Barry Niven of Clifton Ingram LLP’s Corporate Recovery and Insolvency Team explains the nature of director’s duties and their potential liabilities when their company is facing insolvency.
When a company is experiencing financial difficulties its directors face a difficult balancing act of managing the company’s business and stakeholder expectations whilst also considering their own personal liabilities.
If a company is insolvent or on the verge of insolvency it is essential that directors are aware of the duties they owe to creditors as in certain circumstances the directors can be personally liable if the company goes into insolvent liquidation and they have failed to carry out their duties with the appropriate level of skill and care. Directors should ensure that they know what their duties are and that they act correctly to minimise any such risk.
When a company is solvent the duties of the directors are to act in the best interests of the company and its shareholders. Where a company is insolvent or facing insolvency the directors’ duties switch to ensure that the company acts in the best interests of its creditors whose interests must be put before those of the shareholders.
Directors can be personally liable for wrongful trading if, during the period they are a director, the company continues to trade when the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. If found guilty of wrongful trading a director can be ordered by the court to pay to the company an amount equal to the losses it has suffered as a result of the continued trading.
Liability for wrongful trading can be avoided if the director can show that, he took every step that he ought to have taken with a view to minimising the potential loss to the company’s creditors.
Directors must seek professional advice at the earliest opportunity if they believe that the company may be getting into financial difficulty. Timing is crucial as the directors will be judged on when they knew or ought to have known that there was no longer a reasonable prospect of avoiding an insolvent liquidation. They will also be judged on the actions they take or ought to have taken to minimise the loss to the company’s creditors.
To protect themselves the directors should:
- Take professional advice and ensure that such advice is both documented and followed.
- Ensure that the most accurate and up to date financial information on the company’s affairs is available so that the directors can evaluate the trading and financial position of the company and the viability of its business;
- Hold regular board meetings and keep detailed minutes of the strategy being followed by the board and the steps they are taking to minimise potential losses to creditors.
- Keep in regular contact with the company’s bankers to ensure that facilities are sufficient to meet the company’s cash flow requirements and inform major creditors of the financial condition of the company and where appropriate seek their support for the continued operation of the company.
Directors of companies experiencing financial difficulty often ignore or take too long to see the warning signs. Taking professional advice at the earliest opportunity not only protects the directors from potential personal liability, it also increases the options available for the rescue or turnaround of the company.
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