Shoosmiths

Beyond reproach: examining director behaviour in face of insolvency

Question

What are the duties of, and risks for, company directors in the case of insolvency?

Answer

Following the headline hitting liquidation of Carillion in late 2017, a parliamentary joint business and pensions select committee launched an enquiry into the financial collapse of the construction giant which looked very closely at the conduct of the company’s directors in the lead-up to the appointment of liquidators. This is not the first time directors’ conduct has been high on the national agenda following the financial collapse of a high-profile company, but what are the duties of a director when a company faces insolvency and what risks might they face?

How do directors’ duties change?

In usual profitable trading circumstances the duties of a director are to the shareholders of that company. However, at the point that the company may be approaching insolvency or insolvent, a director has a duty to minimise the potential loss to any creditors of the company (which may include lenders, landlords and employees), which will supersede any other directors’ duties.

Wrongful trading

Under the Insolvency Act 1986 when a company becomes insolvent or is at risk of insolvency a director must take every step to minimise the potential loss to the company’s creditors to avoid the risk of a claim against them for wrongful trading.

Wrongful trading is one of the most common allegations faced by the directors of a company which has become insolvent. When the director(s) of a company knew, or ought to have known, that their company was heading towards insolvency, they should cease trading. A director who continues to trade in the knowledge that the company is likely to face insolvent administration or liquidation leaves themselves open to a claim of wrongful trading, if the company is in a worse financial position as a result of continuing to trade.   

Reviewable transactions

It may be tempting for a director to restructure securities or cash-in company assets prior to entering an insolvency process. In the months before the liquidation of BHS in 2016, Philip Green sold various commercial properties owned by the company to friends and family members in the industry. This is not necessarily a problem in itself, as long as the action does not put the company in a worse financial position than it would have been without taking such action. One such property, sold by BHS to Green’s step-son for £6.9 million, was resold just three months later for £3 million profit. At this point, it is reasonable to question whether this sale amounted to a transaction at an undervalue, thus depriving the appointed liquidator of a valuable asset which could have otherwise been realised for a higher sum for the benefit of the company’s creditors.

Other reviewable transactions which may be challenged by any insolvency practitioner include, but are not limited to: making severance payments to directors or senior members of staff when anticipating imminent insolvency; making selective payments to some creditors while leaving others unpaid (this may amount to a ‘preference payment’); or granting security or increased security to a creditor which will increase their recovery prospects in the administration or liquidation of the company.

Misfeasance                                                                                                                                         

If it becomes apparent that a director has misappropriated or retained any money or other property of the company in the course of the company becoming insolvent, in accordance with the Insolvency Act the court may order the director to repay, restore or account for any money or property wrongly directed away from the company.

Appointment of experts

When an insolvency practitioner is appointed (usually an administrator or liquidator) they act on behalf of the creditors of a company and not the company itself, and the behaviour of directors will be subject to scrutiny.

It is the duty of an insolvency practitioner to obtain the best possible outcome for the creditors of the company, and in doing so they will want to establish that all of the steps taken by the director in the lead up to the appointment of an insolvency practitioner were in the best interests of the creditors.

What does this mean for the director?

Directors can be held personally liable for any losses to the company that are suffered as a result of directors’ conduct, such as those actions set out above.

In accordance with the Companies Act the court may relieve a director from liabilities arising as a result of their conduct if it considers that the director has acted fairly and reasonably, and that on consideration of all the circumstances the director ought fairly to be excused. If they are concerned, director may make an application to the court in accordance with this provision in advance of any claim being brought against them.

When the going gets tough, can a director resign?

Resigning from directorship is not likely to be an issue when there are multiple directors. However for a sole (or last remaining) director, the position can be very different.

The Companies Act 2006 prescribes that a private company must have at least one director. In normal trading circumstances, if a sole director resigned from his position this would result in a breach of the Companies Act by the company, but not a breach of director’s fiduciary duties. However, in an insolvency situation a director’s duties will change in accordance with the provisions of the Insolvency Act, which will supersede the Companies Act provisions.

If a sole director resigns from a company of doubtful solvency, their resigning from office would leave the company rudderless at a time where the company needs direction more than ever. In such circumstances it is doubtful that the resignation of a sole director would be found to be in the best interests of the creditors of the company.

Lucy Gray is a trainee solicitor in the commercial litigation team in Shoosmiths’ Birmingham office.

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