What Are the Duties of a Director in Insolvency?
Under normal circumstances, a company director’s duty is to promote the interests of their shareholders. However, their responsibilities change once the business enters into insolvency. They must protect the interests of their creditors – not those of the company.
For directors who fail to uphold their fiduciary duty to creditors there can be severe financial and legal consequences, which can result in personal bankruptcy or even imprisonment.
So what are the duties of a director in insolvency? What are the potential consequences? And how can you protect yourself?
Contents
What Are the Duties of a Director?
- Act according to the company’s constitution
- Only use powers for their intended purpose
- Act in good faith to promote the success of the business as a whole
- Exercise reasonable care, skill, and due diligence
- Avoid conflicts of interest with the company
- Cannot accept payments from third parties in exchange for influence
Essentially, directors can’t act in self-interest. They must act in a way that furthers the interest of the business’s shareholders and employees.
When a company enters into insolvency, a director’s fiduciary obligations shift from their company members to their company creditors. Generally speaking, this involves directors securing the position of creditors by stopping the company from trading and placing it into liquidation.
How Do I Know When My Company Is Insolvent?
If you’re worried your business may be insolvent, you can find out by answering two simple questions:
- Do the liabilities of your company exceed its assets?
- Are you unable to pay your company debts when they fall due?
If the answer to either of these questions is yes, your business is insolvent. This switches your responsibilities as a director from your shareholders to your creditors.
What Are the Consequences of a Director Breaching their Fiduciary Duty?
Failing to protect the interests of your creditors can have a number of potential consequences. Different charges – both civil and criminal – can be made depending on the severity of the case. Each of these charges carry a range of potential consequences for directors.
Misfeasance
Misfeasance occurs when someone neglects the responsibilities of their position. In insolvency terms, misfeasance applies when a director fails – either through carelessness or maliciousness – to uphold his duty to his creditors.
There are several ways a director can find themselves accused of misfeasance:
- Making preferential payments
- Making transactions at an undervalue
- Concealing or removing company assets
- Taking out an unreasonable salary
Prior to the Small Business, Enterprise and Employment Act 2015, only office-holders (liquidators or administrators) could accuse directors of misfeasance. Now, however, any third party – such as shareholders or creditors – are free to make a claim.
If you’re found liable for misfeasance, you could be disqualified from acting as a company director for anywhere between 2-15 years, or you may be made personally liable for company debts.
Wrongful Trading
The Insolvency Act 1986 states that wrongful trading occurs when a business continues to trade when it knew it is insolvent and fails to protect the interest of company creditors.
Trading while insolvent often makes the position of creditors worse. The business generates additional expenses and reduces the chance of successfully repaying creditors.
If you’re found liable for wrongful trading, you could be made personally liable for company debts, disqualified from acting as a director and issued with heavy fines.
Fraudulent Trading
Fraudulent trading is much like wrongful trading – however, it serves as a more severe charge for directors who have grossly neglected their duties. Unlike wrongful trading, which is a civil offence, fraudulent trading is a criminal offence.
Fraudulent trading is distinguished from wrongful trading by director intent. Whereas wrongful trading can be performed unwittingly or with good intentions, fraudulent trading is a malicious and deliberate attempt to defraud creditors.
The charge can see you made personally liable for company debts, disqualified from future directorship, issued with large fines, or even imprisoned for up to 10 years.
How Can I Protect Myself?
If you think your business has entered into insolvency, you should seek the guidance of an insolvency practitioner as soon as possible.
Operating an insolvent business can be a bit of a minefield – improper handling of the situation can cause a lot more problems for you down the line. Enlisting the help of an insolvency practitioner will allow you to navigate through the uncertainty, ensuring that you’re meeting your fiduciary duties to your creditors. Contacting an insolvency practitioner shows you’re taking your responsibilities seriously.
We may suggest that you pursue a CVL to ensure a safe exit from the business, or potentially suggest entering into a CVA or administration to achieve a financial turnaround.
Contact us today to book a free consultation.
