inbrief

Insolvency - issues for directors

Inside Duties owed by directors Who is a director? When is a company insolvent? Areas of potential liability Practical steps inbrief

All directors owe duties to their Who is a director? companies. However, once a The Companies Act 2006 describes a director In the light of COVID-19, the Corporate director knows or should know the as including any person occupying the position and Governance Act (CIGA 2020) company is (or is likely to become) of director by whatever name called. A person was introduced by the Government and insolvent, ’ interests become registered at Companies House as a director will came into force on 26 June 2020. CIGA paramount. In practical terms this be a director. Someone who is acting as a director 2020 made substantial changes to the law means that the nature of directors’ without having been validly appointed will also, of insolvency. Relevant to this note was duties undergoes a significant shift generally, be a director. Directors include executive the introduction of temporary changes to and non-executive directors and anyone in the wrongful trading regime. These were when insolvency threatens. accordance with whose directions or instructions intended to encourage directors to continue the directors of a company are accustomed to act their businesses without threat of personal (a shadow director). It is a person’s function rather liability should the company ultimately fall than his or her title that is important. into insolvency. CIGA 2020 retrospectively Someone closely involved in the management and introduced an assumption to the effect that direction of the company, even if employed as a directors are not to be considered responsible consultant or through a service company, may be for any worsening of the financial position deemed to be a director for all purposes relating of their company over the period 1 March to insolvency. 2020 to 30 September 2020. Thereafter, by regulations made in November 2020, a When is a company insolvent? second such period was enacted running from 26 November 2020 until 30 April 2021, which The point at which a company is insolvent is has since been extended to 30 June 2021. The fundamental to directors’ decision making, assumption applies even if the company is not as it is from that point on that directors may directly affected by COVID-19 related issues. become personally liable for debts incurred by the company. Therefore, directors must be able to Where wrongful trading provisions would recognise when to stop trading and to take every usually encourage directors of companies step to minimise losses to creditors. facing financial difficulties to restrain borrowing and reduce liabilities (for example, The two most generally accepted tests of in the number of staff they employ), the insolvency are: above measures act as a recognition that • Balance sheet test (where the value of a directors continue to face unprecedented company’s assets are less than its liabilities, difficulties in assessing the ongoing financial taking into account contingent and viability of companies through such uncertain prospective liabilities). times and should not be penalised. Notably, whilst CIGA 2020 is framed in terms of an • Cash flow test (where it is proven that a “assumption”, from guidance issued by the company is unable to pay its debts as they Government, it is not thought likely that this fall due. This is deemed to be so where a is to be considered rebuttable. company fails to comply with a statutory demand for a debt exceeding £750, or a It is important to note that CIGA 2020’s judgment debt remains unsatisfied). temporary measures do not have any impact on directors’ statutory duties more generally, Areas of potential liability including elsewhere under the Insolvency Act. These have remained in force throughout. Generally, directors are not responsible for a This means that during these periods, company’s debts - other than when they have directors have been required to consider and agreed to be liable, for example, by giving a treat creditors’ interests as “paramount” from personal guarantee in support of a loan to the the point that at which they knew, or ought company. Three statutory exceptions to this to have known, the company was (or was general rule are where a court makes findings likely to become) insolvent. Whilst this is in of wrongful trading, or against a director. A further possibility is where a director is found liable for the tort of deceit. inbrief

fact a common law duty, it is given statutory Misfeasance of the company and conduct of directors who effect by language appearing at s172(3) of If, in the course of a winding up, it appears that were in office for the last three years of trading. 1 the Companies Act 2006. a director has misapplied or retained, or become The has extensive powers to require information and documentation and is required to In view of CIGA 2020 measures, the parts of accountable, for any money or other property of report unfit directors’ conduct to the Secretary of our note below regarding Wrongful Trading the company, or been guilty of any misfeasance State to decide whether to bring disqualification will not apply to steps taken (or not taken) or breach of any fiduciary or other duty, the court proceedings. The Secretary of State for Business, by directors during the period of March to may order the director to repay, restore or account Innovation & Skills will take action if a director’s September 2020 and 26 November 2020 to 30 for money or property with interest or contribute behaviour has fallen below the appropriate June 2021. Curiously a gap was left between to the company’s assets by way of compensation. standard. 30 September and 25 November 2020 which This section of the Insolvency Act also applies to may complicate the position for courts in any officer of the company and any person who future when assessing conduct. has been concerned, or has taken part, in the Transactions at an undervalue and promotion, formation or management of the Wrongful trading occurs if a company has gone preferences company. It could therefore form the basis for a into insolvent or , and claim under s172(3) of the Companies Act 2006 An administrator or liquidator of an insolvent before the commencement of the winding up mentioned earlier in this note. company, can challenge certain pre-insolvency or administration, a person who is or has been transactions including preferences and The application for this remedy may be made to a director, knew or ought to have concluded transactions at an undervalue. A transaction at an the court by the Official Receiver or liquidator or that there was no reasonable prospect that undervalue is a transaction which took place up to any or contributory and the court can the company would avoid going into insolvent two years prior to the onset of insolvency, where make such order as it thinks fit. liquidation or administration but the company the disposition was a gift or the value received continued to trade and incur credit. by the company was significantly less than the Directors disqualification value of the assets sold and the company was Following a declaration of wrongful trading a A disqualification order may be made against either unable to pay its debts at the time of the director may incur personal liability for debts a person who is or has been a director of an transaction or was made unable to pay its debts incurred by the company after the point he insolvent company where that person’s conduct as a result of the transaction. If the transaction or she knew or ought to have concluded there as a director of that company makes him unfit to is with a connected person, (e.g. with a director was no reasonable prospect of avoiding insolvent be concerned in the management of a company. or a company with common directorships or liquidation or administration. A disqualification order will last for a minimum of shareholdings), a court will presume that a Being found liable under these provisions may also two and a maximum of fifteen years. The Registrar company was insolvent or was made insolvent by lead to disqualification from acting as a director. of Companies maintains a publicly available list of the transaction. disqualified directors. A company gives a preference if in the period of Fraudulent trading In determining conduct that has rendered a six months prior to the onset of insolvency (or Fraudulent trading occurs if a company has gone person unfit to be a director, the court will have two years if the transaction was with a connected into insolvent liquidation or administration, and, regard to several matters including any breach of person) it does something which has the effect on application of the liquidator or administrator, duty by the director in relation to the company, of putting a creditor or a surety or a guarantor in it is found that the business of the company has any misapplication or retention of the company’s a better position in the event of the company’s been carried on with the intent of defrauding money or property, or the conduct of the director winding up than they would otherwise have been creditors, or for any fraudulent purpose. in relation to an insolvent overseas company. In in. In deciding whether a preference has been The potential scope is wide: a liquidator or addition, the court will assess the extent of the given, a court must be satisfied that the company administrator can apply to court for a contribution individual director’s responsibility for: was influenced by a desire to produce that from any persons who were knowingly parties to outcome. In the case of a person connected to • The causes of the insolvency the carrying on of a business in such a manner. the company, the desire to prefer is presumed. An Fraudulent trading is also a criminal offence. Again • Any failure by the company to supply goods example of a preference would be if a company it may lead to disqualification from acting as a or services which have been paid for were to discharge a bank loan which it was director. personally guaranteed by a director. • The entering into by the company of any transactions being a preference or at an 1 s172 of the Companies Act 2006 sets down the general duty If a court decides that a transaction was at an to promote the success of the company, providing that directors undervalue. undervalue or was a preference it can, in certain must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit circumstances, set the transaction aside or make of its members as a whole. Subsection 3 goes on to clarify A liquidator of a company has a positive duty that the duty is subordinate “to any enactment or rule of law other orders to remedy the wrong done or loss requiring directors, in certain circumstances, to consider or act to investigate the affairs and causes of failure in the interests of creditors of the company”. The effect here is caused, including demanding financial restitution to import the common law duty to have regard to the interests from the company’s directors. of creditors. inbrief

Deceit Assignment of rights of action A director may also be personally liable for highlight his concerns but the full reasoning damages where he or she signs a document behind that resignation should be properly As a general point, an administrator or liquidator which represents that a company has capacity minuted/recorded in writing. of an insolvent company can assign the company’s to meet its obligations in circumstances where claims or causes of action to a creditor or other • Hold regular board meetings and keep he or she knows that it does not. Although the third party (subject to any contractual provisions proper records of board reasoning and underlying statute dates back to 1828, the courts which may prohibit assignment). This might be decisions. If the board considers whether the have demonstrated a willingness to apply it in an attractive where there are insufficient funds to company should continue trading, minute insolvency context against directors. pursue it on behalf of the estate or due to the this carefully. factual complexity or time involved in pursuing The representation may be made impliedly rather • Take advice if the company is considering litigation. The terms of assignment might than expressly. For example, the Court of Appeal entering into a contract with a connected be absolute in return for a one-off payment. upheld a judgment against a director who had person or where the value accruing to the Alternatively, the office holder might agree to take signed a document containing a promise (by the company seems low, or where one creditor is a share in proceeds arising. company) to pay for goods to be ordered in the being paid off in preference to others. future. The court held that the promise included Since 1 October 2015, rights to assign have been an implied representation as to the company’s • Seek professional advice from an insolvency extended to include those type of claims which capacity to make payment. practitioner, appropriate lawyer or were previously exclusive to the office holder, accountant. There are new provisions in arising only upon their appointment. These include Practical steps place under CIGA 2020 which provide fraudulent trading, wrongful trading, transactions for a Moratorium to allow companies the at an undervalue, and preference claims. There are steps that directors can take to minimise flexibility they need to continue trading so exposure to personal liability upon the occurrence Once assigned, the creditor or third party takes they have the maximum chance of survival of corporate insolvency. Overall, directors must the claim forward. This may be significant during this period of economic uncertainty, take every step possible to minimise potential because claims could be assigned, for example, without the threat of creditor action. losses to creditors, remembering that there is to shareholders, creditors or employees of the no general defence that having regard to all the • If in place, check the terms of directors’ insolvent company, any of whom may have circumstances, a director acted “honestly and and officers’ insurance policies for cover more resources and/or appetite to pursue claims reasonably”. for liabilities related to insolvency. If not, in satisfaction of sums they have lost in the consider taking D&O insurance. It is designed insolvency. Do’s to protect directors against claims made in • If you propose to carry on trading, be certain respect of discharge of their duties. that there is a reasonable prospect that all Don’ts debts can be paid as they fall due. CIGA 2020 introduced a Moratorium which will • Wait for the service of proceedings for failure provide companies with a payment holiday to pay a debt to be alerted to problems. for pre-moratorium debts against legal and • Incur further credit that cannot be repaid. enforcement action subject to some wide- ranging exceptions. The detail here is beyond • Resign immediately at the first sign of the scope of this note. trouble. Resignation is unlikely to constitute taking every step to minimise losses to • Be proactive - regularly monitor the creditors. Actions of past directors will be company’s finances and management scrutinised if the company becomes insolvent accounts. Ensure that they are up to date so later. that a proper assessment of the company’s financial status can be made. • Declare a dividend if there are concerns about solvency. • Comply with financial covenants and monitor loan facilities. If the company misses • Divert business away from the company a repayment, the entire amount of a loan without taking advice. might become repayable - a sum which the • Try to rescue the insolvent venture through company may not be able to meet. a purchase of the business by a company Mark Lim • Communicate with other directors. in which you are involved without taking Partner and Head of Dispute Concerns as to the solvency of the company advice. If the companies trade under the Resolution should be raised and reviewed at board same name, involvement by you in both level. If, when legitimate concerns are raised can lead to personal liability for the old by one director, the others refuse to act, company’s debts and may be a criminal +44 (0)20 7074 8186 that director may contemplate resigning to offence. [email protected]

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© June 2021 Lewis Silkin LLP ‘20210609 Insolvency - Issues for directors ‘