January 6, 2020
A director of a company in financial distress faces the thankless task of balancing optimism with realism.
Should the company soldier on in the hope that it will turn a corner? Or is it time to face the music and cease trading?
The right answer is not always obvious, and for that reason, we have a lot of sympathy with directors facing this dilemma. The insolvency legislation is, however, not quite so forgiving, and directors who opt to persevere in the hope of a turnaround risk exposing themselves to personal liability.
This article takes a look at some of the considerations that directors ought to bear in mind when faced with this predicament, and the risks that they face if they choose to continue trading.
When is it time to cease trading?
The classic and obvious scenario when a company should consider ceasing to trade is when it cannot afford to pay its bills; however, it is not always that simple.
As soon as a director is aware that the company is in financial difficulty (or is likely to run into such difficulty) it is important to immediately seek external advice. The first port of call may be to consult a solicitor specialising in insolvency, but other options include turning to the company accountant or an insolvency practitioner.
One thing you should not do is bury your head in the sand.
If it appears that a person who is, or was, a director of a company knew or ought to have concluded at some point prior to the commencement of liquidation or administration that there was no reasonable prospect of the company avoiding going into insolvent liquidation or administration, he/she is at risk of being the subject of a claim by a liquidator/administrator to make a contribution to the company’s assets.
However, a court will not make an order for wrongful trading if, knowing there was no reasonable prospect that the company would avoid going into insolvent liquidation or administration, the director took every step with a view to minimising the potential loss to the company’s creditors as he ought to have taken.
We have underlined the words “knew or ought to have concluded” and “took every step” to underline just how onerous the obligation is on directors. This serves to underline the importance of directors adopting prudent, measured steps when a company is in financial distress.
Similar to wrongful trading, directors face the risk of being the subject of a claim to make a contribution to the assets of the company if it appears that the company has been carried on with the intent to defraud creditors, or for any other fraudulent purpose.
A court may make a disqualification order against a person that he shall not, without leave of the court, be a director of a company or be directly or indirectly involved in the promotion, formation or management of a company.
Such action against directors is initiated by the Secretary of State if a director’s conduct is deemed to make him/her unfit to be concerned with the management of a company. When assessing the conduct of a director, consideration will be given to any matter connected with or giving rise to the insolvency of the company.
When the ship is going down and directors have money tied up in the company, there may be a real temptation to transfer money from the company back to the director. However, directors ought to be aware that the liquidator/administrator appointed when the ship eventually does go down has wide-ranging powers to pursue a recovery of the monies (or other assets) transferred prior to the insolvency.
Therefore, in these circumstances, directors ought to be wary of the manner in which they deal with the company’s assets.
How can we help?
The risks to directors of companies in financial distress are serious and can have far-reaching consequences.
Prosperity Law LLP are experts in insolvency law, with extensive experience in assisting directors to navigate the risks of exposing themselves to personal liability when their company is in financial distress.
For more information on how we can help you, please contact Simon Gerrard, Head of Insolvency, at firstname.lastname@example.org or 0161 667 3686.