Dispute Resolution

Recently, there have been a number of high profile insolvencies hitting the headlines with a number of High Street retailers entering insolvency either by proposing a company voluntary administration (“CVA”) or via another formal insolvency process. With the recent number of high profile insolvencies there has been scrutiny of directors’ duties not only by media but also at government level. Recently, for example, the Department for Business, Energy and Industrial Strategy paper on Insolvency and Corporate Governance was published which discusses, amongst other issues, directors’ duties and the enforcement of directors’ duties.

Statutory Duties of Directors and Impact of Insolvency

The statutory framework for directors’ duties is set out in sections 170-180 of the Companies Act 2006. The duties are general and apply to all directors, including shadow directors and de facto directors. Directors’ duties are owed to the company and its shareholders, not individual members, which means that only the company may enforce them.

Directors have the following duties:

  • to act within powers;
  • to promote the success of the company;
  • to exercise independent judgement;
  • to exercise reasonable care, skill and diligence;
  • to avoid conflicts of interest;
  • not to accept benefits from third parties; and
  • to declare interest in proposed transaction or arrangement.

Ordinarily, directors owe duties to the company and its shareholders but when a company is verging on insolvency or becomes insolvent the directors are obliged to have regard to the interests of creditors. Once an insolvency practitioner (“IP”) is appointed and the formal insolvency process has begun IPs, and in some cases creditors, have the ability to challenge the conduct of the company’s directors in order to recover monies and/or assets from the director for the benefit of the creditors.

Although a company may continue to try to trade out of its financial difficulties in an attempt to avoid formal insolvency, directors must be mindful of creditors’ interests and should be aware that a director has duties to creditors when a company is insolvent or verging on insolvency. On insolvency becoming likely, directors must ensure that the financial position is kept under constant review to ensure that they are not acting to the detriment of creditors and that by continuing to trade they are not worsening the creditors’ position.

Challenges Under the Insolvency Act 1986

In terms of the Insolvency Act 1986 (“the 1986 Act”) there are a number of grounds for challenge including:

  • Misfeasance under section 212 of the 1986 Act. Where a director has misapplied, retained or become accountable for any money or property of the company the court may order a director to make such a contribution to the assets of the company as the court thinks proper.
  • Fraudulent trading under section 213 of the 1986 Act. Where it appears that a director has carried on any company business with intent to defraud creditors of the company, the court may order a director to make such contribution to the assets of the company as the court thinks proper for the benefit of creditors. In practice, actions under section 213 of the 1986 Act are relatively rare.
  • Wrongful trading under section 214 of the 1986 Act. If the company is insolvent, or at some time before the winding up, the directors knew or ought to have concluded that there was no reasonable prospect that the company could avoid an insolvent liquidation or administration  the court may order a director to make such contribution to the assets of the company as the court thinks proper. The court will not grant this order if it considers that the director took every step possible, with a view to minimising the potential loss to creditors. The court will also consider the general skill, care and experience that may be expected of person carrying out the same functions as the director in relation to the company as well as the general knowledge, skill and experience that the director has.

The underlying aim of sections 212, 213 and 214 of the 1986 Act is to restore the company to the position that it would have been in had the conduct that is challenged not taken place, and so avoid disadvantage to creditors.

In addition, a director can be disqualified for a period of between 2 – 15 years if a director breaches his directors’ duties and falls below the standard required of a director rendering him unfit to be concerned in the management of a company.

Warning for Directors

The high profile cases that have hit the headlines act as a stark reminder that all directors of companies, regardless of how small or large, must comply with their directors’ duties. Directors must be particularly mindful of creditors when a company is verging on insolvency or becomes insolvent. The consequences of a director breaching his duties can have serious repercussions, including personal liability to repay monies to the company and being disqualified from being a director. If a director is in any doubt, independent advice should be sought as soon as possible.