Share this content
AIA

Directors’ duties for companies in difficulty

by
24th Apr 2012
Share this content

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.

Tags:

Replies (11)

Please login or register to join the discussion.

By ksagroup
25th Apr 2012 11:05

Good Article

This is a very good article.  The first point is important as any director should get insolvency advice from a turnaround practitioner as often initial advice is free and can help put directors minds at rest. 

If a company is in difficulty then the directors also have an obligation not to make the creditors position worse and stopping trading immediately should be considered if the company really has no future and debts are likely to increase.  It is harder to criticise a director that has realised the problem and has not made it worse by continuing.

 

 

 

Thanks (1)
avatar
By brianheg
25th Apr 2012 11:07

Good article

I would add 1 to your list of "don't dos" - if there is a personal guarantee in relation to an overdrawn bank account, the directors will be creating a preference in favour of both themselves and the bank by lodging receipts from debtors to the bank account. Where possible, the directors need to hold any monies received and pass them to an incoming liquidator rather than lodging them to the overdrawn account. 

Thanks (1)
avatar
By Peter Rust
25th Apr 2012 11:21

Bradford & Bingley

I just wonder if any of this is relevant to the directors of Bradford & Bingley, among other banks? Was there not a Rights Issue rather late in the day?

Thanks (0)
avatar
By The Rogue
25th Apr 2012 11:21

Why bother?

My company has had many customers go bust owing us money.  It's a fact of life in our industry and we make provisions for the likelihood.  Generally the pattern is that they buy as much as possible just before the end in an attempt to keep supplies in and production going even if they know that the company is doomed.  And if they don't realise the end is nigh they must be pretty rubbish.

Because they have often done other things to keep the cash flowing (factoring debts, injecting personal loans etc) there is generally no cash at all in the company and the liquidator won't run any kind of investigation because they won't get paid for it out of the proceeds.

Thanks (1)
avatar
By lme
25th Apr 2012 11:29

Great article - thanks

I found the point about acting for the creditors particularly helpful - I thought you had to cease to trade immediately the company is insolvent but presumably, say, if there are a couple of pieces of profitable work in progress they could be finished up and the profit booked, to everyone's good.

Thanks (1)
avatar
By zebaa
25th Apr 2012 15:52

This is a poor article

I take a different opinion to ksagroup for several reasons. To list but a few, this has been written as though it has been extracted from a text book. As far as I can see there is no personal voice. No tales from the coal face. On this site there seems to be little understanding from some people of what happens when a company fails and this article does little to redress that.

In many cases there is no liquidator. In other cases there is sharp practice of directors being given doubtful advice to spend several thousand pounds to wind the company up.

Which brings me to my final points. The one bit of real advice Ms Adams offers is' ...most importantly...don’t resign. This could also be viewed by the liquidator as “failing to meet obligations”.

This bald - and bad - advice comes without any qualification or reference whatsoever. Has she ever seen a liquidator take action for a director resigning? We do not know. We are not told.

My real point, however, is In the case of no liquidator, resignation may progress the companies' end and may also provide directors with protection. For the reasons given, this is a poor article

 

Thanks (0)
avatar
By EOAKS
25th Apr 2012 16:47

Good article

As someone who specialises in businesses facing closure (companies, partnerships etc) may I say that I do not agree with zebaa - may I also make a suggestion that he has not read the article as intended.

Nowhere did Jennifer say that an insolvency practitioner is appointed in all cases. All the points made are valid whether a 'one man director' company or a large company with more directors.

Also... its a 'checklist' quoting the tax law as it stands quoting tax cases that might be less well known - there's no room for personal stories.

 

 

Thanks (0)
avatar
By philh74a
26th Apr 2012 13:05

Good in principle...

Two weeks ago, our customer placed a sizeble order with us which we delivered on credit. Credit rating agencies had them at £10k limit so no problem. A week later we received the Liquidation documents from the Liquidator - has the Director committed some illegal act as he knowingly ordered on credit knowing he was going bust? Retention of Title isn't worth a light in these situations as the customer always moves the goods out before shutting the doors.

And what about the Liquidator - they were obvioulsy in discussions with the customer about liquidation at the time they placed the order. Surely they've failed in their duty as well.

I would like to see some changes in legislation where Liquidators inform Companies House at the outset of discussions with struggling companies so that the credit rating / risk can be adjusted earlier to help us Creditors.

All the theory above is nice, but the reality is the creditor is stitched right up everytime.

Thanks (0)
By ksagroup
01st May 2012 16:24

Wrongful trading

To knowingly take on credit when you know you cannot pay it is what is known as wrongfully trading and you could be disqualified as a director.  The same applies to taking deposits when you know that you cannot fulfill orders.   The liquidator will not have known that the director had done this prior to his official appointment at the creditors meetings.  Directors lie to the liquidators as well especially when .  Once appointed then the liquidator can look at the transactions.  Of course proving wrongful trading is not easy. 

Thanks (0)
avatar
By The Rogue
01st May 2012 18:11

Wrongful Trading

Nor is proving wrongful trading cheap.  The liquidator will only put any effort into an investigation if their time costs will be re-imbursed.  I understand that this comes from the proceeds of the liquidation so if there is nothing left in the business (usually the case in my experience) there will be no investigation.  Johnny Director can start a new business (blaming the recession for the failure of the old one) and two years later he will go bust again because actually the problem was that he didn't know how to run a business.

And if wrongful trading is proved does anything happen to the directors?  They will have signed any valuable possessions to someone else or taken out a large mortgage on their houses so even if they are found guilty of wrongful trading and made personally liable for any debts they won't have a bean to actually make payments.  Then they start up a new business with someone else listed as director but really they call the shots.

While the article above is no doubt a good summary of the law and directors are supposed to look after the creditors in the event of pending collapse in real life it ain't like that.

Thanks (0)
avatar
By yeboyye
04th May 2012 22:45

Liquidator says "I can't tell you"

For what its worth I agree 100% with The Rogue.  The liquidator reviews the director's or the directors' actions prior to liquidation and, I'm told, sends a report to the Department of ... however the creditor has no right to read this report.  As for Retention of Title, unless your goods are sitting at the back door of the warehouse, untouched, still in their boxes, forget it.

Thanks (0)