A company becomes insolvent when it cannot afford to pay its debts as they fall due, or when its liabilities exceed its assets. Whilst a company is solvent, as a director, you are duty bound to act in the best interests of the company and its shareholders, however when the company is facing insolvency, your legal duty of protection moves from the interests of the shareholders to those of the creditors.
In the post-Brexit world, if the doom mongers are to be believed, it is an appropriate time to raise the issue of insolvency and the duties of directors!
If you are a director of a company that is facing insolvency, there are certain legal obligations that you must meet in order to avoid personal liability and, in some cases, potential criminal liability. Some examples are as follows:
The official receiver, liquidator, a creditor or a shareholder can recover money from directors of the company or those concerned in its management, who have misapplied, retained or become accountable for any money or property of the company, or have been guilty of any misfeasance. Examples include but are not limited to; improper payment of dividends, unauthorised loans or payments and application of monies for a dishonest purpose. The director may be compelled to repay monies, restore property or compensate the company by contributing money to the company’s assets.
A director can be personally liable where they either deliberately continued trading the company, or negligently continued trading the company, where insolvency was unavoidable. A director does not need to have been dishonest to be liable for wrongful trading.
The liability will arise where a director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation and then failed to take every step with a view to minimising the potential loss to the company’s creditors. In these circumstances a director could be ordered to contribute to the company’s assets.
The dilemma facing a director of a company which is at significant risk of becoming insolvent is how do they ensure they have satisfied the test in the legislation and taken every step to minimise losses to creditors? The duty imposed on directors is quite onerous and the steps to be taken will vary from case to case but it will rarely, if ever, be sufficient to argue that it was thought the company could trade out of the situation. A careful evaluation of the situation must be carried out with the aid of a professional adviser to establish the best course of action to take so as to avoid personal liability. DTM Legal specialise in providing advice to directors whose company is facing insolvency and are able to offer guidance and support prior to and during the process.
Rarer than wrongful trading is fraudulent trading. This can arise whenever the business of a company has been carried on to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose. The consequences are severe as not only can an individual be held liable to contribute to the assets of the company, they could be found guilty of a criminal offence.
A director is under an obligation to make payment of any liabilities owed to the Crown in the form of PAYE and National Insurance Contributions. Failure by the company to pay the correct level of National Insurance Contributions (NIC) and/or PAYE could result in the issuing of a Personal Liability Notice (PLN). A PLN will be issued by HMRC when there is sufficient evidence to show that a company’s failure to pay NIC/PAYE was due to the neglect or fraud of a director or officer of the company. Before issuing the notice, HMRC will carry out a full investigation of the company’s books. The accused will have an opportunity to make a case or negotiate payment with HMRC and we strongly suggest legal advice is sought at the earliest opportunity. After the PLN is made there is the possibility of appealing the decision however a director is in a stronger position if they are shown to have been cooperating with HMRC investigations. As well as personal liability, a PLN presents strong grounds for director disqualification.
In addition, HMRC has the power to recover unpaid PAYE debts of the company from a director or employee personally where their salary payments have been received with the knowledge that the employer intentionally failed to deduct tax.
Breach of Fiduciary Duties
Both during and after insolvency proceedings the company can bring a claim against directors where it can be demonstrated that they breached any of their fiduciary duties to the company. The appointed liquidator or administrator can issue such proceedings on behalf of the company. Alternatively, a personal claim against directors for breaches of fiduciary and non-fiduciary duties can be brought by third parties, where a duty is owed to them.
It is often the case that once a company enters into insolvency proceedings any liability under the terms of a personal guarantee offered by the director(s) to creditors is triggered. In any event the very fact a company is insolvent would ordinarily mean that the creditor was not being paid and would be able to seek recourse against the guarantor. This means that creditors with such personal guarantees can seek to recover the company’s debts from the director’s personal assets and they may be subject to court proceedings, bankruptcy or have to try and set up an individual voluntary arrangement (IVA) with their creditors.
Even where a company has written off the director’s loan the director will be expected to repay the loan out of their own pocket. If the director is unable to repay the loan they may be subject to court proceedings, bankruptcy or have to try and set up an IVA with their creditors.
Within 3 months of the insolvency date the appointed office-holder is required to file a report on the conduct of the company’s director(s). This may lead to further investigations by the Insolvency Service resulting in the issuing of proceedings to disqualify the director(s) from being involved in the management or control of any companies. The disqualification proceedings may be issued up to 3 years from when the company became insolvent posing a real risk to directors’ future ability to act in a similar capacity.
It is important as a director that you have legal support prior to and during insolvency procedures. DTM Legal is able to provide advice and guidance for directors and companies facing insolvency. For legal advice please speak to Richard Thomas on 01244 354 801 or email him at firstname.lastname@example.org.