For most limited company directors, the state of insolvency is uncharted territory.
In this article we will explain some of the key duties and responsibilities you will face once your company has become insolvent.
It’s vital you understand these to avoid breaking the law unknowingly and risk accusations of directorial misconduct.
We would always recommend making contact with us for a free confidential discussion at the earliest opportunity so we can offer some insight on your best course of action.
Why are Directors Duties Altered in Insolvency?
For directors who have spent many years successfully generating profits for shareholders, it may be difficult to imagine prioritising any one else. But it’s essential that you do.
At the point of insolvency, your legal responsibilities shift from creditors to shareholders and your behaviour must be seen to demonstrate this.
Obviously it doesn’t make sense to prioritise the interests of shareholders while your company owes money to others.
Make sure to keep clear records of emails and conversations. Maintain accurate books and records. Understand the rules around trading when insolvent.
And most importantly take qualified advice from insolvency practitioners such as ourselves at the earliest opportunity.
What does the Insolvency Act 1986 Say About Directors Duties?
The key legislation regarding directorial conduct in insolvent situations is the Insolvency Act 1986. Here are the sections of particular relevance.
Section 212: Misfeasance
This section on misfeasance outlines the laws surrounding misapplying company money, misapplying or retaining company property, or breaching fiduciary responsibility around money. It applies to both current and ex-officers of the company.
Section 212 makes officers personally accountable to the extent of the loss caused by their actions. It is also taken into considered by the directors disqualification unit.
Section 213: Fraudulent Trading
A criminal rather than a civil offence, fraudulent trading is where it can be proven that there was a knowing attempt to defraud creditors.
One example of this would be where a director manages to obtain credit or finance while aware of the company’s inability to pay it back.
Conviction for fraudulent trading requires definitive proof which, in practice, is often difficult.
Nevertheless, fraudulent trading is a serious offence carrying with it financial penalties, potential jail time, and personal liability for corporate debts.
Section 214: Wrongful Trading
An insolvency practitioner involved in liquidating a company has a duty to investigate directorial conduct in the time directly preceding the point of insolvency.
In particular, they will be looking for evidence that a director understood the law and did not seek to prioritise any other interests than creditors once they understood their situation.
Wrongful trading is a civil offence, carrying with it fines, penalties and in the most serious cases jail. Conviction of wrongful trading may also cause directors to held personally liable for some or all of the corporate debt.
This is where directors who have kept clear records, including recording all key decisions in the minutes of board meetings, stand a better chance of demonstrating their adherence to the law.
The key point within insolvent trading legislation is that :
- directors failed to establish that they took every possible step to prevent losses to company creditors
- director(s) knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation
Section 238: Transactions at Undervalue
This section covers the risks of directors selling goods or assets at a lower than market value, in the period preceding insolvency. IP’s will be looking at a period of up to two years prior to liquidation.
Where evidence of transactions at undervalue is discovered, these sales may be ‘set aside’, which means the court can reverse of invalidate the sale.
Section 239 – Preferences
This section refers to the possibility of a director or other office holder putting through a transaction which puts one creditor in a preferential position over another after the insolvency.
Again, the insolvency practitioner has the power to set these transactions aside if they have occurred in the period of six months before insolvency. This period is extended to two years where ‘connected’ persons are involved, (such as family members, shareholders or other directions.)
Can a Director of a Limited Company be Personally Liable in Insolvency?
Where directors can be proven to have knowingly placed other interests before creditors after recognising the company’s insolvent position, he or she may be held personally liable for some or all of the debts.
Where directors hold a personal guarantee, they may also be held liable up to the limits stated on the guarantee.
Can You be a Director of Another Company After Liquidation?
Assuming you haven’t been found guilty of any wrongdoing and subjected to a directors disqualification order, there’s no reason you shouldn’t be the director of another company.
What are a Director’s Duties to Creditors in Insolvency?
While the law states directors should put the interests of creditors first in insolvency, this translates to the following practical measures:
- Ensure clear communication with company accountants so that the financial position is understood at all times
- Directors should keep informed and take legal advice about any potential transactions, as well as their own personal liabilities
- speak with an insolvency practitioner as soon as the situation is understood to establish whether corporate rescue may be possible
- Ensure the board is regularly informed as to the situation
- Ensure no one is paid preferentially, including directors loans, suppliers, severance pay
- Ensure creditors, including HMRC and financial institutions are well informed
- Ensure employees are treated fairly as per the legal requirements
- Proceed with formal insolvency measures efficiently and in a timely manner, if this is deemed the best way forward