which a director may be held liable for a company’s insolvency are provided for in Sections 505 to 507 of the Companies and Allied Matters Act (CAP C20, Laws of the Federation of Nigeria, 2004) and include the following:
- Fraudulent trading – this occurs where it appears that the company’s business has been carried out in a reckless manner or to defraud creditors or any other person for any fraudulent purpose, including lying to creditors or entering false accounting information.
- Misfeasance – this occurs where the directors or parent company misapply or retain or become liable or accountable for any of the company’s money or property. This includes using the company’s property for non-company purposes or paying illegal dividends to shareholders.
- Undervalue – this is where the director sells or transfers the company’s assets at undervalue.
- Wrongful trading – this occurs where credit is obtained for the company with no realistic prospects of it being able to repay such credit but the company continues to do business with knowledge of its insolvency.
A parent company may be liable for the obligations of its subsidiaries or affiliates and vice versa if there is a contract between them to that effect or evidence of fraud.
What defences are available to a liable director or parent company?
Defences available to a liable director include as follows:
- He or she took every reasonable step to prevent the company from incurring the debt which caused the insolvency.
- He or she had reasonable grounds to expect that the company was solvent when the debt was incurred.
- He or she had reasonable grounds to expect that the company would remain solvent if it incurred the debt.
- He or she relied on the advice of certified experts.
A director must have reasonable grounds to believe that:
- another competent and reliable person could provide adequate information about the solvency of the company;
- the other person was fulfilling that responsibility; and
- the company was solvent at the time and would remain solvent even if it incurred debts based on the information provided.
Defences available to a liable parent company A subsidiary is a distinct corporate entity from its parent company. Thus, unless there is a contract to the effect that the parent company is liable to its subsidiaries’ creditors for fraud in the case of management of the subsidiaries to the benefit of the parent company, which leads to the insolvency of the subsidiary, the parent company cannot be held liable for its subsidiary’s debt.
What due diligence should be conducted to limit liability?
Due diligence includes:
- taking steps to minimise the potential loss to the company’s creditors and performing fiduciary duties diligently;
- taking creditors’ interests into account in decision making and complying with statutory directors’ duty;
- monitoring the company’s financial position at all times and controlling the company’s debts;
- taking specialist advice and, if there is a prospect of insolvency, refraining from incurring new liabilities;
- if there is an indication of the company’s insolvency, considering discontinuing business and commencing appropriate insolvency proceedings before creditors do so; and
- if there is a reasonable chance of saving the business, taking appropriate action – for example, negotiating new financing and working with creditors to settle the debt amicably.
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