Directors Duties – the formal stuff
Company directors should be aware of their duties under Companies Act 2006 (Act) which are:
- To act within their powers given under the company’s constitution and the Act;
- To promote the success of the company for the benefit of its shareholders;
- To exercise independent judgement;
- To exercise reasonable care, skill and diligence;
- To not to accept benefits from third parties; and
- To avoid or manage conflicts of interest and to declare interest in proposed transaction or arrangement.
Insolvency and directors’ duties – when economic hardship strikes
The duties are owed to company and in certain circumstances to its shareholders. However, when a company is insolvent or is likely to become insolvent, the directors must take into account the duties they owe to creditors of the company in addition to the duties set out in the Act. The directors should also take care to ensure that they do not make the creditors’ situation worse to avoid any personal liability. It is no longer possible to act in the interests of shareholders – all actions must be taken to be in the best interest of the creditors.
Is my company solvent?
In the current rapidly changing circumstances, the directors should check regularly (and probably daily) if the company is still solvent and seek appropriate advice should there be any doubt with regards to the company’s solvency. There are two tests of solvency:
- cash flow test – a company can pay its debts as they fall due.
- balance sheet test – a company has sufficient assets to meet its liabilities (including contingent and prospective liabilities) as and when they fall due.
Checking for solvency includes being in regular contact with the company’s bankers, to ensure that banking arrangements are secure, and the bank is kept updated. It is important to maintain good communication so that funding is not withdrawn unexpectedly, or if your cash flow dries up you are not unable to replace it with bank funding. You must document these discussions and any decisions you take.
Risk of insolvency in the times of COVID19 and directors’ obligations
The directors may become personally liable for wrongful trading if company continued trading at a time when they knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration. The liquidator or administrator of the company will be able to seek a court declaration that the directors of such company make a contribution to the company’s assets.
Even though no specific legislation has been produced yet, the Government announced on 28 March 2020 that it is to suspend the operation of rules relating to wrongful trading for three months from 1 March 2020, with the possibility that such period of suspension may be extended. It is widely anticipated that there may be some caveats to this general rule.
However, the directors should be careful as the other provisions of the insolvency laws still apply.
Directors should be very careful when they are proposing to transfer any assets of the company if there is any likelihood of insolvency. An appointed liquidator or administrator may seek to set aside a transaction entered into below market value before a company entered into liquidation or administration. Likewise, if some creditors are paid in preference to others, you need to be very clear as to why those payments have been made – for example because a statutory demand has been presented. It would be difficult to explain payments made to connected parties, such as the directors or shareholders or any associated companies, as these will be vulnerable to attack by any appointed liquidator or administrator.
Directors may become personally liable if they are found guilty of a breach of their fiduciary duties which may include improper payment of dividends. Directors should be cautious and aware of their duties and liabilities in current time and seek advice in doubt.
What should directors do to minimise personal liability
If appointed, the administrators or liquidators will review all available records. Decisions to take further action will be made considering any contemporaneous documents (or lack thereof!). Any director of a company at risk of insolvency should
- hold board meetings regularly to ensure all decisions are taken after due and careful consideration by all directors
- keep detailed minutes of the meeting and discussions held and circulate them to all the directors
- record as much information as possible in relation to any transactions entered into or decisions made and why those decisions were made
- review the financial health of the company on a regular basis and update forecasts and keep cash flow under control in these changing circumstances
- keep in touch with your bank
- if in doubt engage professionals and obtain advice to ensure and demonstrate that you have conducted your duties diligently and in the best possible manner in these challenging times.
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