What are the duties of directors if a business becomes insolvent?
With a number of high profile businesses going into administration in recent months, Coodes Solicitors’ Commercial Disputes Associate Abi Lutey discusses the duties of directors, when a business becomes insolvent.
Last year, the number of businesses collapsing into bankruptcy hit a four-year high and 2018 is already shaping up to follow the same pattern. Well-known companies such as Orla Kiely, Saltrock, ToysRUS, Henri Lloyd and Maplins have gone into administration this year. Some have continued trading, including Patisserie Valerie, which was recently saved by a £10million cash injection, while others have closed their doors completely.
What role do directors’ duties play if a business becomes insolvent? And what if a director’s failure to carry out his or her duties results in a business going into administration?
What are directors’ duties?
Although the Companies Act 2006 sets out general duties of directors there is no comprehensive legal definition of what a fiduciary duty is. In the case of Bristol & West Building Society vs Mothew (1996), the Court of Appeal decision described it as ‘someone who has undertaken to act for or on behalf of another in a particular matter which gives rise to a relationship of trust and confidence.’
There are seven general duties, which are:
- The duty to act within powers
- The duty to promote the success of the company
- The duty to exercise independent judgment
- The duty to exercise reasonable care, skill and independence
- The duty to avoid conflicts of interest
- The duty to not accept benefits from third parties
- The duty to declare interest in proposed transactions or arrangements.
A director’s duties apply from the moment he or she is appointed and only come to an end following a resignation.
My colleague, Partner and Head of Corporate and Commercial Sonya Bassett discusses directors’ duties in more detail in this article.
What if a director’s actions cause a business to become insolvent?
Directors’ duties become particularly relevant if their actions, or decisions, directly contributed to a state of insolvency.
A director could continue to be held liable after their resignation. This is most likely when it can be proved that they breached one of their duties during the time when they were a director of the company in question.
What sanctions will a director face if their actions led to a business entering administration?
If a director is found to have been responsible for a business’ downfall, there are a number of possible sanctions he or she could face, depending on the circumstances:-
- A company that has become insolvent may wish to issue a notice under Section 212 of the Companies Act. This enables it to investigate its directors. If it can then be proven a director has breached their fiduciary duty, compensation is then paid to the insolvent company.
- The common civil liability faced by a director is allowing the company to trade while insolvent, which is known as wrongful trading. It must be proved that the director knew or ought to have known prior to insolvency proceedings that there was no way of avoiding insolvency and that they did not take steps to protect creditors from losses.
- Another action against directors can include a claim for fraudulent trading. This is where a company has suffered loss by carrying out its business with the intention to defraud. The sanctions are similar with additional criminal sanctions to include imprisonment of up to ten years. This can be seen in the recent news from Patisserie Valerie when the company reported that there were ‘accounting irregularities’ and that its finance director had been suspended and arrested.
- There are a number of other circumstances, known as misfeasance claims, which cover all of the director’s duties. These include wrongly applying money or assets, making preferential payments to creditors, disposing of company assets for less than their true value or taking too high a salary when the company is struggling. The sanction is usually limited to putting right the loss suffered but a director can also be disqualified as a result of a misfeasance action.
What can directors do to protect themselves?
Although there are defences to claims against directors when faced with liability here are some steps to take to minimise liability:
- Be on top of the company’s financial position by holding regular board meetings (simply being unaware of the company’s problems is not a defence)
- If there is a concern seek financial and legal advice
- Communicate with creditors (the presentation of a statutory demand can have a drastic effect on a company)