Practical advice for the director of a company in financial difficulty

In this article we take a look at directors’ duties in the context of possible company insolvency. Our aim is to provide some practical steps for a director in this position to assist in fulfilling their duties and to mitigate their risk of personal liability.  As such, it hopefully provides some useful initial guidance but it is no substitute for seeking further advice from appropriately experienced solicitors and/or insolvency practitioners.

The Situation

The Switch of Responsibility

Ordinarily, your primary duty as a director is to act in the best interests of the company and its shareholders. This entails making decisions that promote the success of the business while considering the long-term interests of shareholders.  This duty changes, however, once you form the view (or ought to have) that the company is insolvent or is bordering on insolvency, at which point your primary duty is to act in the interests of the company’s creditors.

Most basically, a company is insolvent when its assets are exceeded by its liabilities.  For a clearer view on this, see our previous article on this point.

Personal Liability

Where the company does enter a formal insolvency procedure, such as liquidation or administration, the conduct of directors is scrutinized to determine whether they have acted properly. The following are key areas where improper conduct can lead to personal liability:

• Wrongful trading
  This is allowing the company to continue trading when insolvency is inevitable.
• Fraudulent trading
  The knowing engagement in fraudulent activities to deceive creditors, or falsifying company records.
• Misfeasance or breach of fiduciary duty
  Directors must handle company funds and assets with care and integrity and avoid breach of fiduciary duties, such as misapplying company funds.
• Transactions at an undervalue
  These are transactions that disadvantage creditors, such as making a gift or selling assets below market value when insolvent, or which causes the company to be unable to pay its debts as a result of the transaction.
• Preferences
  Giving preferential treatment to certain creditors over others may be deemed unfair and subject to court intervention if the preference was given at the relevant time and the company was insolvent at the time, or became insolvent as a result.
• Personal guarantees
  Directors who provide personal guarantees for company debts may be personally liable if the company defaults.

How to approach it

Practical Steps

It is advisable to keep financial matters under constant review in this situation. More specifically, consider taking the following actions:

• Regular meetings
  Convene frequent board meetings dedicated to reviewing the company’s financial status. Ensure comprehensive minutes are taken, highlighting decisions and their rationale.
• Maintain records
  Maintain accurate and up-to-date financial records for the company.
• Monitor expenditure
  Continuously monitor the company’s financial health and future cash flows, exploring ways to reduce expenditure.
• Take advice
  Engage professional assistance to explore strategies to alleviate or resolve financial challenges and to evaluate whether insolvencyis unavoidable.
• Resignation as a last resort
  Resignation from office should be a last resort and does not end your responsibilities or release you from liability. If it is unavoidable, record any dissent with other directors and explain your reasons for leaving in a resignation letter addressed to the whole board.

Additional Steps

For situations where a company’s survival depends on securing additional funding, consider the following:

Do:

• Seek professional advice
  Obtain expert advice for major decisions, ensuring that advice is properly documented as a reference point. Consider seeking separate advice in your personal capacity.
• Review funding sources
  Prepare a comprehensive list of potential funding sources, documenting the board’s approach to pursuing each option.
• Convene regular board meetings
  Ensure all directors attend regular board meetings so that the whole board is aware of the company’s financial status. Circulate the minutes of such meetings as evidence and be clear to explain the steps taken to mitigate potential loss for the creditors.
• Engage with stakeholders
  Interact with lenders and other stakeholders to address any breaches of contracts promptly.
• Establish timetables
  Develop a timetable for financial decision points to determine whether insolvent liquidation/ administration is unavoidable and then strictly adhere to such deadlines to assess the company’s viability.
• Maintain personal records
  Keep personal records of discussions and meetings, especially if in disagreement with decisions made.

Don’t:

• Incur new liabilities
  The company should avoid incurring substantial new liabilities until securing further funding, except in cases deemed essential and in the company’s best interest.
• Delay reporting issues
  You should immediately report any concerns regarding the company’s insolvency to the board so that legal and financial advice can be taken.
• Wait for external signals
  The company should avoid relying solely on external indicators such as winding-up petitions. Instead, directors should maintain up-to-date financial information and monitor compliance with financial agreements proactively.
• Overlook warning signs
  Whilst you should not be relying on them in place of your own monitoring, where warning signs such as creditor pressure or late filing of accounts do arise these should be given due attention as possible indicators of insolvency.
• Ignore conflicts of interest
  You should remain mindful of potential conflicts of interest and act in the best interests of the company and its creditors.
• Neglect insurance coverage
  You should check the terms of applicable directors’ and officers’ insurance policies to understand the extent of coverage.
• Think that resignation will absolve you
  Directors should be taking measures to minimize potential losses for creditors, including potentially triggering insolvency procedures. Simply resigning does not achieve this and certain obligations continue past resignation.

Contact our corporate recovery and insolvency solicitors today

If you have any questions regarding any of the issues raised in this article, please do not hesitate to contact our specialist corporate recovery and insolvency team by using our online enquiry form or by calling 0330 191 5713.