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Every year, Fox Williams LLP is called upon to advise boards and individual directors of fashion clients as to legal issues arising when a company is on the brink of insolvency.
Directors are responsible for the day to day running of the company’s business. This was set out as 7 duties which the law imposes on directors for the first time in the Companies Act 2006 as follows:
When a company is solvent, these duties are owed to the shareholders. As a general rule, as a company’s financial position worsens, the interests of the company’s creditors become of paramount importance. Under UK law, an individual director has the dual threat of (a) potential personal liability for future debts, and (b) disqualification as a director, to make sure the interest of the creditors are at the forefront of their thinking!
Personal liability can arise under a number of fronts:
If a company is nearing insolvency, the directors should only continue to trade and take on liabilities if there is a reasonable prospect of avoiding insolvency.
There are two main defences:
First, the liquidator has to show that the company was insolvent, or became insolvent, at the time of the alleged wrongful trading. There is no prescribed or unequivocal test of a company's solvency. Directors would be expected not only to consider the net asset position but also the ability of the company to settle its reasonably foreseeable liabilities out of its expected cash flow.
Second, a statutory defence is provided if it can be shown to the Court that the director "took every step with a view to minimising the potential losses to the company's creditors as soon as he knew, or ought to have concluded, that insolvent liquidation was unavoidable".
Directors are judged individually, rather than as a board, and it is imperative that regular board meetings are held; there’s a clear divisions of responsibility; regular updates of financial information, clear justification for continuing to trade etc. A resignation from the board will not necessarily save the director from liability. The law also applies to ex-directors. In addition a liquidator will not look kindly on a director who resigns when the ship is deemed to be sinking.
(b) Breach of duty
The Companies Act 2006 also contains provisions which apply to derivative claims (for this purpose, claims instigated by a shareholder on behalf of the company). One of the main substantive changes introduced by the Companies Act 2006 was to prescribe a wider range of circumstances in which a derivative action may be brought by a shareholder against a director. For example:
The shareholder is required to make an initial case for permission to bring/continue a derivative claim and the court is required to consider the issue on the basis of the evidence filed by the shareholder, without requiring evidence from the defendant. The courts must dismiss the application if the applicant cannot establish an initial case.
For example, directors can be made personally liable for national insurance contributions due by the company. They can also be fined for breaches of legislation such as failure to file accounts/confirmation statements etc. If such documents are not filed on time, outside suppliers/customers may also get very nervous and stop dealing with the company.
Power to Disqualify Directors – Company Directors' Disqualification Act
Also if a company does go into insolvency, the liquidator has a duty to report to the Insolvency Service re the actions of the directors (and directors in office over the two years prior to the insolvency). Those whose conduct make them unfit to be considered in the management of a UK company, can face disqualification orders of between 2 and 15 years.
In recent times the courts have attempted to offer guidelines as regards the definition of "unfit" conduct. The courts have outlined directors' duties generally:
It has been decided that it was not necessary to show that the person in question was unfit to be concerned in the management of any company in any role. If the person's conduct in his actual management role in the company showed incompetence to the requisite degree then a finding of unfitness should be made.
Directors with concerns about their company going into insolvency are well advised to take proper professional advice as soon as their concerns occur.