As probably all company directors know, they are not personally liable for their company’s debts – with some notable exceptions. The current health crisis is likely to mean that many limited companies are facing financial distress. So, it will be understandable that directors will attempt to avoid this problem by sourcing additional funding to tide their business over as well as negotiating extended payment terms from its existing lenders and creditors.
Whilst this will likely be a good idea, one must always remember that a company’s directors owe a plethora of legal duties. Whilst, primarily, these are owed to the company, in certain circumstances these duties are also owed to the company’s creditors. Indeed, a company director could potentially face not only civil liability but criminal too, and should be aware how such dangers will arise.
Financial distress: Directors' duties
In normal times, a director’s primary duty is owed to the company. This duty is discharged by the director promoting the company’s interests for the benefit of its shareholders. However, if the company approaches insolvency, this duty shifts. If this happens, the the primary duty is then owed to the company’s creditors as opposed to its shareholders. Also, the directors will have to comply with their statutory obligations, such as a duty to avoid conflicts of interest; to exercise independent judgment and generally to exercise “reasonable skill and care”.
Of course, the obvious question will be “when does this shift in duties occur?”. This is a difficult question to answer. A useful indicator will be when the directors know, or should reasonably have known, that the company is likely to become insolvent.
What should directors be looking out for?
Whilst the legislation surrounding wrongful trading is to be relaxed, the precise details are unknown. The current rules stipulate that, to avoid personal liability if the directors do not believe that the company has a reasonable prospect of avoiding insolvent liquidation/administration, then they must take every step to avoid potential loss to creditors. To achieve this, directors should ask themselves the following questions:
- How can new credit be minimised?
- Can creditor balances be maintained?
- How can fraudulent trading be minimised?
Broadly speaking, there are two tests:
- The “cash flow test” – here, a company will be insolvent if it cannot pay its debts as they fall due.
- The “balance sheet test” – here, a company is insolvent if, in the balance of probabilities, the company has insufficient assets to meet its liabilities (including contingent and prospective liabilities) as and when they fall due.
Directors should not pay some creditors in preference to others unless they can demonstrate a good reason for doing so.
Directors should not sell or gift the company’s assets for less than their true value, particularly to the company’s associates.
Joint and Several Liability for Unpaid Tax
Company directors are reminded that HMRC have the power to make company directors and shadow directors personally liable for the company’s taxes jointly and severally with the company should there be a serious risk of insolvency.
What should company directors do?
Whilst company directors may be aware of these duties, actually identifying them in the course of trading may be a bit more difficult. If directors are in any doubt, then professional advice should be taken. Yuill + Kyle are able to collaborate with the insolvency team at MacRoberts. We will objectively evaluate the facts and offer directors guidance to ensure that they do not incur statutory penalties or personal liability if their company is still trading and is potentially facing insolvency.
Yuill + Kyle, along with MacRoberts, will review the company’s financial position. A close study of the company’s cash flow will help to establish a business plan which could help steer it through these troubled financial waters. Should creditor consent be needed, then we are here to secure their agreement to the company’s proposals along with their forbearance. It is just possible that, if additional funding can be arranged, then insolvency can be avoided in tandem with these measures.
And to ensure that directors can evidence compliance with their legal obligations, we will make certain that you hold regular director’s meetings which are accurately minuted, detailing the various available options and the rationale for the decisions which were made.
Help is at hand
The joint Yuill + Kyle and MacRoberts teams are here to offer you guidance if you are at all concerned about your exposure to personal liability. We can explain the measures which you will need to adopt to avoid personal liability and to ensure that the decisions which are taken protect the interests of the company, its shareholders whilst not at the expense of the company’s creditors.