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Considerations for Directors of Companies facing financial difficulty

Directors facing personal liability for the debts of a company

An advantage of business being traded through a limited company is the protection afforded to Directors by the ‘corporate veil’ – precluding personal liability for debts incurred by the company (except where the Director has provided a personal guarantee). However, the corporate veil is not a complete defence. If a Director has not discharged their duties to the company and is therefore considered personally liable, the veil will be lifted.

Directors’ duties

In law, all company Directors owe duties to their company. These include administrative obligations to keep the statutory books up-to-date and to maintain the records held at Companies House. This is in addition to duties to remain appraised of the company’s financial affairs, to act within the powers granted to them (by the articles of association of the company or an agreement), to promote the success of the company and to exercise reasonable care, skill and diligence.

Generally, and in the absence of any internal checks, the assessment of whether a Director has discharged his duties to a company is made once the company is placed into formal insolvency proceedings (administration or liquidation). The Insolvency Practitioner (appointed to manage the affairs of the company on its insolvency) will investigate, and report on the conduct of each Director.

The standard required of Directors in discharging their duties is: to exercise the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience expected when carrying out the functions of that Director and the general knowledge, skill and experience that the Director actually has.

In applying the test, consideration will be given to the particular role performed by the Director, as well as their responsibilities and the company’s circumstances. If a Director is considered not to have met the minimum standard expected of them, he or she may face claims for ‘misfeasance’, ‘wrongful’ and/or ‘fraudulent trading’.

Misfeasance, wrongful trading and fraudulent trading

The definition of misfeasance is “a transgression, especially the wrongful exercise of lawful authority”. Put simply, if a Director acts in a way that breaches his or her duties, they may face a claim by the Insolvency Practitioner for misfeasance, wrongful trading or fraudulent trading.

A claim for wrongful trading will arise where a Director continues to trade when he or she knew, or ought to have known, there was no reasonable prospect of the company avoiding insolvent liquidation. Where a Director knowingly continues to carry on business with the intention of defrauding creditors, the Director(s) may face the more serious claim of fraudulent trading.

The aim of the Insolvency Practitioner in advancing these claims is to raise money, or secure the return of assets, to increase a dividend to creditors. In the case of wrongful or fraudulent trading claims, the aim is to recover the loss caused during the period of prolonged trade. That loss is the increased value in creditors from the date (identified by the Insolvency Practitioner) that the Director knew, or ought to have known, there was no reasonable prospect of the company avoiding insolvent liquidation, to when the company was placed into a formal insolvency procedure.

Company Directors Disqualification Act 1986

Where matters of misconduct are identified, the Director may also face a claim by the Secretary of State to disqualify them from acting as a Director pursuant to the Company Directors Disqualification Act 1986 (“the CDDA”). That disqualification can then form the basis of a ‘compensation order’, which requires a Director to make payment to the creditor or class of creditors involved.

The amount of compensation will be assessed by considering matters such as:

  • the loss suffered by the creditor(s);
  • whether the creditor(s) in question already received any form of payment from the insolvent company or individual Directors; and
  • the specific circumstances surrounding the Director’s disqualification, such as whether they tried to avoid responsibility at any stage, whether the Director co-operated with the Insolvency Practitioner/investigating authorities, and the Director’s attitude towards the company’s creditors.

How to avoid claims for misfeasance, wrongful trading and disqualification

These claims aim to deter Directors from engaging in matters of misconduct and to reinforce the need for all Directors to adhere to legal requirements when operating a UK company with the benefit of limited liability. The claims encourage Directors to act in the way they consider most likely to promote the success of the company while balancing the commercial risk-taking needed to procure a profitable return.

Not every company failure will result in claims being made against the Director. A Director will not be held liable for a mere error of judgment and Directors will likely avoid any liability if they acted honestly and reasonably. An all too common complaint against Directors is that they fail to keep or produce accounting records, as this alone stands as evidence of imprudent management.

Prudent Directors therefore:

  • understand their duties to the company and its creditors, and properly consider and discharge those duties;
  • read and consider contract terms before signing them. In some cases they may include personal guarantees within them;
  • ensure regular and effective management meetings are held to review and consider the financial performance of the company;
  • prepare, maintain and retain appropriate records for the company, including the financial and other information considered, and decisions made during management and board meetings;
  • acknowledge and consider events which may impact the financial performance and solvency of the company, and cashflow cycles;
  • where company solvency becomes a concern, take and act on professional insolvency advice; and
  • consider obtaining adequate Directors’ and officers’ liability insurance, which can prove a valuable tool in defending or settling claims.

If your company is facing financial difficulties, our specialist Insolvency Team can advise you on your options. This could include the actions you should and should not take, such as: avoiding extending further and/or obtaining new credit; preferring a creditor over another; and disposing of assets at an undervalue.

Defending claims for misfeasance, wrongful trading and disqualification

Inevitably these claims arise only after the Insolvency Practitioner has investigated the affairs of the company. As part of that process, as the Director (or former, shadow, etc. Director) of the company, you will be invited to respond to enquiries presented by the Insolvency Practitioner. Failure to respond to reasonable requests should be avoided, and it is prudent to obtain advice prior to responding to the office holder to ensure your interests are best served. We can assist you in responding to enquiries, and advise you on the likelihood of a claim arising.

If you face a claim, we can advise you on the risks involved and your defence. We will also work with you to defend or settle the claim, as appropriate.

A substantial part of our work relates to advising Insolvency Practitioners on these claims, so we understand the situation from all perspectives. We can work with you not only in dealing with the situation at hand, but also in planning for the future. Please contact a member of the Insolvency Disputes Team for further assistance.

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