The differing methods of ceasing a company have been covered in previous articles but should a company be staring in the abyss, the future being possible liquidation (whether voluntary or otherwise), directors do need to take care of their actions, says Jennifer Adams.
In one of my first articles on company secretarial matters I wrote that: ‘Directors hold a position of trust on behalf of the company’s shareholders. Their prime duty is to manage the company for the benefit of those shareholders and not for any individual shareholder or group of shareholders.’’
Actually that statement is not strictly correct as when a company is insolvent then those duties change and then a director's prime duty is to the company’s creditors overriding all other duties.
A liquidator will look back over two years from the date of appointment, scrutinise the directors actions both before and during the liquidation process and if found to have failed the creditors interests or be deemed to be incorrect could be required to answer claims of breach of duty, wrongdoing or fraudulent trading (to be covered in a subsequent article).
Therefore as soon as it is recognised that a company is having difficulties directors need to:
- Obtain professional advice as to the appropriate method of cessation if a choice is available
- Keep the company’s books and accounts up-to-date
- Prepare a statement of affairs of the company, including a schedule of its creditors and amounts owed
- Consider whether a financial strategy is possible identifying any part of the business capable of rescue (or even worth saving) plus any possible sources of funding but borrow only if the board are certain that the loans can be repaid
- Hold regular board meetings to discuss the position with all directors and thus ensure that all are aware of the situation. Minutes must therefore be kept - keeping notes and minutes will assist should a liquidator enquire into the actions taken
- Construct a ‘plan of action’ and try to determine the final ‘point of no return’ after which there will be no reasonable prospect of the company continuing
- Despite the protection of limited liability be aware that directors could be made personally liable for any debts being required to contribute to the company’s assets in a winding up should there be a breach of duty, fraudulent or wrongful trading (Insolvency Act 1986 s213/s214 and Re DKG Contractors Ltd (1990)). A director may be liable for unpaid personal PAYE and NI
- Retain the employees necessary for the continued running of the business and pay only current wages. In an insolvency procedure employees can make claims for arrears of wages, holiday pay, etc under the Employment Rights Act 1996
- Ascertain which goods are subject to ‘retention of title’ clauses in the conditions of sale where legal ownership does not pass until the buyer has paid for the goods - these goods cannot be removed in a liquidation unless the liquidator has scrutinised the claim
In the period leading up to cessation, the directors should:
- Not incur any further credit - pay by cash or accept deliveries from suppliers only if it can be proved that the goods can be sold at a profit. Do not dispose of any company property on credit
- If the usual practice is to take deposits from customers suggest place those deposits in a separate bank account and only accept if the contract can be fulfilled
- Not dispose of company assets at an undervalue - defined by the Insolvency Act 1986 s 238 as “occurring where the company confers a benefit without obtaining due consideration at a time when the company is unable to pay its debts”. The court has the power to reverse the transaction if having taken place within the two years prior to liquidation unless made in the reasonable belief that the company was able to continue trading - again, record/minute everything - keep the paperwork
- Sometimes directors buy assets personally to inject monies into the company; if so the transaction must be at “arm’s length” and if in excess of £5,000 formal written resolution allowing the sale is needed. Failure to obtain approval could be investigated by the liquidator
- Not pay one creditor to the detriment of another. The liquidator will look at the treatment of creditors and specifically for evidence of preferential treatment (eg warning a creditor of the impending liquidation and settling their debt in full) as those payments could be set aside by the court (Re Conegrade Ltd 2002)
- Not make payments to satisfy directors loans (see Re Corfe Joinery Ltd 1997 where payments made to directors in the last days of a company to repay outstanding loan accounts were ruled ‘preferential treatment’ by placing the directors in a better position than other creditors)
- Not conceal or destroy any company books or papers.
And most importantly... don’t resign. This could also be viewed by the liquidator as “failing to meet obligations”.
The penalties for non-compliance will be discussed in the next article.
Jennifer Adams FCIS TEP ATT is a freelance writer and author specialising in tax and company secretarial issues, and can be contacted at Abacus Business Solutions.