Given the current unpredictability of the economy due to, not least in part, political considerations and generally difficult trading conditions, companies may find themselves facing cash flow issues or worrying about future order or trading volumes. As with most things concerning insolvency, the key is to take legal and financial advice and to take it as early as possible. There are several things a concerned director can do and often many of these may facilitate the survival of the company if addressed early.
Key areas of concern for directors
A director must ensure that by keeping the company going in the face of ongoing solvency concerns, they are not themselves committing an offence or incurring potential personal liability.
The main offence a director needs to be aware of is that of “wrongful trading”. If a company becomes insolvent and is wound up or placed in administration and a director of that company knew or ought to have known before that occurred that there was no reasonable prospect of the company avoiding that insolvency procedure, any liquidator or administrator appointed to the company can require the director to make a contribution to the company’s assets via a court declaration. This offence can only apply to directors, but this is widely defined and can include shadow directors or de facto directors.
There is much case law on this subject, setting out the court’s views on liability and defences. These can be briefly summarised as follows:
- The court will calculate if there has been an increase in the net deficiency of company assets from the time the directors first concluded (or ought to have concluded) that the company could not avoid insolvent liquidation or administration;
- If there is no material loss to the company’s asset position (and thereby the company’s creditors) then no court order for wrongful trading will be made. If a loss is shown, any liability for wrongful trading will be for that amount;
- The test for the facts of insolvency which a director knew or ought to have known is both subjective and objective – what would a reasonably diligent person with the requisite skill and knowledge in that office be reasonably expected to do in the circumstances?
- Actual dishonesty by the directors is not required to prove wrongful trading.
A court will be satisfied that a director is not liable for wrongful trading if the director can show that he took every step to minimise the impact and loss to the company’s creditors. This is why taking early legal and financial advice is so crucial as soon as there is even the slightest concern over the solvency of a company. Note it can also be the case that deciding to put a company into an insolvency procedure too early can cause a loss to creditors and so it does need to be carefully addressed.
There is another Insolvency Act offence of “fraudulent trading”, which is also a criminal offence under the Companies Act 2006. It can be punishable by up to 10 years in prison, a fine or both.
This is harder for a liquidator or administrator to prove, but if it appears that any business of the company was carried out with the intent to defraud creditors or for any other fraudulent purpose, the insolvency office holder can seek a contribution from anyone who was knowingly party to the fraud. This therefore can apply to anyone who has shown actual dishonesty in their business dealings, not just directors, and liability and amount of contribution can be apportioned depending on the degree of control a party may have had over the business and the subsequent benefit received.
Practical advice for concerned directors
If in doubt about your company and its solvency, it bears repeating that you must seek independent legal and financial advice early.
Have regular meetings with your fellow directors, finance department, credit controller, and bookkeepers etc. to have as full a picture of solvency as possible. Minute all decisions and commercial considerations for future record.
Ensure all your financial information is up to date, have up to date cash flow reports; be aware of late payments by your suppliers/customers which may affect your own liquidity going forward and address any delays promptly.
Remember the statutory test for insolvency is not just about balance sheet solvency (assets being greater than liabilities) but also about the company’s ability to pay its debts as they fall due. Missing a payment to a third party can precipitate a rapid descent to liquidation if your company’s creditors present a winding up petition for a missed debt payment.
Directors cannot avoid liability for wrongful or fraudulent trading just by resigning. You must show you are taking every step to avoid loss to the company’s creditors. There may be circumstances where one director is aware of the pressing need to take action over the potential insolvency of the company but cannot persuade the rest of the board to do so, then resignation may be prudent. However, independent legal advice should be taken in those circumstances.
Directors should also be aware that the court can make a disqualification order against any director of a company which becomes insolvent, where they are concerns about the fitness or otherwise of the director’s conduct, and disqualification is also applicable where liability for wrongful or fraudulent trading has been established. The minimum period of disqualification is two years and can be up to a maximum of 15 years. It is a criminal offence to ignore any disqualification orders.
In conclusion, it should be apparent that legal advice should be taken as early as possible to avoid the potential pitfalls for directors, even when they are “confident they can turn their business around” or “ride out any storms”: to carry on regardless could spell disaster for your company and you personally.
For more information or advice contact the Thompson Smith and Puxon Insolvency team on 01206 574431 or by email at firstname.lastname@example.org.