If your company enters financial distress, as a director you need to be aware of your evolving legal obligations. In this blog, we’ll examine the duties imposed upon directors by the Insolvency Act 1986 and Companies Act 2006 and the potential consequences a director may face if they breach those duties.
Shifting duties from shareholders to creditors
As a director, under Section 172 of the Companies Act 2006, you’ll ordinarily have duty to promote the success of the company for the benefit of its shareholders. However, once insolvency is imminent, this duty shifts and you’ll need to act in the best interests of the company’s creditors to minimise potential losses
Wrongful trading (section 214 Insolvency Act 1986)
As a director, you may be held personally liable for wrongful trading if, at some point before the company enters insolvent liquidation, you knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation, and you failed to take appropriate action.
Wrongful trading does not require dishonesty. However, once the relevant point is reached, as director, you must take every step a reasonably diligent person would take to minimise potential losses to the company’s creditors. This may include seeking professional advice, closely monitoring cash flow, and avoiding actions that worsen the position of creditors.
If the court is satisfied that a director failed to meet this standard, it may order the director to make a personal contribution to the company’s assets, recoverable for the benefit of creditors.
Fraudulent trading (section 213 Insolvency Act 1986)
As a director, you may be held personally liable for fraudulent trading if, during the winding up of the company, it is shown that the business was carried on with intent to defraud creditors or for any fraudulent purpose.
Section 213 of the Insolvency Act 1986 provides a civil remedy, allowing the court to order directors or others involved to make a personal contribution to the company’s assets. Fraudulent trading may also constitute a criminal offence under section 993 of the Companies Act 2006, punishable by imprisonment and/or a fine.
Fraudulent trading requires actual dishonesty involving moral blame. Examples of fraudulent trading include:
- Raising funds with no intention to repay
- Using false information to secure loans or credit
- Falsifying financial records or creating fictitious transactions
- Concealing or dissipating company assets to mislead creditors
In determining liability, the court will focus on whether you, as director, acted dishonestly based on what you knew or believed at the time and whether your conduct would be regarded as dishonest by ordinary standards.
Misfeasance (section 212 Insolvency Act 1986)
As a director or former director, you may be held personally liable where, in the course of your company’s insolvency, you’re found to have committed misfeasance or breached your fiduciary or statutory duties.
Misfeasance includes situations where a director has misapplied, misappropriated or retained company money or property, or otherwise breached their duties to the company. Examples may include unauthorised use of company funds, improper payments to directors, or failure to account for company assets.
If a liquidator considers that misfeasance has occurred, they may bring a claim seeking an order that you, as a director, repay, restore or account for the relevant money or property, or contribute by way of compensation to the company’s assets. Any recovery is for the benefit of the insolvency estate as a whole, rather than individual creditors.
Transaction at an undervalue (section 238 Insolvency Act 1986)
A transaction at an undervalue occurs where a company, prior to entering insolvent liquidation or administration, makes a gift or enters into a transaction on terms that provide no consideration or consideration significantly less than the value of the assets or benefit transferred.
For a transaction to be challenged, the company must have been insolvent at the time of the transaction, or become insolvent as a result of it, and the transaction must have taken place within the relevant statutory period before insolvency.
If a court finds that a transaction at an undervalue has occurred, it may make an order restoring the company’s financial position to what it would have been had the transaction not been entered into. This can include reversing the transaction or requiring the recipient of the undervalue to repay money or return assets to the company.
Preference payments (section 239 Insolvency Act 1986)
A preference occurs where a company, prior to insolvency, makes a payment or enters into a transaction that has the effect of putting a creditor, guarantor or surety in a better position on insolvency than they would otherwise have been, and the company was influenced by a desire to prefer that person.
Preference claims commonly arise where payments are made to connected creditors, such as directors, shareholders, or businesses controlled by connected parties. In those circumstances, the law presumes that the company was influenced by a desire to prefer, unless the contrary is shown.
A liquidator may review transactions made within the relevant statutory period before insolvency (generally six months for unconnected creditors and two years for connected creditors). If a preference is established, the court may order that the position be restored as if the transaction had not taken place, including requiring the preferred creditor to repay the funds.
Investigations and enforcement
The Insolvency Service has powers to investigate the conduct of current and former directors, including shadow directors, in connection with insolvent companies where there is evidence of misconduct or breach of duty.
If misconduct is established, the consequences may include:
- Director disqualification for up to 15 years
- Compensation orders, requiring disqualified directors to contribute to creditor losses
- Criminal prosecution in serious cases involving fraud or other criminal offences
Conclusion
If you’re a director of a company, it’s important that you have a firm understanding of your duties in the event your company is at risk of insolvency or has already become insolvent. Failure to perform the duties required can result in personal financial liability and even a criminal conviction.
When facing insolvency, seeking early professional advice can help ensure you do all required of you throughout the process. If you need help with your own legal matter, contact Gorvins Solicitors today. Call us on 0161 930 5151, email us at enquiries@gorvins.com or fill in the online form.