Directors’ duties in the face of financial difficulties
When a company is at risk of insolvency, the directors’ duties will involve having to make a number of difficult decisions, for example: (i) which creditors to pay; (ii) whether to accept deposits and how to treat them; (iii) whether to honour contractual agreements; (iv) redundancy decisions and so on. Directors must avoid continuing to trade if they know or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation.
Upon formal insolvency, the insolvency practitioner appointed over the company is required to review the directors’ conduct, particularly in the period leading up to insolvency. A director who is found to have breached his duties to the company or its creditors (including by failing to act) may be held personally liable for any loss caused to the company and/or its creditors as a result. Dependent upon the severity of the misconduct, they may be disqualified from acting as a director in the future.
To reduce the risk of personal liability directors should, at minimum, keep the following points firmly in mind:
- Ignore evidence of insolvency e.g. breach of suppliers’ credit terms;
- Accept orders and take deposits if the company will not be able to fulfil those orders;
- Take further credit if the company will be unable to make payment;
- Promise payments which cannot be honoured or pay certain creditors in preference to others (creditors should be treated equally);
- Give creditors the impression that you have your “head in the sand” and that there is no strategy to deal with the difficulties.
- Take professional advice from an insolvency practitioner and/or solicitors immediately that signs of financial difficulties first arise;
- Hold regular (daily/weekly) management and board meetings to review the financial position of the company, the viability of continued trading and the benefit to creditors of doing so and minute all material decisions taken and the reason for those decisions;
- Ensure that you have an ongoing understanding of the company’s financial situation, its assets and liabilities;
- Retain control by maintaining lines of communication with all creditors and stakeholders reducing the likelihood of them taking action against the company.
Contemporaneous evidence of the rationale behind the directors’ decisions will be a key factor in demonstrating that they have acted appropriately thereby reducing the risk of personal liability.
It is therefore critical for directors to monitor the situation closely to enable them to recognise the warning signs and to seek independent professional advice without delay thereby enhancing the range of options available.
John Bradshaw is a partner and head of the Business Services department at Barker Gotelee Solicitors.
(This article previously appeared in EADT on 19th July 2017)