How can directors ensure they do not get in hot water if their company is facing financial difficulty?
When a company is solvent a director’s duty is to “promote the success of the company.” But what if the company is insolvent? Writes Jamie Playford, a director and licensed insolvency practitioner with Parker Andrews Ltd.
It is important that a director understands what “insolvent” means.
The Insolvency Act 1986 contains three texts which broadly are:
- Balance sheet –if a company’s liabilities exceed its assets
- Cash Flow – if a company cannot pay its debts as they fall due.
- Legal Action – if a company has an unsatisfied CCJ or Statutory Demand.
If insolvency occurs, a director’s duty is in the general body of the company’s creditors rather than the shareholders or the company generally.
A director should take an objective view as to whether the problems the company is facing can be overcome. The reasons should be carefully documented at regular board meetings. This should continue until the company is out of difficulty.
If a director fails to do this and the company does enter liquidation or administration, a director could find they are facing a “Wrongful Trading” claim and can be held personally liable for any debts incurred during a period of reckless trading when the director had no reason to believe the company could survive.
There are two other, perhaps more obvious, claims that a director must avoid.
“Preference payments” are where a director allows the company to repay one of its creditors ahead of the others. The director may face having to repay this money. The most common are the repayment of a company debt which a director has personally guaranteed, or
the repayment of sums owed to a director.
A “Transaction at an Undervalue” is where a director allows the company to sell an asset for significantly less than its true value. Again, a director may be asked to repay the difference. If a company is facing difficulties, the top tips for directors to help protect themselves are:
- Objectively review the business on a regular basis. This could be monthly or even weekly.
- Document reasons that support trade continuing, such as payment plans agreed, new customers, or overdraft extension.
- Ensure financial management information is kept up to date to help rebut any claim of recklessness.
- Do not incur credit if it is unlikely to be repaid.
- Do not accept deposits for orders if they are unlikely to be fulfilled.
- Take professional advice as soon as possible. Most insolvency practitioners will also offer the first few hours of advice free; and we are able to recommend some.
