Directors' Duties When A Company Is Facing Insolvency

Introduction It is well established that the fiduciary and statutory duties of directors are generally owed to the company. However, where a company is insolvent or is threatened with insolvency this fundamental principal changes; the duty to act in good faith and to show the utmost care, skill and diligence will become owed by the directors to the creditors.

This does not mean that a company should close down at the first sight of economic difficulty. Although the directors may have no choice but to recommend placing the company in liquidation and distributing the assets for the benefit of the creditors, this may not always be the case. It may be that by trading forward, a more favourable outcome for creditors is achieved. Where it is reasonable to continue to trade, for example in an effort to complete a contract and generate further revenue, the directors will not necessarily be on the hook for reckless trading. This was recognized in Re: Hefferon Kearns Limited (No. 2)1, where the Court commented that

"it would not be in the interests of the community that whenever there might be significant danger that a company was going to become insolvent, the directors should immediately cease trading and close down. Many businesses which might have well survived by continuing to trade coupled with remedial measures could be lost to the community".

However, continuing to trade with caution in times of difficulty should be contrasted with not winding up a company which has been shown to be insolvent and the principal reason for not winding it up is that the assets would be insufficient to cover the associated costs. Section 251 of the Companies Act 1990 is intended to address this and identifies the remedies a liquidator or creditor may seek in such a situation. These include:

the power of the Court to impose criminal and civil liability on directors for failure to keep proper books of account; the power to apply to Court for return of assets of the company improperly transferred; liability for fraudulent and reckless trading; and restriction of directors. Personal Liability For Debts Of The Company When considering how and where directors' duties are owed to creditors of a company, it is useful to recall those situations in which personal liability will be imposed.

Fraudulent Trading If in the course of a winding up of a company, or where company has been shown to be insolvent but is not being wound up, or in the course of an examinership; any person found knowingly a party to the carrying on of the business of a company with intent to defraud its creditors or for any fraudulent purpose, may be guilty of fraudulent trading under Section 297 of the Companies Act 1963. Section 297...