If solvent, a director of a company is under a duty to act in the best interests of the company and its shareholders, along with the other duties set out in the Companies legislation. However, when the company is insolvent, the predominant duty is to act in the best interests of the company’s creditors instead of shareholders.
A company is insolvent if it is either unable to pay its debts as they fall due or the value of its assets is less than its liabilities, including contingent and prospective liabilities.
If a company is insolvent then the directors can be personally liable for failing to act in the best interest of creditors (known as misfeasance) and also wrongful trading, if they continue trading beyond the time when they knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation and did not take every possible step to minimise the potential loss to the company’s creditors.
All directors (including shadow and de facto directors) can be held personally liable for the debts incurred. There is no distinction between executive and non-executive directors and the duty can extend beyond an insolvency process.
Directors also need to be wary of selling assets at significantly less than true value (transaction at an undervalue) and doing things which has the effect of placing a creditor in a better position if the company was to go into an insolvency process than if the transaction had not occurred, with the intention to achieve that outcome (preference).
Transactions at an undervalue and preferences can be “clawed back” by a liquidator or administrator and can be a ground for a misfeasance claim against the director or disqualification (see below).
If the company enters insolvent liquidation or administration, the insolvency practitioner appointed must investigate the circumstances leading to the company’s insolvency and will look into the conduct of the directors and transactions undertaken by the company in the lead up to and during the company’s decline.
They must report to BEIS on the conduct of anyone who was a director in the previous three years who will consider whether proceedings should be commenced to disqualify directors for a minimum period of two years up to a maximum of fifteen years.
If a company is in financial distress, directors should seek legal and, possibly, accountancy advice, continually assess the company’s financial position and keep accurate financial records, aim not to increase liabilities, meet regularly and keep written records of decisions made.