Directors and officers

Directors’ liability – failure to commence proceedings and trading while insolvent

If proceedings are not commenced, what liability can result for directors and officers? What are the consequences for directors and officers if a company carries on business while insolvent?

A consequence of carrying on business when insolvent can be that the court finds a director guilty of wrongful trading under section 214 of Insolvency Act 1986 (the Insolvency Act) where the other requirements for that offence are met. The court may declare that person liable to make such contribution to the company’s assets as the court thinks proper, the amount being compensatory rather than penal.

A further consequence of carrying on business when insolvent can be that the court finds a director guilty of fraudulent trading under section 213 of the Insolvency Act. Where it appears that any business of the company has been carried on with intent to defraud creditors or for any fraudulent purpose, the court may declare that any persons who were knowingly parties to the carrying on of business in that manner are liable to contribute to the company’s assets. This section goes beyond directors and officers and applies to anyone who has been involved in carrying on the business of the company in a fraudulent manner. Actual dishonesty must be proved. Both a liquidator and an administrator (or an assignee of such) can bring this action. Last, a director could be disqualified under the Company Directors Disqualification Act 1986 (CDDA).

Directors’ liability – other sources of liability

Apart from failure to file for proceedings, are corporate officers and directors personally liable for their corporation’s obligations? Are they liable for corporate pre-insolvency or pre-reorganisation actions? Can they be subject to sanctions for other reasons?

The company’s officers and directors will not generally be personally liable for obligations of their corporations unless they have entered into personal guarantees. However, the company’s officers can be held personally liable to contribute to the company’s assets for any one of the following reasons:

  • misfeasance or breach of any fiduciary or other duty;
  • wrongful trading; and
  • fraudulent trading.

 

The company’s officers can also be criminally liable under sections 206 to 211 of the Insolvency Act for fraud, misconduct, falsification of the company’s books, material omissions from statements and false representations. They are also liable to disqualification from being a director of any company for up to 15 years under the CDDA. The court can also make a compensation order where a director has been disqualified. A director can also be disqualified in the United Kingdom if they have been convicted of (among others) an offence in connection with the promotion, formation, management, liquidation or striking off of a company outside the United Kingdom. Last, environmental and health and safety legislation may provide for personal liability on directors and officers.

Directors’ liability – defences

What defences are available to directors and officers in the context of an insolvency or reorganisation?

In relation to wrongful trading, assuming that the necessary limbs of the statute are met (ie, the director at the time knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation or insolvent administration), then there is a defence available to the director if they have taken every step to minimise the potential loss to the company’s creditors as they ought to have taken. Resignation is not generally considered a defence to directors – indeed, resigning may be viewed by the court as an insufficient step to minimise the potential loss to creditors (and therefore negate the possible defence).

In relation to a misfeasance claim under section 212 of the Insolvency Act, the Companies Act (section 1157) provides for relief from liability for directors if they have acted honestly and reasonably and if it is fair in the circumstances to excuse the person from liability.

Shift in directors’ duties

Do the duties that directors owe to the corporation shift to the creditors when an insolvency or reorganisation proceeding is likely? When?

When a company’s financial position has deteriorated to the point where its solvency is in question, the focus of the directors’ attention must shift away from the shareholders and towards protecting the interests of creditors. The Insolvency Act underscores this shift by exposing directors to the possibility of personal liability for wrongful trading. The Companies Act 2006 also recognises this shift (in section 172(3) of the Companies Act 2006). Directors must consider the interests of creditors as a whole, and not just the interests of any individual creditor or class of creditors. A director is subject to these duties irrespective of whether they are an executive or non-executive director and even if appointed as a nominee of a particular creditor or shareholder.

Directors’ powers after proceedings commence

What powers can directors and officers exercise after liquidation or reorganisation proceedings are commenced by, or against, their corporation?

In a reorganisation outside a formal insolvency process, the directors retain their management powers and will be tasked with driving the restructuring.

In a scheme of arrangement or a restructuring plan, directors remain in control of the management of the business.

In a moratorium, the directors retain control of the company, although a licensed insolvency practitioner (the monitor) will be appointed with certain oversight duties. Directors will need to seek permission from the monitor to engage in certain acts such as disposing of property (unless disposed of in the ordinary course of business or in pursuance of a court order), granting security or paying certain pre-moratorium debts for which a payment holiday applies (this permission is only required if the total payments to a person exceed the greater of £5,000 or 1 per cent of the value of the debts and other liabilities owed by the company to its unsecured creditors when the moratorium begins).

In a company voluntary arrangement (CVA), the directors remain in control with the assistance and supervision of the nominee and supervisor of the CVA.

In a liquidation, the directors’ powers will cease unless (for a voluntary liquidation) the creditors’ committee and the creditors (in a creditors’ voluntary liquidation), or the shareholders in a general meeting (in a members’ voluntary liquidation) or, in both cases, the liquidator, agrees otherwise. In administration, the directors’ powers to exercise any management function, or actions that interfere with the administrator’s powers, cease unless prior consent is given by the administrator.