On the Brink of Insolvency - Personal Liability Pitfalls for Directors

Posted Thursday 30th July 2020

If a company unfortunately goes into insolvency, it can often be a shock to its Directors when they receive a court order requiring them to make a personal financial contribution back to the company. Summarised below are some of the main offences that can lead to a personal contribution order being made together with some protective measures to consider if a company is ever in financial distress.

Wrongful Trading Offence

This is where a director knew, or ought to have known, there is no reasonable prospect of a company avoiding insolvency and the director did not take action to minimize any further loss to the Company’s creditors that he ought to have taken prior to the insolvency. This offence often arises where a company continues to trade despite there being no reasonable prospect of the company recovering from its financial difficulties.

This offence relates to a shift in one of the director’s statutory duties. When a company is doing well, directors must act in the best interests of its shareholders. However, when the directors need to start considering whether insolvency is a possibility, the directors no longer act in the best interests of its shareholders but instead its creditors.

It is often difficult to pinpoint exactly when this shift in duty occurs so it is important to engage with lawyers and insolvency practitioners early on if the company is heading into financial difficulty to help reduce the risk of committing this offence.

Recovery for Misfeasance

This is often referred to as the “catch all offence” whereby a director has either breached his duties in relation to the company or has become liable or accountable for any money or property of the company. The most common scenarios where this applies is if an insolvency practitioner has found that the Directors authorised a transaction in the two years prior to the insolvency which breaches UK Insolvency Law, these are:

Transaction at undervalue – the Company has disposed of an asset for nil value or for consideration which is less than its market value.
Preferable transaction – the Company approves a transaction which puts a creditor in a better position in insolvency than he otherwise would have been in had the transaction not gone ahead.

Fraudulent Trading Offence

If a director knowingly carries on any business of the company with the intent to defraud creditors of the company or any other person for any fraudulent purpose.

This is also a criminal offence under UK Company law and may (depending on the severity of the offence) also incur a fine and/or a lengthy custodial sentence.

Disqualification as Director

As a result of a director’s actions prior to insolvency, a director may be deemed to be unfit to be a director of any company by the UK Courts. Depending on the actions which have led to the disqualification order, the director may be required to financially contribute to the company.

Protective Measures

Review payments to Directors – paying directors a salary (as opposed to dividends or repayment of loans) is less likely to be challenged by an insolvency practitioner. Dividends could be challenged if they were not declared and distributed correctly in accordance with UK Company law and repayment of loans may be considered as a preferential transaction (as mentioned above).
Hold board meetings regularly and provide details in the official minutes of what decisions were approved and the rationale behind them as this will help in showing that the directors acted reasonably and in good faith prior to the insolvency.
Financial information should be kept up to date and reviewed regularly so directors can react quickly to any changes that occur.
Seek professional advice from lawyers, accountants and insolvency practitioners as early as possible and as often as is necessary when making tough decisions relating to the business.

This article is for reference purposes only. It does not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking or deciding not to take any action.