Commercial Property Sector Insolvency: Landlord Actions Against Directors of Insolvent Companies

The commercial property sector in the UK has faced mounting financial challenges, with many businesses grappling with insolvency. This has been exacerbated by economic pressures such as rising interest rates, inflation, and hybrid working patterns. With an increasingly cautious consumer market, we may continue to see elevated insolvency levels, particularly around retail and hospitality.

When a company in these sectors becomes insolvent, it can have far-reaching consequences for stakeholders, including creditors, landlords, and tenants. Landlords in particular, can feel hard done where tenants have been trading from their premises without paying rent, service charge or utilities, only to be wound up leaving significant unpaid property debts to the Landlord.

One critical area of focus in such situations, which can sometimes be overlooked and can be used by Landlords and other stakeholders, is the potential for legal action against the company's directors.

Director's duties

Company directors have specific duties, which are outlined in the Companies Act 2006, such as to promote the success of the company and to act within their powers. However, when a company is in financial difficulty, the duties of company directors shift to taking steps to safeguard the interests of its creditors.

When a company enters insolvency, the actions of directors will then be investigated by the officeholder, who will be a qualified insolvency practitioner.

In certain circumstances, where wrongdoing has been established, the court can order directors to make a contribution personally to a company’s assets.

Actions against Directors

There are a number of actions which can be taken against directors by officeholders of an insolvent company:

• Wrongful trading: the officeholder could bring a wrongful trading claim against directors. This would arise in circumstances where the directors continued to trade, even although they knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation or entering insolvent administration. This is a high test, and will require the officeholder to assess the general knowledge, skill and experience of the directors, the moment they should have known that the company could not avoid insolvency, and the actual loss to the creditors arising as a result of continued trading. If wrongful trading is established the court can order the director to make a contribution to the company in respect of the losses they have caused.

• Misfeasance: if it appears that any of the directors misapplied or retained, or have become accountable for any money or the property of the company, or been guilty of not performing their duty properly or breach of any fiduciary or other duty in relation to the company, then the court may order repayment or a contribution to the company by the directors. An action for misfeasance can be brought not only by the officeholder, but any creditor of the company.

• Trading misfeasance: this concept has only recently been introduced by the courts following the landmark 533-page judgment against the former directors of the BHS Group of companies. It involves trading in breach of directors’ duties when the company should have gone into administration or insolvent liquidation much earlier if those duties had been complied with. While there is an overlap with wrongful trading, the risk of trading misfeasance arises much earlier and can bypass the requirement that the directors knew, or ought to have known, that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration. This arguably makes it easier to establish than wrongful trading and for the officeholder to bring a claim. Again, the remedy here is that if trading misfeasance is established the court can order the director to make a contribution in respect of the losses they have caused.

• Fraudulent trading: this occurs where the directors knowingly carried on business with intent to defraud creditors or any other person, or for any fraudulent purpose. Directors found liable can be subject to a penalty, while the court on application by the officeholder may declare that contributions must be made by directors to the company's assets. Fraudulent trading will not normally, however, be made out against a director who has acted honestly.

• Transactions at undervalue or for preference: claims may be brought by the officeholder against the directors if they entered into transactions at an undervalue, or if they gave a preference creditors to the detriment of other creditors, in the lead up to the insolvency event. If such claims are successful, the court can set the transactions aside, or make an order to restore the company to the position it would have been in if the transaction had not taken place.

Key takeaways

In the commercial property sector, where assets and liabilities can be substantial, insolvency places directors under intense scrutiny. Directors must therefore ensure that they act with utmost caution when financial distress looms. If they don't, it gives stakeholders such as Landlords the opportunity to look to the directors for some degree of compensation. The remedies available to Landlords and officeholders can be a powerful negotiating tool when you find that a tenant has been continuing to trade to your detriment.

If you are a commercial landlord or tenant and are concerned about the actions of a company director where there has been an insolvency, or there is a risk of insolvency, please do not hesitate to get in touch with our Real Estate Litigation team or your usual Brodies' contact.