What are a director’s duties in Insolvency?
We often receive phone calls from directors who speak to insolvency firms and become worried about their duties as a director. We know that insolvency can be a minefield, so we’re answering the question, what are a director’s duties in Insolvency?
What are your director’s responsibilities when you’re not insolvent?
- Act in the best interest of the company
- No conflicts of interest
- Exercise reasonable skill, care and diligence
When your business is solvent, your responsibilities are to the shareholders of the company. A member’s voluntary liquidation is an option for solvent companies. Find out more about overdrawn director’s loan accounts in a member’s voluntary liquidation.
What does it mean when a company becomes insolvent?
- Can’t afford to pay company debts when they fall due (financial difficulty)
- Your liabilities are worth more than your company assets
- Someone has taken legal action (CCJ, Statutory Demand or a Winding-Up Petition)
When your business becomes insolvent, your responsibilities as a director change from your shareholders to your creditors. From the point of a company’s insolvency, you have to act in the best interest of your company’s creditors and not make their positions any worse.
What happens if you breach your director’s responsibilities?
The consequences of breaching your director’s duties can be pretty harsh. They can include personal liability for business debts and disqualification. Your duties need to be taken seriously. Don’t worry – we’re going to give you some tips if your business is becoming insolvent and you still need to adhere to your duties.
Tips on adhering to director’s duties in insolvency procedures
Don’t take any more debt
If you know your business isn’t going to survive, you should avoid taking on more debt and running up bills with suppliers or creditors or increasing your HMRC arrears.
Don’t pay creditors preferentially
If you have some money left in the bank, you can’t pay one person over another. This is known as a preference payment. Even if you have signed a personal guarantee on a payment, you cannot pay this back over another payment.
Keep up to date with your management accounts
Many directors rely on their year-end accounts instead of keeping up with accounts throughout the year. This can be a problem because by the time you assess your year-end accounts, they’re likely out of date. We would recommend tracking the accounts monthly or quarterly so that you know the financial position of your company in real-time.
Keep regular meeting notes
If you’ve become insolvent but you’re going to continue trading through it, you need to keep a record of your decision-making process and justification as to why you are continuing to trade. You may be opting to continue trading due to having some significant business proposals in the pipeline, and perhaps just one of these would be enough to turn the business around.
Make sure you keep all of these notes on file. If you do end up in liquidation further down the line, these notes will be helpful for the insolvency practitioner. These notes will show that you are taking your fiduciary duties seriously.
Ensure your HMRC filings are up to date
This involves getting your VAT returns in on time and getting your year-end accounts done.
Continue to speak to creditors
Our best advice is to speak truthfully to your creditors. If your creditors are aware of your financial situation, they might be more understanding when you do struggle to make payments.
If you are experiencing creditor pressure and you’re choosing to ignore it and bury your head in the sand, you may end up facing bailiff action. This may lead to bailiffs turning up at your door, or you may receive a winding-up petition through the post.
It’s really important that you speak to creditors and keep them updated with the situation if your company is insolvent or if you believe you are becoming insolvent. This could be a simple phone call where you tell them you can’t afford to pay, but you’ll see what the situation is like next week.
I think my company is insolvent – what do I do?
If you think your business is insolvent, you must seek advice early. This will give you more options. Even if you believe you are insolvent, there may be a way of turning it around and recovering the business. Some directors choose to re-finance business assets or enter a Company Voluntary Arrangement or an administration.
There are lots of options available, but the longer you leave it, the less chance you have of getting a favourable outcome.
If you get advice to enter liquidation or administration, you should do this promptly. If you get a proposal and then leave it for 6 months, you are not acting responsibly as a director, and you may be trading insolvently.
Your director’s duties will be in the spotlight when you become insolvent. If you end up in liquidation, the insolvency practitioner is going to look at how you have behaved in the run-up to the insolvent company closure. If you are found to have breached these key duties and responsibilities, personal issues may arise.
What is wrongful trading?
According to the Insolvency Act 1986, wrongful trading is when company directors have continued to trade even though:
“They knew, or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation.”
They did not take “every step with a view to minimising the potential loss to the company’s creditors”
If your business is heading for insolvency, you, as a company director, must act responsibly and put your creditor’s interests ahead of your own. The liquidator is going to look very closely at how you acted in the time leading up to your insolvency.
What are some examples of wrongful trading?
- Not submitting up-to-date accounts
- Building up large HMRC arrears with no intention to pay them
- Draining the business account down to zero before you liquidate
- Repaying money to yourself over other creditors
- Continuing to take credit from suppliers knowing that you can’t pay it back
- Taking deposits off customers with no prospect of completing the work
A preference payment is a payment made to a creditor when others are due to be paid first. Occasionally, directors receive payment from family members to keep the business afloat. Then, when directors suspect insolvency, they make a payment back to the family member.
When this is uncovered by the insolvency practitioner, it will be labelled as a preference payment. Other examples of preference payments are as follows:
- Director’s loans are repaid, or other payments are made to directors or the company’s shareholders before any external creditors.
- Certain suppliers are repaid who will continue to supply when a future business is set up.
Any payments made from contractual obligation, such as employee salaries or those made under evidence of duress, would not be considered a preference payment.
A transaction undervalue is when a company’s assets are sold for much less than their market value. Directors may choose to do this as they plan to reopen the company after insolvent liquidation. If this is your plan, you can use a pre-pack liquidation. You must meet specific criteria and chat with an expert to ensure that it is the most suitable option for you.
A pre-pack liquidation will ensure that all aspects are completed correctly and legally. All of the company’s assets must be valued by an independent valuation company.
Overdrawn director’s loan accounts
Efficient tax planning can involve the use of directors’ loans, but they must be considered as part of an insolvency process. Debts can begin to spiral if not adequately managed. Still, it is important not to prioritise repaying a director’s loan over other creditors, as this could fall into the category of preference payments.
It is crucial that you ask the licensed insolvency practitioner to check all director’s loan accounts before you appoint them. Failure to do so may result in a nasty surprise further down the line.
This is more serious than wrongful trading because it is a legal matter rather than a civil matter. Fraudulent trading is generally classified as promising services by taking money from customers with no intention of fulfilling them.
If your business is at risk of insolvency, directors can reduce the risks of being accused of fraudulent trading by doing what they can to limit losses to creditors.
What are the consequences for a director?
Wrongful trading is not something to be taken lightly. If you are accused of wrongful or fraudulent trading, you could be faced with a number of issues. These may include fines, director disqualification or even a prison sentence. You may even be held personally liable for some of the company’s debts. These are not things that you want to deal with in addition to the liquidation.
We hope this has been useful and given you a better understanding of director’s duties in insolvency. We’re always happy to provide honest, confidential and professional advice.
Director’s Duties in Insolvency FAQs
Can directors face criminal charges for breaching their duties in insolvency?
Depending on the extent of the breach, a director can face criminal charges. Within every liquidation, the director’s conduct must be assessed. If you are found to have badly breached the contract, you will face consequences.
Is there any defence available to directors in case of breaching their duties in insolvency?
There may be some options for defence if you have breached your duties. These include the business judgement rule, reliance on others or delegated power. You will need to prove that the reason for breaching was to benefit the company.
Can directors be disqualified from acting as directors if their company becomes insolvent?
If you have acted responsibly, you will not be disqualified as a director. However, if you have breached duties and not acted responsibly, you could face disqualification. The courts will inform you of their decision.
What should I do if I suspect that the company is facing insolvency?
If you suspect that your company is heading to insolvency, you should seek advice as soon as possible. If you seek advice early, you’ll be adhering to your duties as you’re trying to help the company rather than running it into the ground.