Directors, remember your duties

Over the last few weeks you can surely not be criticised if directors duties were not the first thing you woke up and though about each day.  Many business owners have spent their days wrestling to understand the assistance being made available to their businesses and trying to manage employees through new concepts such as furlough leave but most of what you did, whether you knew it or not, revolved around your directors duties and it is a good time just to recap what these are particularly in such turbulent times.

Your duties are never so important as when your company may be in distress so we are going to refresh these to ensure that you don’t inadvertently fall into a breach.  There are, at the time of writing, some changes in relation to insolvency due to Covid 19 that are expected to be brought in to law over the coming weeks which are intended to give businesses extra protection from their creditors in these unprecedented times to try to rescue their businesses. These will extend to the wrongful trading provisions as noted below although here is a summary of the position as it currently stands. 

Directors will be familiar with their duties to:

  • Act within their powers under the company’s constitution
  • Promote the success of the company for the benefit of its shareholders
  • Exercise independent judgement
  • Exercise reasonable care, skill and diligence
  • Avoid or manage conflicts of interest which may affect their objectivity

However, if a company is insolvent then the directors’ duty is to protect creditors, not themselves nor their shareholders. If a company is insolvent or in danger of becoming insolvent, it is essential that directors are aware of the duties they owe to creditors, and of the things they should and should not do.

The precise details of what factors they should take into account to discharge those duties varies from one case to another, and they should seek professional advice if in any doubt. In certain circumstances, personal liability can be imposed on directors of companies which go into insolvent liquidation, and so it is crucial that directors act correctly to minimise such risks.

Key issues for consideration

Directors need to ask themselves on a regular basis whether their company remains solvent:

There are two tests:

  1. The ’cash flow test’, a company is insolvent if it cannot pay its debts as they fall due.
  2. The ’balance sheet’ test, a company is deemed insolvent if it’s satisfied, on the balance of probabilities, that a company has insufficient assets to meet all its liabilities (including contingent and prospective liabilities) as and when they eventually fall due.

If directors think their company may be insolvent on either test, duties are owed primarily to creditors as a whole.

Directors need to consider whether the company should continue to trade if it is insolvent:

Personal liability can attach to the directors for wrongful or fraudulent trading, such that the directors can be ordered to contribute to the assets of the company. Directors can be liable for wrongful trading where they continued trading at a time when they knew (or should have concluded) that there was no reasonable prospect of the company avoiding an insolvent liquidation and they failed to take every step a reasonably diligent person could be expected to take to minimise loss to creditors.

Transactions completed in the run-up to insolvency can be challenged by the courts and, in some cases, the courts can overturn them:

Directors should be very careful if they plan to transfer assets out of a company if there is any doubt as to whether it is solvent. If the company enters into a transaction below market value (for example it sells an asset at a knock down price), there is a risk that a subsequently appointed liquidator or administrator of the company may seek to set aside the transaction as a transaction at an undervalue. In addition, care should be taken to avoid doing anything which may put a creditor in a better position than it would be in on an insolvent liquidation.  Decisions around declaring dividends are also something which can be challenged at this time so a review of your remuneration structure would be recommended.

Directors should take particular care if a group of companies is involved.

Directors of multiple companies in a group should bear in mind that transactions within the group can be vulnerable too. A director of multiple companies owes duties to each individual company and therefore conflicts may develop.

If a Director is faced with such challenges, the following practical steps should be taken:

  • Board meetings should be held regularly,
  • Full board minutes should be taken (and circulated to all directors after the meeting),
  • Maintain and review up-to-date management accounts and prepare regular cash flow forecasts, and
  • Take prompt professional advice

If you have read any of this and feel like you may need a conversation just to review your current position please do not hesitate to contact us; our team and our professional network are ready to help you in whatever way they can. In the first instance please call either; Jo Brown,  Richard Grayson, Richard Hallsworth or Emma Murray.