This Note deals with the potential liabilities under English Law of the directors and officers (secretary and managers) of a UK company in the event of its (potential) insolvency.
Directors - and, to a lesser extent, other officers of a company - face a number of areas of potential personal liability. Of most relevance is the liability of the directors for ‘wrongful trading’.
The directors will need to consider as a priority the viability of the company and how to proceed, which will include consideration of whether the company should be put into a formal insolvency process. Generally, assistance will need to be sought from a specialist Insolvency Practitioner.
Any attempt by the company to sell off assets at this point at an ‘undervalue’ or to give a ‘preference’ to a creditor, guarantor or surety of its debts, could be vulnerable to later challenge by a liquidator, who has the power to set aside such transactions.
The position of directors and officers
General duties of directors: The general duties owed by directors to their companies are now set out in the Companies Act 2006 (“CA”). A director’s primary duty is to promote the success of the company for the benefit of its members as a whole (section 172(1) CA). However, that primary duty is qualified by the CA to the extent that it is stated to be subject to any enactment or rule of law requiring directors, in certain circumstances (eg when the company is approaching insolvency), to consider or act in the interests of the company’s creditors. It is generally assumed that this is a reference to concepts such as fraudulent or wrongful trading which are contained in the Insolvency Act 1986 (“IA”) (as to which see immediately below), which, if applicable, would qualify a director’s primary duty.
Wrongful Trading: A director faces the potential for a civil claim against him/her personally for ‘wrongful trading’ under section 214 IA. This would be a claim made by a liquidator in the course of a winding up.
A director will be liable for wrongful trading if, before the commencement of a winding up, the director knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation and thereafter the director failed to take every step that a reasonably diligent person would have taken with a view to minimising the potential loss to the company’s creditors. In other words, this is a claim that a director has not acted reasonably in the management of the company.
If the court finds that the director is liable for wrongful trading, the director could be ordered to contribute to the company’s assets for an amount that the court thinks proper.
Fraudulent trading: The ‘fraudulent trading’ provisions of the IA (section 213) will apply in circumstances which amount to the carrying on of a business with an intent to defraud creditors. The IA imposes civil liability and the court can order any person concerned (not just a director) to make a contribution to the insolvent company’s assets. Fraudulent trading is also a criminal offence.
A finding of fraudulent trading (as well as a finding of wrongful trading) would also be relevant to the possible application of the Company Directors Disqualification Act 1986 (“CDDA”) jurisdiction (see below), and is almost certain to lead to the disqualification of a director.
Misfeasance etc: Section 212 IA provides a method by which a liquidator can attack those responsible (ie again, not just directors) for the misapplication of company property or who have been guilty of misfeasance or have caused loss to the company through a breach of a fiduciary or other duty in relation to the company. Those duties could include matters such as a director’s involvement in the company entering into an undervalue transaction or granting a preference (see below).
If the court finds that there has been misfeasance etc, it can order the person responsible to repay, restore or account for the money or property of the company or contribute to the company’ assets by way of compensation for what has happened.
Disqualification of directors: As part of a liquidator’s investigations into an insolvent company’s affairs, the liquidator could consider the conduct of the officers in the context of the scheme of the CDDA. While any person can be disqualified from acting as a director if a disqualification ground is established (eg a company secretary who is persistently in breach of the Companies Acts by the failure to file documents), the majority of persons disqualified are directors.
Under the CDDA, the court has the power to disqualify directors from acting as such, or being involved with the management etc of a company, for a specified period of time, the minimum period being 2 years.
The grounds for making disqualification orders under the CDDA include where the court is satisfied that the director’s conduct makes him “unfit to be concerned in the management of a company”. Case law suggests that in considering whether to make a disqualification order, the court will look to see whether there has been dishonest conduct, or something akin to that, whereas “ordinary commercial misjudgements” would not be enough to justify disqualification.
Some practical considerations:
- In order to minimise the risk of a successful claim being made against the directors for wrongful trading (and also to avoid other potential areas of liability as detailed above), the directors should take action to ensure that as far as possible no further debts are incurred by the company.
- It is important to ensure that regular board meetings are held with as much up-to-date financial information as possible being available to the meeting, and that those meetings, and the decisions made at the meetings, are fully documented.
- Assistance should be sought from a specialist Insolvency Practitioner who will advise about the viability of the company and how to proceed. This will include consideration of whether the company should be put into a formal insolvency process, for example Administration (a process designed to enable a company to be rescued or restructured or its assets to be sold whilst creditors’ abilities to enforce their rights are subject to a statutory moratorium).
- While resigning as a director may, superficially, appear to be a good idea, it is probably not a viable option. This is because of (among other things) the obligation imposed on directors under the wrongful trading provisions in the IA to minimise the potential loss to creditors - who will not be assisted by the resignation – and, as such, resignation could increase the risk of personal liability for wrongful trading. If in place, D&O policies should be checked for cover for liabilities related to insolvency and, if appropriate, consideration should be given to making a precautionary notification to the D&O insurer of any circumstances that could give rise to potential claims that might be brought against the directors.
Any transactions entered into by the company at this point could, depending on the facts, be vulnerable to later challenge by a liquidator on the basis either that they were made at an ‘undervalue’ or that they were 'preferences'. Both types of transaction reduce the assets of the company in a way that is unfair to the body of creditors as a whole.
Undervalue transactions: The relevant provisions of the IA provide that a company enters into a transaction with a person at an undervalue if the company makes a gift to that person or if the value of the consideration for the transaction is significantly less than the value of the consideration provided by the company.
There is a ‘good faith’ saving in the IA for transactions that might otherwise be held to be undervalue transactions - namely if the court is satisfied that the company entered into the transaction in good faith and for the purpose of carrying on its business, and at the time it did so there were reasonable grounds for believing that the transaction would benefit the company.
Preferences: A company gives a preference to a person if that person is one of the company’s creditors or a guarantor or a surety of its debts and the company does anything which has the effect of putting that person into a position which, in the event of the company going into insolvent liquidation, will be better than the position the person would have been if that thing had not been done.
Again, there is a restriction in the IA on the application of the preference anti-avoidance provisions, namely that a court will not make an order that there has been a preference unless the company which has given the preference was ‘influenced by a desire’ to improve that particular creditor’s position in the event of an insolvent liquidation.
The Court has extensive powers if it finds that the company has entered into an undervalue transaction or has given a preference. These powers include requiring any property transferred as part of the transaction or in connection with the giving of the preference to be re-vested in the company, the transaction to be set aside and requiring any person who received any benefits from the company to repay those benefits.