When a company gets into financial difficulties and moves towards insolvency, the duty of the directors shifts from a primary duty being to the company, to a primary duty to the creditors of that company. During this time, (known as the twilight zone), directors face a risk of being held personally liable for certain actions (or lack of action) if the company then goes into insolvent liquidation or administration.
It is vital that directors are fully aware of their responsibilities and duties at times of insolvency, or on the cusp of insolvency, to avoid falling foul of these provisions. The personal financial consequences can be very severe for a director found guilty.
One of the most common issues, and therefore one of the most common claims against a director that can arise in these circumstances, is a legislative provision called ‘wrongful trading’, which our director disqualification solicitors explore in more detail here.
- What is wrongful trading?
- Who can commence a wrongful trading claim?
- Who is at risk?
- What does it mean for a director found guilty of wrongful trading?
- What is required in order to bring a successful claim?
- How easy is this to prove?
- Directors’ disqualification
- The Corporate Insolvency and Governance Act 2020 – temporary respite
- What should I do as a director in this position?
What is wrongful trading?
A wrongful trading claim can be brought against a director of a company (or a limited liability partnership) which has gone into an insolvent liquidation or administration, if at some time before the commencement of the liquidation or administration, its director(s) knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation or administration; and from that time, the director(s) failed to take ‘every step’ with a view to minimising the further potential loss to the company's assets or creditors after that time.
Who can commence a wrongful trading claim?
Either a liquidator or an administrator will usually bring a claim, but they can also assign a claim to a third party, such as a creditor.
Who is at risk?
A claim can only be taken against a company director, however this not only covers directors registered at companies house, but also de facto directors (these are directors that may not be registered but act as directors), as well as shadow directors (someone with a significantly controlling interest in the decision making of the company). This includes non-executive directors as well as executive. Note that resigning as a director does not get you off the hook either.
What does it mean for a director found guilty of wrongful trading?
The order the court will usually make on the finding of wrongful trading is that the director contributes personally to the company for the value of the increase in loss to creditors during the period of wrongful trading. If there is more than one director, the court can decide how much each director should pay, or order that the amount to be paid is a joint and several liability.
Any money ordered to be paid by the director will go back to the company for the benefit of all creditors, not just the creditor that took the claim.
What is required in order to bring a successful claim?
For a claim to be successful, the following needs to be evidenced:
- The date the company's director knew or should have known that there was no reasonable prospect of the company avoiding going into insolvent liquidation or administration; and
- That from that date, the directors failed to take ‘every step’ to minimise additional losses to company creditors; and
- That loss was actually caused to the company’s creditors as a result.
How easy is this to prove?
It is essential a claimant sets a date of knowledge of insolvency. This is not always an easy task. Retrospectively trying to establish a specific date when the directors should have known there was no chance of recovery is not easy for an insolvency practitioner looking back. The required date is when the directors knew, or should have known, that the company was or was likely (in the sense of probable) to become insolvent. This will depend on the circumstances of the case. An example may be when a company that has asked for the forbearance of creditors for a short while to secure extra funding, realises that the funding is not going to be forthcoming, but carries on trading anyway.
Failure to take ‘every step’ is hard to quantity, but the burden of proving that the director took every step with a view to minimising future loss lies with the director. So, it is vital that when a director is making decisions for the company during this time, they should keep detailed records of their decision making process at the time, to help explain actions (or inaction) should it be necessary.
Regarding proving that the creditors suffered further loss, a court will take the point at which it believes the company should have ceased trading but didn’t, and then look at the increase in the deficiency to creditors as a whole from that date until the date that company actually ceased trading.
Note that wrongful trading is also a very frequently cited wrongdoing in directors’ disqualification proceedings. For more information see: Directors’ duties: being disqualified from acting as a company director, and obtaining leave to act despite disqualification.
The Corporate Insolvency and Governance Act 2020 – temporary respite
In response to the economic impact of the Covid-19 pandemic, and to help prevent directors commencing insolvency proceedings prematurely to avoid personal liability for wrongful trading, the government made temporary changes to the wrongful trading regime. This means that during the periods between 1 March 2020 and 30 September 2020, and then between 26 November 2020 and 30 June 2021, the court will assume that a director was not responsible for any worsening of the financial position of the company or its creditors that occurred.
What should I do as a director in this position?
- Always keep on top of the accurate financial position of the company, and make sure your co-directors are also fully aware of this. You must have an accurate view of the finances.
- Hold regular board meetings to discuss what you should be doing, and make sure these are minuted in detail should they be required later on to confirm the thinking behind decisions.
- Don’t take on any more credit during this time unless you can be sure it will be repaid.
- Don’t remove assets from the company, and any sales of company assets must be at market value – having obtained an independent valuation.
- Don’t repay personal loans, or any loans that may personally benefit you – for example repaying an overdraft which you have personally guaranteed. This can all be clawed back.
- Take legal advice as early possible – either from an insolvency solicitor or a director disqualification solicitor, or both, if in any doubt at all.