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Understanding personal liability in insolvency
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On 28 March 2020, the Government announced new insolvency measures to support businesses under pressure as a result of the coronavirus outbreak. The Government will amend insolvency law to give companies breathing space and keep trading while they explore options for rescue and temporarily suspending wrongful trading provisions retrospectively from 1 March 2020 for three months. You can find out more here. Directors must still be mindful of their fiduciary duty to creditors and shareholders and early advice is always the best protection against any criticism.
Actions against directors: assignment of claims to a third party
New legislation to protect the interests of creditors means that, as a director, you’re more at risk of personal liability. An amendment introduced in the Small Business, Enterprise and Employment Act, 2015, means that various actions against directors, including wrongful and fraudulent trading, can now be sold to third parties.
So what does this mean for you as a director? One of the main concerns is that companies will be set up with the sole aim to profit from aggressively pursuing litigation claims against directors. Even without that particular threat, however, the fact that actions can now be brought by administrators as well as liquidators, increases your overall exposure to risk.
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One of the reasons why action isn’t always pursued by an administrator or liquidator is the uncertain cost of bringing a case, and the burden of proof that’s needed to successfully complete it.
Even if the proof is there, it isn’t always in the administrator’s interests to continue because of the time involved in pursuing these cases.
But the fact that they can now be sold to creditors, either individually or as a group, means that actions are likely to become more common. So what are the types of action that we’re talking about?
- Wrongful trading: mismanagement of the company without the specific intent to defraud. For example, failing to complete statutory returns or allowing tax arrears to build up.
- Fraudulent trading: this could include deliberately entering into transactions with suppliers in the knowledge that payments won’t be met, or taking a high salary from the business when figures show that it can’t be supported.
- Preference: placing a third party or connected party in a more favourable position than would have been the case, should the company become insolvent.
- Transactions at undervalue: allowing a transaction to be made below market value for the benefit of the recipient or the business.
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If creditors suffer significant losses because of the way in which directors have run the business, it’s easy to see why they would be motivated to take the matter further. Former employees who have lost their only source of income could group together, or join other creditors who have suffered a material loss.
A feeling of aggrievement naturally provides much greater motivation for creditors to take action, than that of an insolvency practitioner who has an eye on the time involved as well as the uncertain costs. But of even greater worry is the fact that cases could be taken on by claims firms, established purely to profit from this amendment to legislation.
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It’s possible that an entire industry could arise from these new measures. Aggressive pursuit of directors by claims firms specifically set up for this purpose presents a significant new threat for company directors.
The government’s aim is to bring more unlawful trading and wrongful trading cases against directors, in order to increase transparency in business and confidence in the insolvency process as a whole.
The encouragement of civil claims is likely to result in just that – more claims against directors, which if successfully made could result in:
- Director disqualification for up to 15 years
- Personal liability for some or all company debt
- A prison sentence in the most serious cases of unlawful trading
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As a director, you have a legal obligation to manage the company responsibly. This includes filing statutory returns and making payments, but above all, being aware of the company’s financial situation and taking appropriate action quickly if necessary.
If you suspect that insolvency is looming, you need to maximise creditor interests if you’re to avoid allegations of wrongful or unlawful trading. The fact that insolvency practitioners are now required to report to the Secretary of State on all directors during an insolvency process, immediately increases the risk of action being taken against you.
If your business is struggling financially, you can help to protect yourself by getting professional advice on where you stand as a director. It’s highly recommended that you seek this well before insolvency is an issue – it might only take a few minor adjustments to cash flow management to set your business back on track.
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Further Reading on Actions against directors: assignment of claims to a third party
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