Corporate Insolvency Claims: Understanding your duties as a company director

Wed 11th Oct 2023

As a company director, understanding your legal responsibilities is of the utmost importance.

Without a full understanding, you could breach your statutory duties unintentionally. Lucy Vaughan, Solicitor at Coodes, explains how these duties can be breached.

Directors’ Duties

As a director, or office holder, duties are owed to the company under Sections 171 to 177 of the Companies Act 2006. An office holder owes a duty to:

  • Act within its powers, and within the company’s constitution;
  • Promote the success of the company;
  • Exercise independent judgment;
  • Exercise reasonable care, skill and diligence;
  • To avoid conflicts of interest (unless authority has been obtained);
  • Not to accept benefits from third parties;
  • To declare its interest in any proposed transaction or arrangement.

There are many ways in which such duties could be breached and a risk of doing so unintentionally.

Following the onset of insolvency of a limited company, a director or guarantor remains personally liable for antecedent transactions which took place whilst they were in office. We take a brief look below at the types of claims which may be brought, and how to avoid the situation.

Wrongful Trading

Wrongful trading refers to the situation where a director of a company continues to allow the company to accrue debts despite knowing, or that they ought to have known, that the company was insolvent. This could be continuing to trade and take customer orders where the orders cannot realistically be fulfilled, or allowing the company to take out credit where there is no realistic prospect of paying it back.

Should this occur, a claim may be brought against directors personally for causing the company’s position to deteriorate and jeopardise its creditors. The court may make an order that the director make a contribution which it sees fit, towards the company’s assets unless they can show that they made all reasonable efforts to minimise the potential loss to the company. The important point to note here is that the director’s actions must have been reasonable, having the skill and diligence which would be expected of a director.

Fraudulent Trading

Fraudulent trading refers to a deliberate act by an officer of a company to defraud creditors, or to put funds out of reach of creditors. Fraudulent trading differs from wrongful trading as here there is a deliberate act with the intention to commit fraud, as opposed to simply allowing something to happen.

Since the pandemic, there has been an increase in litigation against directors for allegedly obtaining credit at a time when the company was not trading and had no real prospect of recommencing trade when restrictions eased.

If proven, this is a criminal offence which can lead to disqualification, personal liability fines and even prison sentences. While convictions are rare, it is nonetheless extremely important that legal advice is taken at an early stage should a director have concerns as to a transaction or potential claim.

Preferences

A preference claim is one in which it is alleged that a creditor has been ‘preferred’ over another. This situation commonly arises where a director has loaned personal money to the company and later pays themself that money back whilst other debts remain outstanding. Where the transaction involved a connected person, such as the director themself or an associate, a preference will be presumed. That is to say that it will be for the office holder to prove that they did not prefer specific creditor(s) as opposed to the usual situation in which the burden of proof rests on the claimant.

In order for a preference claim to be successful, there must have been a “positive wish to improve a creditor’s position in the event of insolvency”.

Again, this may happen without any intention to commit a wrongful act under the legislation, however it is important for company directors to be mindful of the financial position of the company when deciding to repay monies owed. Professional advice should be taken in cases of uncertainty.

Transactions at an Undervalue

Transactions at an Undervalue relate to a situation where an asset of the company is disposed of for an amount less than market value. When subsequently dealing with the company’s insolvency, a claim may be brought that such a transaction served to put funds out of reach of creditors which would have otherwise been available had the asset been disposed of at full market value.

Such transactions include transactions by way of gift, or which have been disposed of for less than money or money’s worth and claims can be in respect of any transaction which took place within two years of the onset of insolvency. It is therefore vital to keep accurate records of the company’s affairs at all times to protect against any potential future claim.

Transactions Defrauding Creditors

A claim in respect of transactions defrauding creditor may incorporate some or all the causes of action discussed above. It relates to any transaction which has an intention of putting funds out of reach of creditors. The courts have positively upheld that the decision to take a dividend at a time when you knew, or ought to have known, that the company is insolvent, or where insolvency is imminent, will fall into this category.

Decisions as to whether dividends may be taken are a balancing act and must be looked at on a case-by-case basis. It may be that the intention behind taking such action appears reasonable and is intended to protect the members’ interests. However, you must consider whether such payments would result in pushing the company further into insolvency and, ultimately, worsening the outcome for creditors.

Given the similarities between the breaches discussed, it is not uncommon for multiple breaches to be alleged in one claim and for a director to be pursued for the difference between the assets of the company had there been no breach, and the current value.

What does this mean for you?

This is not an exhaustive list of potential pitfalls which a company director may face, however it’s a reminder that it’s essential for directors to be mindful of their duties under the Companies Act 2006 both throughout their time in office and to ensure that they are always fully aware of the company’s financial position.

Whilst it is best to obtain advice in the case of any uncertainty, this is not always possible. Should a former office holder receive notification of a potential claim, all available evidence must be preserved, and legal advice sought as soon as possible to maximise the prospects of forwarding a robust and successful defence. It is very common for legal advice to be taken too late, and for protective action to be taken only after the formal claim process is begun. Office holders are then met with an uphill struggle to defend their actions. It is therefore recommended that assistance is sought at the outset of a dispute.

We at Coodes have experience acting in a variety of insolvency disputes, so we understand the complexity and difficulties faced by both sides of the claim. If you are a company director or liquidator looking for advice or representation in an insolvency dispute, please get in touch today.

Wed 11th Oct 2023

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