Directors' duties: company in trouble

Introduction

This article addresses the personal liability and risks associated with fiduciary duties and wrongful trading because these are the key areas of responsibility and risk that need to be understood. We will then look at some practical tips on managing the risk and then deal with some related issues.

Fiduciary Duties

Directors must act with “utmost good faith” in what they reasonably consider to be the best interests of the company. They must act honestly, diligently and for a proper purpose and not allow their personal interests to conflict. They also owe a duty of skill and care.

Wrongful Trading

The law here can be simply put: it applies if a Director allows a company to continue trading and taking credit from suppliers when no-one could reasonably have thought the company could avoid insolvent liquidation. If a Director does so he can be made personally liable for those additional liabilities. In practical terms this means:

• Taking independent professional advice as soon as possible;
• Ensuring there is up-to-date financial information; in addition to normal monthly management accounts and cash flow projections, a weekly cash flow may be advisable;
• Being careful not to take goods or services on credit if the financial position of the company is very uncertain;
• Ensuring that the basis for any decision to continue trading is carefully documented and minted by the Board;
• Considering the possible use of one of the insolvency procedures described in section D above.

If a company goes into one of these insolvency procedures its Directors will be asked to fill in a detailed form. This will seek to establish what financial information the Board had to hand and on what basis they acted as they did. Documenting decisions formally will help Directors to answer the questions in this form and avoid disqualification proceedings (see below).

Disqualification

The DTI has power to bring proceedings to disqualify a person from acting as a Director. Breach of fiduciary duty or allowing a company to trade wrongfully can lead to disqualification.

Allowing a company to trade wrongfully would be grounds for such proceedings as would other unlawful actions (see below).

Preferences

Where a company is in financial difficulties, Directors should not deal more favourably (or prefer) one creditor or group of creditors. Again, the Directors should take and act on professional advice.

At first sight paying employee salaries when other suppliers are not being paid may seem wrong. However, the key issue will be why the payment is being made; if it is made, not with the intention of preferring the employees, but because the future viability of the business depends on employee support and confidence, then payment can almost certainly be made provided the Board reasonably believes the company can survive.

Self-Dealing by Directors

Sometimes Directors may choose to buy assets from a company in financial difficulty in order to provide cash injection.

Care should be taken before doing this. First, the transaction should be on arms' length terms and if not could be set aside on the basis of a transaction at an undervalue if the company goes into insolvent liquidation. Secondly, it is likely that formal shareholder approval will be needed; failure to obtain that approval will again leave the transaction vulnerable to be set aside by a liquidator.

Phoenix Companies

Suppose a company fails, can the Directors simply start trading again using a company with the same or a similar name?

The answer is that if a company has gone into insolvent liquidation a Director will commit a criminal offence if his new company uses the same or a similar name for the next 5 years. There are exceptions to this prohibition; in particular if substantially all of a company's assets have been bought from an administrator or liquidation and creditors have been circularised so they are aware of the Director's connection with the failed business.

False Accounting

The onset of financial difficulties may be a temptation to present the financial position of a company more favourably than should be the case (e.g. by over-valuing stock or recognising income too early). Great care must be taken that window dressing does not become false accounting. This is a criminal offence.

Fraudulent Trading

Those who allow a company to trade dishonestly with an intent to defraud creditors, will commit the criminal offence of fraudulent trading.

Resignation

A Director who is not happy with the way in which a company is being run may need to consider resigning his Directorship. Care must be taken, however.

In circumstances where the key Director or Directors resign without having first initiated one of the insolvency procedures described in section D, they may have failed to meet their obligations as Directors.

Conclusion

For a businessman who has put his heart and soul into a venture, the poor financial performance of that business will be a very stressful experience. The insolvency of such a business is sometimes likened to bereavement.

The co-Directors' family and the friends of such a businessman should recognise these intensely personal issues in offering their help and support.