Directors' Duties and The Threat of Insolvency

With the UK economy facing an uncertain path on account of domestic and global upheaval, businesses continue to face challenges, and it is essential for directors to be mindful of their duties both generally and more particularly where there is the risk of insolvency.  The Insolvency Service has issued refresher guidance on the Government website (Director information hub: Director duties upon insolvency - GOV.UK (www.gov.uk)) to highlight risk areas for directors.

Directors are responsible for the day-to-day management of companies and need to ensure they comply with duties imposed on them. Many of the duties owed by directors are set out in the Companies Act 2006, with further statutory duties arising from other laws and regulations. Otherwise, non-statutory duties must be observed, such as duties of confidentiality, fiduciary duties and other duties that have evolved through case law. 

A key duty owed by directors is to promote the success of the company for the benefit of its shareholders; however, where a company faces financial difficulty, the focus shifts so that directors owe a duty to the company’s creditors to ensure that their losses do not increase. At that point, directors are obliged to treat all creditors equally without prioritising some over others, and ensure that the company’s assets and their value are protected. This presents a challenge for directors, as the desire to continue a business that directors view as viable may conflict with the economic reality of a situation, and there is often no clear-cut answer as to whether or how a company should continue to trade.

Ordinarily, a director will not be personally liable for the debts of a company, but where a company has been mismanaged and becomes unable to settle its debts, personal liability can arise. 

Where a company continues to trade after there is no reasonable prospect of the company avoiding liquidation, the directors are at risk of being liable for wrongful trading, and a court could order that directors responsible for this are held personally responsible for the company’s debts. 

More serious is where directors continue to manage an insolvent company with the intention of defrauding creditors - fraudulent trading - a court can order that directors reimburse the company to redress what has gone wrong. Fraudulent trading is also a criminal offence.

Additionally, where directors breach their duties and exceed their authority, they may personally be liable for misfeasance, and an order might be made for misused funds to be repaid.

In any of these circumstances, and where a liquidator might report on the acts of directors in the lead up to insolvency, directors are at risk of being disqualified from acting as directors for a period.

Following new legislation in 2015, the Insolvency Service has been able to apply to court on behalf of the Secretary of State for Business and Trade for a compensation order within two years of a disqualification so that losses to creditors of insolvent companies can be made good. It is also possible for compensation undertakings to be agreed with the Insolvency Service, where a director agrees to pay compensation but without being subject to a court order.

So, given the outcomes identified above, what should responsible directors do to protect themselves against the potential pitfalls of insolvency?

• It is vital that directors manage the company’s affairs responsibly, maintaining accurate and up to date records of transactions entered into and decisions made.
• Directors must remain mindful of their obligations and their duties to the company and to others.
• Where a board of directors does not agree on the path forward, it is important that any diverging views are taken into account and recorded in board minutes.
• Where asset values are to be considered – are assets to be dealt with at written down value or by reference to any form of valuation?
• Directors should always bear in mind whether conflicts of interest apply that might interfere with their ability to act independently or at all.
• Directors should consider whether they ought to remain appointed as a director in a given situation, while always ensuring that there are enough directors appointed to the board to enable the company to continue to operate in accordance with its constitution.
• Directors should take professional advice on their duties and the company’s position where appropriate, whether from accountants, insolvency practitioners or solicitors, particularly where there is a possibility of insolvency arising.

If you have any questions relating to this article or would like advice on your duties as a director, please contact the Corporate and Commercial team on 01689 887887.