Directors’ Position and Responsibilities

This article looks at the risks directors face of insolvency and disqualification when a business is in difficulty and how to manage these risks.

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When a business is insolvent its directors face particular risks and duties as a result of its position which they need to ensure they manage.

But before talking about these insolvency specific items, it is important to remember that they also still have their normal responsibilities and duties which they will need to comply with, and risks that they will have to manage. So they will need to be concerned with everything from ensuring that their accounts are up to date and they are aware of the financial position, through keeping statutory filings up to date at Companies House, right through to issues such as Health and Safety and environmental protection. Indeed as will be discussed below, ensuring that these basic duties are executed properly is part of helping to manage your risks of both personal liability and disqualification.

Insolvency offences and actions

Normally the directors and shareholders of a company have no personal liability for the debts of the business and this protection is known as the veil of incorporation. However, when a business fails the Insolvency Practitioner will review the events leading up to the failure and can bring action to make the directors personally liable to contribute towards the loss suffered by the creditors if he can prove either:

wrongful trading, which means continuing to trade past the point where you knew, or ought to have known, that an insolvent liquidation was inevitable, or
the more serious charge of fraudulent trading where you were trading in a way designed to defraud creditors.

In addition to these statutory items, directors have a fiduciary duty to the company and so an action for misfeasance can be brought against a director if they can be held to have breached this duty by misapplying or becoming accountable for the company’s money, as may happen for example if dividends have been paid when there were insufficient distributable reserves.

A Liquidator may also act to set aside some transactions made before the liquidation in order to increase the assets in the pot available to all creditors, where they are held to be:

preferences, where some creditors were deliberately put in a better position than others, or
transactions at undervalue where assets were sold off cheaply.

They can also look to set aside some charges given as security which could for example effect the recoverability of a director’s loan made on the basis of this.

And of course some creditors may be able to seek to payment from directors where they have given a personal guarantee (‘PG’) in respect of a company debt such as a lease or a bank loan, although some such guarantees are difficult to enforce in practice.

The result of any of these actions can be large claims against you as a director personally which in extreme cases can lead to a director’s personal insolvency.

Directors disqualification

With the exception of a Company Voluntary Arrangement, under the Company Directors’ Disqualification Act 1986 the Insolvency Practitioner has to file a report on the directors’ conduct within six months of their appointment. These reports will cover all directors of the company in the three years leading up to the insolvency and that will also include anyone who may have acted as a shadow director (someone on whose instructions the directors were accustomed to act) or anyone held out as a director or acting as a de facto director.

The Crown may then seek to disqualify a director where they have been failing to file properly at Companies House (hence the need to keep this basic paperwork up to date), are found guilty of wrongful or fraudulent trading, or their conduct has made them unfit to be involved in managing a company. As case law has developed in this area the tests that are being applied by the courts are becoming wider ranging so that ‘trading at the expense of creditors’, or trading using Crown monies’ are now issues taken into account.

If a decision to prosecute is made you will normally be notified within about eighteen months of the failure and you should take expert legal advice immediately.

Protecting yourself and your position

It is important to remember that the rules concerning insolvency offences and directors disqualification are not meant to punish the directors of an insolvent business for failure, they are there to deal with poor conduct. The Courts are also unwilling to punish decisions made in good faith at the time on the basis of judgements in hindsight.

So the key steps you have to take to protect yourself from any insolvency related action are to be able to show you took the appropriate steps in the light of your knowledge at the time, having ensured your knowledge was as good as it could be. You can do so by demonstrating that you prepared and maintained accounts, trading results, and forecasts, you took professional advice about whether you should continue to trade, and about any major proposed transaction such as refinancing or selling major assets, and critically, you held and minuted board meetings to record these decisions and the basis on which they were made.

So to be able to demonstrate this at a later date, remember to keep personal copies of all such documents.

Finally, protecting yourself

Unless you thrive on seemingly impossible challenges, having your business get into difficulty will be a stressful, depressing, and difficult experience that will put a strain on you, your family, and your employees. You therefore need to recognise these as valid appropriate reactions and emotions as it is your business and livelihood to which you are committed, but you also need to prevent these feelings from overwhelming you and preventing you from taking action, and you have to preserve your own mental health.

When it comes to rescuing your business you are the most important factor, so if you are feeling depressed or stressed, you should see your doctor and get professional help and support to help you get through this period.

Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and you should always seek appropriate professional advice on your own particular circumstances before taking any action.