Directors' responsibilities if a company is in financial difficulty and dealing with investigations
If a company is in financial difficulty, directors’ responsibilities may change.
Responsibility to creditors before insolvency and for wrongful trading and other conduct
Directors of a company in financial difficulties should consider seeking appropriate professional advice (see ICAEW’s practical guidance on Why early action is the key to avoiding or surviving financial difficulties).
s172(3) CA2006 provides that the duty under s172 to promote the success of the company for the benefit of its members has effect subject to any rule of law that require directors to consider or act in the interests of creditors. Under common law, where the company is insolvent, or bordering on insolvency, but is not faced with an inevitable insolvent liquidation or administration, the directors should consider the interests of creditors, balancing them against the interests of shareholders where they may conflict. The greater the company’s financial difficulties, the more the directors should prioritise the interests of creditors. Where an insolvent liquidation or administration is inevitable, the creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company. The duty is engaged when the directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable.
For instance, if the directors were to pay dividends in these circumstances, this would almost certainly not be in the interests of creditors and the company is likely to have a claim against them for breach of duty.
Directors should therefore consider whether the company will still be solvent following a proposed dividend or other distribution. This means considering the immediate cash flow implications of a dividend and the continuing ability of the company to pay its debts as they fall due.
When the duty to consider the interests of creditors is triggered, directors must consider the interests of creditors as a whole, and not only the interests of a particular creditor or class of creditor.
If a company goes into insolvent liquidation or administration, a director can be personally liable for wrongful trading under IA1986 s214. This liability arises if the director concludes or should have concluded that there is no reasonable prospect of avoiding insolvent liquidation or administration (under a balance sheet test) and does not take every step that the director ought to take to minimise potential loss to creditors.
To avoid (or minimise) liability for wrongful trading, directors may have to cease trading. Resignation may be considered as an abrogation of responsibility and not serve to protect a director from liability. A director who resigns from office may still be liable for any wrongful trading that took place during the director’s time in office.
Even if a company is not insolvent on the balance sheet test, directors should be aware that a creditor may be entitled to seek to have a company wound up if it is insolvent under a cash flow test. Winding up may trigger a forced realisation of the company's assets, possibly leading to a balance sheet insolvency that might not otherwise have arisen.
Directors are also responsible for complying with other laws in the context of insolvency, including the law on fraudulent trading, and should be aware that, when a company goes into insolvent administration or liquidation, past transactions may be challenged, for instance, as a transaction at an undervalue or as a preference. Certain transactions may also be challenged as transactions defrauding creditors (whether or not the company is insolvent). Responsibility for notifications under employment and pensions law.
Responsibility for notifications under employment and pensions law
Directors should consider their notification obligations under both employment and pensions legislation at a time when the company’s solvency is in doubt.
Director’s responsibility after insolvency
When a company goes into liquidation or administration the directors lose their powers to control the company's affairs or to conduct acts in the company's name as the company’s business will be conducted by the insolvency officeholder. However, their general duties (including to act in the interests of creditors when the company is insolvent) may continue and apply independently of duties of the insolvency officeholder (for instance, in connection with a sale of assets between the company and director). Directors may be required to assist an insolvency office holder with the insolvency process. For instance, they may be required to produce a statement of affairs in connection with the insolvency office holder’s report that are produced on all directors of companies in insolvency procedures.
Responsibility to cooperate with investigations
There are powers under CA1985 for inspectors to be appointed to investigate solvent companies, including powers to require production of documents and explanations of them. These powers may be used, for instance, to investigate if the business of the company is being conducted with the intent to defraud its creditors (or others) or to investigate the ownership of a company or possible misconduct by the directors with respect to the company or its shareholders. Directors must provide reasonable assistance to the inspectors.
The behaviour of companies and their directors may also come under scrutiny of Select Committees of the Houses of Parliament.
For other sections of this guide, please see below: