When a company becomes insolvent the directors are legally obliged to maximise interests for the creditors they’re indebted to. A company is considered insolvent when it is unable to meet its financial obligations and/or when its liabilities exceed its assets. After a company has been deemed legally insolvent the directors must begin taking action to repay debts in any way possible. This means they cannot do anything that would increase debt, and there must be a reasonable prospect of the debts being repaid or the company could face further legal action. In other words, the primary function of the company goes from serving the best interests of its directors and shareholders, to serving the best interests of its creditors.
It is important to note that registered directors are not the only entities given the obligation to act in the interest of creditors during times of insolvency. Anyone who actively controls the company is responsible for directing the affairs of the company (i.e. - the owner), or instructs the directors on what actions to take (legally referred to as a “shadow director”) is also obliged to act in the interest of creditors.
If a director fails to act in the best interest of the creditor and the company is subjected to a formal insolvency procedure, the director’s conduct and the company’s transactions are reviewed by the courts and the investigation may reach back as far as 3 years. Ultimately, the company may be deemed bankrupt and go out of business completely. Thus, fulfilling your duties as a director during times of insolvency is crucial in ensuring the survival of your business.
If a director engages in any of the following practices during insolvency they may be held legally liable:
Fraudulent Trading – conducting business with the intention to obtain the funds needed to repay creditors by performing any of the following fraudulent actions:
If the court finds you guilty of fraudulent trading you could be ordered to make a personal financial contribution to the insolvent company in order to cover debts, and you could face up to 7 years imprisonment.
Wrongful Trading – continuing to enter into contracts or trade as usual knowing that there is no reasonable prospect of being able to repay creditors. If you’re found guilty of wrongful trading the court may disqualify you from acting as a director for any company for a period of up to 15 years.
Treating Creditors with Preference – choosing to make payments to one creditor in preference to another; you’re obligated to act in the interest of all creditors, not just one in particular. If the court finds you guilty of this they may set aside the transaction and order the transferred assets to be refunded to the insolvent company or you as the director who authorised the payment may be ordered to refund it.
Misfeasance – violating fiduciary duties by wrongly withdrawing funds from the company or utilising company funds for matters other than business activity. If you’re found guilty of misfeasance you may be ordered to make a personal financial contribution to the insolvent company.
Failing to Meet Personal Guarantees – If you enter into a personal guarantee in order to obtain a loan, and then fail to meet the terms of this guarantee, you could be held personally liable for repaying the amount due.
Undervaluing Transactions – engaging in a transaction in which assets (i.e. – products or services) are transferred at a value far less than their market value. In other words, you can’t sell your entire inventory at half the market value and use this money to repay creditors. If the court finds you guilty of this they may reverse it by ordering you, or the recipients of the assets, to refund them into the possession of the insolvent company.
Of course, there are various exceptions, defences, and time statutes that pertain to the aforementioned statutory duties. The best way to uphold your duties as a director during insolvency is to keep a thorough record of company transactions, and to consult with a professional Insolvency Practitioner regarding any matters you’re unsure of.
4th December 2018
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