Directors' liability for businesses in financial difficulty

How does insolvency affect the role of a director?

As a director, you will be duty bound to act in the best interests of the company and its shareholders at all times. However, when the company becomes insolvent, the focus of the duty shifts towards the creditors of the business. 

Who else within the company can be affected by insolvency?

Whilst registered directors will undoubtedly take on most of the financial burden of insolvency, there are other parties who may also find themselves at risk. This can include anyone who has a level of control of the company, who is responsible for the direction of the company’s affairs, or who advises the directors in any capacity. 

When can a director become personally liable?

In the process of insolvency, there are various different circumstances within which a director can find themselves personally liable to repay to the company in liquidation losses arising out of transactions or conduct or from contracts made during the time the business was trading, including:

• Wrongful trading
• Fraudulent trading
• Misfeasance
• Personal guarantees
• Preferences
• Transactions at undervalue (TUV)

What is a transaction at undervalue?

A transaction at undervalue (TUV) occurs when a company has transferred one of its assets at a price that is significantly less than its market value. If a court decides that the company has entered into a TUV, it may order you as a director to refund part or all of the value of the transaction to the company.

The court will also have to determine whether the company and the recipient of the asset were dealing with each other “at arm’s length”. For example, if the two parties are related to each other, the recipient would be deemed a connected party.

The court may order you or the connected party to pay the difference between the amount paid for the assets and the fair market value, or make an order for the return of the assets.

What is meant by the term 'preferences'?

A preference transaction means you have made a payment or transfer to a creditor in preference of another. When a company becomes insolvent, the director must treat the interests of all the creditors equally. A common example is when the directors direct their company to pay off part or all of a loan or overdraft that the directors have guaranteed to the bank. This is often alleged to be a preference payment.

As with TUVs, the directors can be ordered by the court to repay the full value of transactions that are found to be preferences.

What should I do if my company becomes insolvent?

If your company has fallen into insolvency, or you think it may become insolvent in the near future, there are a number of steps you should take as company director. 

• Seek professional advice as soon as you can; the sooner you do this, the more options there will be available to your company that will reduce your risk of personal liability
• Ensure you have accurate, up-to-date financial records for your business
• Do not continue to trade if your company is insolvent, unless you believe there is a strong possibility that you can do so without the company falling into insolvent liquidation
• Evaluate your business, consider what it is that has caused the problem within your operation, and develop a financial strategy that will reduce costs and highlight which aspects of your business are not profitable
• All creditors have equal priority when you become insolvent. Do not pay certain creditors in preference to others.
• Do not take on additional credit if you know there is little chance of you being able to repay it, and do not write cheques if there is a possibility that they may bounce
• If there are other directors at your company, and they disagree with your insolvency plans, ensure that your thoughts are made clear, whether it be in writing or within the minutes of a board meeting

Directors disqualification

When a Limited Company goes into Liquidation the Liquidator appointed has a duty to report on the conduct of directors to the Department of Business, Innovation and Skills - Insolvency Service. If on investigation the conduct of a director is regarding as falling within the definition of unfitness to act as a director, the Directors Disqualification Unit of the Insolvency Service may commence proceedings for a Disqualification Order to be made.

What can a director be disqualified for?

Under the Company Directors Disqualification Act 1986 there are several reason which could cause you to face disqualification, all which carry a maximum disqualification period of either five or 15 years.

• Convicted of an offence in connection to the promotion, formation, management or liquidation of a company - maximum period of disqualification: 15 years

• Three defaults in the previous five years concerning the filing of documents and returns - maximum period of disqualification: 5 years

• Found guilty of an offence of fraudulent trading or of any fraud in respect of the company or any breach of the duties of a director - maximum period of disqualification: 15 years

• Convicted of a summary offence regarding the filing of returns, accounts or other documents - maximum period of disqualification: 5 years

• If the Secretary of State makes an application to disqualify on the grounds of unfitness after a report by an official inspector - maximum period of disqualification: 15 years

If you would like to know more about your liability as a company director, and how Stephensons can help if your business is in financial difficulty call us today on 01616 966 229.