Potential traps for the unwary director

When a company enters an insolvency process, the appointed Insolvency Practitioner (IP) has a statutory duty to investigate the affairs of the company, the reasons for its failure and the conduct of its officers with a view to determining whether, pursuant to the provisions of the Insolvency Act 1986 (IA86), any pre-insolvency transactions can be challenged (i.e. set aside) for the benefit of creditors.  If claims are identified, the IP has the power to bring proceedings against directors (including shadow directors).  In addition, the IP will report their findings to the Insolvency Service (IS) which may result in the Secretary of State bringing directors’ disqualification proceedings, civil penalties being imposed or, at worst, criminal prosecution.

The most common claims brought by IPs against directors and/or third parties are:

  • Transactions at an undervalue (Section 238 IA86) – when, subject to certain other criteria and within a defined period, a company makes a payment or gift, or otherwise enters into a transaction with a third party, on terms where the company receives either inadequate or no consideration.
  • Preference (section 239 IA86) – when, subject to certain other criteria and within a defined period, a company does anything or allows anything to be done that has the effect of putting a particular creditor, surety or guarantor into a better position (in the event of the company going into insolvent liquidation) than they would otherwise have been in had that thing not been done.
  • Breach of duty and/or Misfeasance (section 212 IA86) – where a director has misapplied, retained, or become accountable for any money or property of the company, or been guilty of any misfeasance or breach of duty (e.g. the misuse of government back Covid-support), the court can order the director to repay, restore or account for the money or property with interest, or to pay compensation to the company.

Other less common claims include:

  • Wrongful trading (section 214 IA86) – where the directors ought to have concluded that the company could not avoid insolvent liquidation and placed the company into liquidation but instead continued to trade and the company’s position worsened during that period.
  • Fraudulent trading (section 213 IA86) – where it appears that any business of the company has been carried on with the intent to defraud creditors or any other person or for any fraudulent purpose, the Court may declare that any persons who were knowingly parties to the fraudulent trading are liable to make such contributions to the company’s assets as the Court thinks proper.

Directors should therefore be mindful of the provisions of IA86 when they are dealing with the company’s affairs, particularly in circumstances where the company is facing financial difficulties.  The reasons underpinning all significant transactions should be clearly and contemporaneously documented so as to reduce the likelihood of challenge by a future office-holder and the risk of any such challenge succeeding.

Sarah Mower is a chartered legal executive and specialist in Insolvency & Business Recovery at Barker Gotelee Solicitors.

For more information on our range of legal services, please call the team on 01473 611211 or email bg@barkergotelee.co.uk