Directors’ duties in troubled times – updated 2 April 2020

When a company is solvent and business is good, the company and its directors owe fairly limited duties to creditors (save, of course, for contractual obligations).  Directors must act in the best interests of the company at all times and must promote the success of the company for the benefit of its members as a whole.

When a crisis event occurs, a director’s main priority will be to try to ensure the survival of the business and this will usually be in line with the company’s and its members’ best interests.  However, amongst the numerous other matters a director will have to think about, it is important to remember that, if the company is insolvent or is verging on insolvency, there is a shift in the director’s legal duties to protect the interests of creditors.

Company directors will have been relieved to hear the Government’s recent announcement that wrongful trading laws will be suspended with effect from 1 March 2020.  Those laws impose personal liability on directors if (a) they knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration; and (b) they did not take every step with a view to minimising the potential loss to the company’s creditors.  The reason for the suspension is to prevent the unnecessary liquidation of companies suffering temporary cashflow problems as a result of the coronavirus crisis: with one of the tests for insolvency being the inability of a company to pay its debts as they fall due, a sudden drop in trade caused by recent events would be enough to make many cautious directors liquidate the company to avoid any personal risk.

However, the Business Secretary cautioned that the other checks that ensure directors fulfil their duties will remain in force and, until legislation to suspend the wrongful trading provisions is drafted, we cannot be sure how far it will go.  Directors are not completely off the hook and should still act with integrity.

In particular, the laws which impose personal liability on directors of companies who are guilty of misfeasance (the director misapplies, retains or becomes accountable for any money or other property of the company, or is guilty of any misfeasance or breach of any fiduciary or Companies Act duty in relation to the company) or fraudulent trading (the director carries on the business of the company with the intent to defraud the company’s creditors, defraud the creditors of any other person, or for any fraudulent purpose) do not appear to be affected by the emergency legislation.

It also appears that, in the event of insolvency, Courts will retain the power to set aside transactions entered into by the company at an undervalue (when the company has disposed of an asset for no value, or at a significant undervalue) or in preference (when the company does something which puts a creditor in a better position than he would have otherwise been in, and the company was influenced by a desire to prefer that creditor over other creditors).

Practical steps

The best course of action if a company is teetering on the brink of insolvency will depend on the company’s position.  Usually, the directors should try to maintain the company and its business as a going concern.  If that is not possible, they should seek to realise the best value they can for the business and assets.

With few exceptions, a director should not resign from a company in financial difficulties until those difficulties are resolved or the company enters formal insolvency proceedings.  On disqualification proceedings the court will often view a resignation when the company is in financial difficulties as compounding any impropriety.

Close monitoring of the company’s financial position is key and the directors would be prudent to do the following:

• instruct the company’s accountants to report on the current position and ensure management accounts and financial projections are prepared as often as needed, to determine whether insolvency can be avoided;
• take legal advice on their responsibilities and on any proposed transactions, bearing in mind that the interests of the directors and the company may conflict and where necessary seeking their own legal advice from a law firm other than the company’s solicitors;
• consult an insolvency practitioner to review recovery options;
• enforce effective credit control (both outgoing cash and receivables collection);
• hold regular board meetings and keep detailed minutes of those and of other meetings such as with lawyers and insolvency experts;
• consider the company’s financial position before incurring further liabilities, repaying loans from directors or agreeing severance terms for departing executives;
• inform the company’s bankers and other major creditors at an early stage and keep them regularly updated (their support will be crucial);
• follow the legal requirements concerning the treatment of employees in an insolvency situation; and
• if it is unavoidable, take steps to commence insolvency proceedings in a timely fashion.

In conclusion, the law imposes significant obligations on directors and these can be intimidating, particularly in troubled times.  The current crisis will bring changing legislation in this area and now more than ever directors should take early legal advice to be sure of their duties and obligations.  If directors keep themselves informed and act responsibly, there is no reason why they should incur personal liability if the worst happens.

Readers may also be interested in our latest EG Property Podcast, “Duties, penalties and best practice –top tips for company directors”. Please click here to listen.