Directors have multiple duties in company insolvency. When the company is in the black, directors serve the shareholders. When it faces insolvency, they serve creditors.
Duty to Minimise Creditor’s Losses
A company becomes insolvent when it cannot pay off its debts. At this point, directors must minimise the creditors’ losses and avoid actions that increase debt.
‘Director’ is widely defined, and these rules also apply to a ‘de facto’ director (one who acts as a director before their appointment) or a ‘shadow’ director (a person who provides instructions for the legally appointed directors).
Their management approach must be proactive and show care towards the creditors. They may have to initiate insolvency procedures if they cannot save the company.
Insolvency Act 1986
The Insolvency Act 1986 is the pivotal piece of UK legislation on debt and insolvency. It establishes all director’s duties in company insolvency and poor practices to avoid.
Wrongful Trading
As a company director, you have a duty of care to act in the Company's best interest. If a director continues to run the company – taking orders and supplies – when they knew (or ought to have known) that the company could not reasonably avoid becoming insolvent, they may be asked to contribute to the company’s assets.
A director can defend a wrongful trading accusation by showing they took every possible step to minimise the creditors’ losses.
If the Court finds ‘wrongful trading’, it will calculate the company’s deficit increase between when the director knew (or ought to have known) about impending insolvency and when the company went into liquidation. The director may be asked to pay an equivalent sum.
Fraudulent Trading
If the insolvency practitioner believes the business acted with the intent to defraud creditors, they can seek a Court declaration that the guilty director contributes to the company’s assets.
The difference between fraudulent and wrongful trading is that the directors have continued business with the deliberate intention of deceiving and defrauding creditors.
For example, directors could set up a company and take orders and deposits for products that did not exist.
A Court can order the director to make whatever contribution they think is appropriate.
A liable director will almost certainly be disqualified from acting as a company director again.
Reviewable Transactions
This issue is a common area of director default in insolvency – commercial pressure may cause directors to treat third parties preferentially or transact with them at an undervalue.
‘Reviewable transactions’ may be generated by:
- Granting security to a previously unsecured supplier
- Paying some unsecured creditors while leaving others unpaid
- Making severance payments to directors or senior employees
- Getting the company to repay monies guaranteed by a director
- Making a gift
- Entering into a transaction with a false third party
In most cases, the insolvency practitioner will make an application to the Court that can order the director to pay sums back to the company. Investors in the company can also make this application.
Unlawful Distributions
A director who authorises dividends exceeding the company’s distributable profits is probably in breach of their statutory common law duties and personally liable to repay. It is covered under the term ‘Misfeasance’: any improper application or retention of company property.
To prove that these distributions were unlawful, the director must have known or ought to have known, as a reasonably competent director, that the company did not have sufficient profits to pay them.
If a company becomes insolvent, the insolvency practitioner will always analyse the paid dividends and judge whether they were unlawful at the time.
Insolvency Consequences for Directors
Failing to fulfil directors’ duties in company insolvency risks Court charges and several costly consequences. Directors at fault face:
A Directors’ Conduct Report
An insolvency practitioner must submit a directors’ conduct report if they believe directors did not fulfil their duties during insolvency proceedings. They have a three-month deadline to do so. Then, the Insolvency Service may investigate the conduct and subsequently bring forth legal proceedings.
Directors Disqualification
Breaching directors face disqualification orders that prohibit them from acting as a director for any company or forming, managing or marketing a new company for up to 15 years. Both the Courts and the Insolvency Service can issue them.
It also harms their reputation and future employment or investment opportunities.
Personal Liability
If the directors’ actions increased the company’s debts, they may be personally liable for the damages. This liability risks their property, including assets like homes, cars, investments and savings.
Get Insolvency Legal Support
Contact our team today for legal support to help your company through insolvency or director liability claims. We will arrange a free consultation.
FAQ
Can a director be personally liable for company insolvency?
Yes. If an insolvency practitioner finds that the director’s actions increased creditors’ losses, they can be liable for insolvency and ordered to contribute to the company’s assets.
They may not be liable if they acted on professional advice.
What duties does the Insolvency Act 1986 give company directors?
The Insolvency Act 1986 requires that company directors act in the interest of creditors to reduce their losses.
How can I promote the company’s success and minimise creditors’ losses during insolvency?
The creditor’s interests are paramount in insolvency proceedings, so you should focus on minimising their losses. Avoid any actions that could increase company debt.
What are the potential consequences of breaching the director’s duties during insolvency?
Directors at fault could face a report on their conduct, personal liability and director disqualification.
How can I combat insolvency?
Seeking professional advice is the best option when combatting insolvency.
Featured image: Pexels Licence - Pixabay
