Directors’ duties – On the company’s insolvency.

Directors owe specific duties when a company is insolvent, or is at risk of insolvency, and can incur personal liabilities. Therefore, and especially in the current uncertain and financially troubling times, it is important for directors to understand their duties and the risks associated with them.

This article focuses on the offences of fraudulent and wrongful trading and misfeasance.

What is fraudulent and wrongful trading and misfeasance?

Claims for fraudulent trading

This is a claim that the business of the company has been carried on with the intent to defraud creditors or for any fraudulent purpose. Such claims may be brought by the liquidator or administrator (in the course of the winding up or administration of the company) who can seek a court order that anyone who was knowingly party to the fraudulent trading make a contribution to the company’s assets.

It is important to note that:

  • all persons who were knowingly parties to the fraudulent trading are caught i.e. it is not only directors who may be liable for fraudulent trading;
  • the intent to defraud requires dishonesty;
  • the court may order the relevant persons to make such contribution as it thinks proper, although it cannot be a punitive amount; and
  • a declaration of fraudulent trading against a director can also lead to disqualification from holding office as a director in the future.

Claims for wrongful trading

Wrongful trading occurs if, in the course of an insolvent liquidation (winding up) or insolvent administration, a director knew or ought to have concluded at some point before the commencement of the liquidation or administration that there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration but nonetheless continued trading. In such circumstances the liquidator or administrator can seek a court order that the director make a contribution to the company’s assets.

It is important to note that:

  • only company directors (including de facto and shadow directors) can be liable for wrongful trading. Therefore, this is narrower then fraudulent trading;
  • liability only arises if it can be shown that the company is worse off as a result of the continuation of trading – i.e. the company must have suffered loss;
  • the court will not make an order if, knowing there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration, the director took every step a diligent person would have taken to minimise the potential loss to the company’s creditors. Such steps could include:
  • informing the creditors of the company’s financial position;
    • considering appropriate insolvency procedures;
    • consulting professional advisors; and
    • reviewing up-to date financial information regularly;
  • the question of whether the director knew or ought to have known that the company had a reasonable prospect of avoiding insolvency or administration can be difficult to resolve. The court will look at a number of factors such as the financial information available to the director and that which should have been available to him and the professional advice received by the director regarding the company’s position;
  • when determining whether a director is in default a subjective and objective test is used; and
  • like fraudulent trading, a declaration of wrongful trading against a director can also lead to their disqualification from holding office as a director.

What has previously constituted fraudulent or wrongful trading?

Previous case law has suggested that:

  • having the intention to prefer one creditor over another, in the knowledge (or with the reasonable suspicion) that the company would not have enough assets to pay its creditors in full is not enough to constitute fraudulent trading;
  • a person ordering goods when he knew there was no reasonable prospect of the supplier being paid could be found to have the requisite intent to defraud.

Typically, wrongful trading claims involve situations where directors are deemed to have closed their eyes to the reality of the company’s position, and carried on trading long after it should have been obvious to them that the company was insolvent and that there was no way out for it. For example, in a recent case the directors of a company were found guilty of wrongful trading because the court found that they were simply hoping ‘something would come up’ and did not take any active steps to protect creditors.

Claims for misfeasance

The concept of misfeasance is broad and encompasses:

  • the misapplication or retention of money or other property of the company;
  • becoming accountable for money or other property of the company;
  • breaching a fiduciary or other duty in relation to the company; and
  • otherwise being “guilty of misfeasance”.

If such a claim for misfeasance is successful, the court may order the director (or other relevant person) to repay, restore or account for the money or property with interest, or contribute such sum to the company’s assets as it thinks fit.

It is important to note that:

  • a claim may be brought against an officer or former officer of the company or a person who is concerned with, or has previously taken part in or been concerned with, the promotion, formation or management of the company. A person is an “officer” of a company if he has acted as a director, company secretary or a manager of the company;
  • the company must have suffered loss as a result of the director’s (or other person’s) actions;
  • misfeasance does not cover contractual claims;
  • a claim for misfeasance cannot be brought if the company has been dissolved; and
  • unlike fraudulent and wrongful trading, the statutory relief from liability can be applied in appropriate cases.

What has previously constituted misfeasance?

Previous case law has suggested that:

  • making gifts of the company’s property for no proper trading purpose could constitute misfeasance;
  • if a director receives a secret commission from the company which he should not have but before the company goes into liquidation he pays the money back then there would no longer be a case of misfeasance.

The Corporate Insolvency and Governance Act 2020 (the “Act”)

The Act came into force on 26 June 2020 to try to alleviate the burden on businesses during the Covid-19 pandemic.

The Act has, among other things, amended/relaxed the wrongful trading provisions (with retrospective effect from 1 March 2020) until 30 September 2020. The amendments are aimed at providing directors with some breathing space so that that can continue to trade through the financial difficulties caused by the Covid-19 pandemic.

Although directors will still owe a duty to act in the best interests of the company’s creditors with a view to minimising potential losses, it will be assumed, for the purposes of wrongful trading, that the directors are not responsible for any worsening of the financial position of the company or its creditors during the relevant period.

It is important to remember that the Act merely imposes an assumption and does not suspend the wrongful trading provisions in their entirety. Furthermore, it is important to remember that the other directors’ duties and responsibilities (such as fraudulent trading) remain unaffected.

Mundays’ Top Tips

Where a company is faced with financial difficulties, directors are advised to tread carefully and to seek early advice to avoid potential personal liability. Our top tips include:

  • ensure you have up to date financial information and cashflow projections which are regularly updated;
  • hold regular board meetings and keep minutes to show that you are keeping the position under careful and regular review;
  • ensure you have a fair and reasoned approach when dealing with creditors. Do not favour connected parties over others;
  • consider the potential impact on creditors of all the decisions you take with regard to the management of the company’s affairs; and
  • seek external advice from your solicitors and/or insolvency practitioners at an early stage.

The contents of this article are intended as guidance for readers. It can be no substitute for specific advice. Consequently we cannot accept responsibility for this information, errors or matters affected by subsequent changes in the law, or the content of any website referred to in this article. © Mundays LLP.

Insights.

Hurry up and wait – will the new employment tribunal procedure rules address the case backlog?
24th September, 2020

Will new employment tribunal procedure rules to cure the backlog? The backlog waiting to be heard has increased every week since lockdown began.

Registering a Birth during Lockdown
9th September, 2020

If you are looking to register your recent addition to ensure they officially 'exist', the Government has relaxed the 42 day law.

Virtual Will signing #SolicitorChat with The Law Society
3rd September, 2020

With rules changing this month Michael Brierley discussed virtual Will signing with The Law Society and other firms for #SolicitorChat.

Back to the Office?
3rd September, 2020

Back to the office? A lot to consider for both Employers and Employees to ensure all scenarios are covered.