When a company enters into an insolvency procedure there is a ripple effect, suppliers can be owed money causing them cash flow issues, which in turn effects their ability to pay their suppliers and so on down the chain. Likewise those who have paid for goods or services may not receive them. The effect on cashflow together with other financial challenges can cause frustration and much worse.
One common question that clients ask us when they are affected by a company’s insolvency is “But how come the director isn’t having to pay.” The first point that has to be made is that a limited company gives its shareholders limited liability, in that their liability is limited to the amount paid for their share.
However, a director may have the potential to be personally liable to repay sums to the company as they could face potential legal claims by the officeholder overseeing the insolvency procedure. The appointed officeholder will conduct investigations and these usually include looking at the conduct of the directors and their decisions in relation to the management of the company as well as the transactions entered into by the company in the lead up to its insolvency.
Director’s duties
Company directors have specific duties outlined in the Companies Act 2006, these include to promote the success of the company and to act within their powers. However, when a company is in financial difficulty, the duties of company directors shift to taking steps to safeguard the interests of its creditors.
In certain circumstances, where wrongdoing has been established, the Court can order directors to make a contribution personally to a company’s assets.
Actions that an officeholder may take against a director include:
Wrongful Trading
The offence of wrongful trading arises under the Insolvency Act 1986 when a director allows a company to continue trading when there is no reasonable prospect that it will avoid going into an insolvent Liquidation or an insolvent Administration. If proven the director can be ordered to make a contribution to the company’s assets.
The claim is made by a Liquidator or Administrator to the Court against a director (whether de facto or a shadow director) of a company where it has gone into an insolvent Liquidation or an insolvent Administration. The Court must be satisfied that the director at some time before the commencement of the winding up or administration of the company, knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into such insolvent Liquidation or insolvent Administration. This is a high evidential test.
In reaching its decision the Court will judge the director by whichever is the higher standard of (1) the general knowledge, skill and experience that the director actually has, and (2) the general knowledge, skill and experience which would be reasonably expected of someone in the director’s position.
A director would have a defence if they took every step with a view to minimising the potential loss to the company’s creditors as the director ought to have taken.
Fraudulent Trading
The offence of Fraudulent Trading arises under the Insolvency Act 1986 if the Court find that any business of the company has been carried on with the intent to defraud creditors, or for any other fraudulent purpose. The application is made by a Liquidator or an Administrator, and if proven they can request an Order from the Court that the director who was knowingly party to the fraudulent business make a contribution to the company’s assets.
The evidential test to prove Fraudulent Trading is even higher than that required for Wrongful Trading.
Fraudulent trading is also a criminal offence under the Companies Act 2006.
Trading Misfeasance
This concept is new and was recently introduced by the Court in the case brought against the former directors of the British Home Stores Group of companies. In the judgment that ran to 533 pages the Court found directors can have personal liability to pay monies into the company insolvency where there was trading in breach of their directors’ duties when the company should have gone into administration or an insolvent liquidation at an earlier time if the director’s duties had been complied with.
Trading misfeasance has an overlap with wrongful trading, but the risk of trading misfeasance arises much earlier. Also without the requirement that the directors knew, or ought to have known, that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration the evidential test can regarded as lower than required for wrongful trading. If proven the Court can order the director to make a contribution to the company in respect of the losses caused.
Misfeasance or breach of fiduciary duty
Section 212 of the Insolvency Act 1986 provides a Liquidator with a summary remedy against a director if the Court find that they have misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any other fiduciary or other duty. The Court may order a director to repay the money or property with interest or contribute such sum to the company’s assets by way of compensation as the Court thinks just.
Transactions at an undervalue
The Insolvency Act 1986 allows both a Liquidator and an Administrator to apply to Court to have a transaction set aside as a transaction at an undervalue. A transaction may be a transaction at an undervalue where a company has transferred assets for significantly less than their market value, subject to certain criteria being met. The company will have to have been insolvent or become insolvent as a result of the transaction, as well as the transaction taking place within certain time periods. If proven to the satisfaction of the Court, the Court can set aside the transaction.
Certain exceptions exist, as do defences but the Court has the power to order a director to refund property or proceeds of sale received by the director to the company. Where a transaction at an undervalue takes place the director may also have a personal liability by way of misfeasance.
Preferences
The Insolvency Act 1986 allows both a Liquidator and an Administrator to apply to Court to have a transaction set aside as a preference.
A preference is where payments are made, or assets transferred to a creditor of the company in preference to another. The rationale being that all unsecured creditors of the company should be treated the same.
Certain criteria have to be met, such as a desire to prefer (which can be presumed in certain cases), but if the Court finds that a company has made a preference, the transaction may be set aside. A director who benefits from a preference may be ordered to refund proceeds received back to the company. The Court can set aside the preference if it was given in a period up to two years before the company became insolvent.
As with a transaction at an undervalue a director of a company who gave a preference can also be pursued personally to make good the loss to the company by way of a misfeasance claim.
Cognitive Law have specialists who can give advice on matters relating to director’s liabilities, should you wish to discuss any issues arising from the above please contact me on darren.stone@cognitivelaw.co.uk
The above is not intended to be regarded as advice or to be a comprehensive guide to the claims referred to, if faced with such claims advice should be sought.