The time when an economy starts to pick up is often the time of greatest risk for many businesses. Increased trading places can put pressure on cash flow, coupled with the rise in interest rates that now seem inevitable. Directors need to be aware of their exposure for personal liability should the company fail and enter into liquidation.
The key issues to remember is that when a company enters into an insolvency process, the conduct of the directors leading up to the company’s failure can be challenged. Many people are aware of the issues of wrongful or fraudulent trading, but fewer know of the general duty that directors have towards creditors which arise only at the point when a company’s position becomes financially precarious.
When a company is solvent and has no financial concerns, the duties that are owned by the company to its creditors are fairly limited. But when a company is insolvent, or is verging on insolvency, there is a shift in the director’s duties, and additional ones arise. The director’s primary duties move from the company’s shareholders to its creditors. From this point onwards, every step that a director takes (or does not take) should be taken in the best interests of the company’s creditors. Failure to act in creditors’ best interests can amount to a breach of the director’s duties and lead to personal claims being brought against directors under the general heading of misfeasance. Such claims are not uncommon.
For such claim to arise, the directors will generally have acted without thought for the creditors’ position in the final trading period of the company. They may have acted so as to protect or enhance their own position. They may have turned a blind eye to things which should have prudently been done. They may have done things they would not have done had the company not been about to fail.
Risk exists for any person who has taken part in the promotion, formation or management of the company. This includes, for instance, the situation where the director of a family-owned business makes his teenage son or daughter a director and they simply do as they are told by their parent, signing papers but perhaps not ever getting involved in the business itself. A court can order a person to repay money or return property (together with interest) or make a payment of compensation in an amount.
A director caught by these provisions can try to use a defence of “honest and reasonable conduct”, which can apply if the court feels that they ought to be excused from liability taking into account “all the circumstances of the case”. That is perhaps a little too vague to be of comfort to many, and the message must be to have a close eye on the financial position of the company at all times, and if in doubt as to how to handle financial pressures, seek early professional guidance rather than risk soldiering on into the quagmire of personal liability.
