Directors Duties – Key Risks during COVID-19
In times of business difficulty, there are several obligations and duties that directors need to bear in mind when carrying on business. Breach of these obligations and duties could result in a director being disqualified from acting as a director, incurring personal liability and/or committing a criminal offence.
In the current circumstances, directors should closely monitor their cash resources and current liabilities, and be mindful of any risk that the company may become insolvent. Where the directors know or ought to know that the company is or is likely to become insolvent, their duties shift to a primary duty to protect the interests of the company’s creditors rather than shareholders and other stakeholders.
If a director causes a company to carry on trading in circumstances where he or she knew, or ought reasonably to have known, that there was no reasonable prospect of the company avoiding an insolvent liquidation, and failed to take appropriate steps to minimise losses to creditors, he or she could be ordered by the courts to personally contribute to the company’s assets on an insolvent winding up of the company.
If a director believes he or she may be in such a precarious position, they should take professional advice (including legal and insolvency advice). They should also carefully document and justify all relevant decisions made by the board during any period of risk, including the reasons for entering into specific transactions and arrangements.
Update: On 28 March 2020, the government announced a temporary relaxation of the rules relating to wrongful trading. For further information on the rule change see this article.
If a director carries on business with the intent of defrauding actual or potential creditors, he or she could be personally liable to contribute to the company’s assets on an insolvent winding up. The key requirement is ‘intent’. From a practical perspective, a director can be deemed to have intended to commit fraud where he or she secures credit on behalf of a company in circumstances where he or she knows there is little likelihood of the company being able to repay that debt. As such, directors need to be careful when causing the company to borrower or secure trade credit.
Recovery for misfeasance
If a director misapplies or improperly takes assets from a company (including by way of dividend), it is open to a receiver, liquidator, shareholder or creditor of the company to recover money and/or damages from the officers of the company involved in the mismanagement/misfeasance.
Transactions at an undervalue
If a company disposes of an asset at an undervalue, it is open for a liquidator to set aside the transaction. For this reason, its appropriate for directors to appropriately value assets (taking professional advice where necessary) and record the reasons for disposing of assets at particular prices.
A preference occurs when a company places one creditor in a better position than others in advance of an insolvency. A common example is simply paying one creditor ahead of others. A liquidator can set aside preferential transactions that occur within six months of the company’s liquidation if it can be shown that payment was made with the intent of providing preference. If the creditor is a connected person, that 6-month period is extended to 24 months.
If a director is disqualified from acting as a director as a result of fraud, preference or transactions at an undervalue, they could face between 2- and 15-years’ disqualification from being involved in the management of any other company.
If you are concerned about the solvency position of your company in light of the current economic environment, we recommend that you take legal and accounting advice.
For further information on any of the items mentioned in this article, please contact any member of our corporate team.
Originally published at Kermanco.com prior to the firm’s combination with Armstrong Teasdale in early 2021.