Directors and Insolvency

The duty of a director is owed to the company. However, if a company is in financial difficulties this duty is owed to the company’s creditors so as to minimise the loss to creditors.

23 Mar 2021 3 min read Article

Financial difficulties in this context refers to a concern that a company is not able to meet its liabilities as they fall due or that the value of its liabilities (including its contingent and prospective liabilities) exceeds its assets. The director of such a company will want to ensure that he bears in mind the following duties:

1 Fraudulent trading

This arises when a director is knowingly a party to carrying on the business of a company with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose.

Such an intent may be inferred if a director allows a company to incur credit at a time when the business is being carried on in such circumstances that it is clear the company will never be able to satisfy its creditors. If the court finds that there was fraudulent trading, a director can be personally liable and be required to contribute to the company’s assets. The director may also be liable on conviction to a fine or imprisonment or both.

2. Wrongful trading

Once a director or directors of a company conclude (or ought to have concluded) that there is no reasonable prospect of the company avoiding an insolvent liquidation or insolvent administration, they have a duty to take every step which a reasonably diligent person would take to minimize potential loss to the company’s creditors.

The court can order a director to make such contribution to the company’s assets as it thinks proper if after the company has gone into insolvent administration or liquidation it is determined that the director has failed to comply with this duty.

3. Fraudulent preference

A company gives a preference to a person if it does or allows to be done any act that has the effect of placing a creditor in a better position if the company goes into liquidation than if the act has not occurred. An administrator or liquidator can apply to the court for order voiding the act constituted by giving the preference if it occurred within a certain period (six months to two years) before the insolvency.

4. Transactions at an undervalue

An administrator or liquidator may apply to the court for an order avoiding a transaction at an undervalue entered into during a certain period, usually two years ending at the commencement of administration or liquidation of the company. Subject to certain exceptions, a transaction at undervalue occurs when the company enters into a transaction for no consideration or for significantly less value than that provided by the company.

In the case of either fraudulent preference or transaction at an undervalue, the court may make various orders including that the assets be vested in the company, that the guarantors who were released  or discharged by the transaction or preference be subject to new or revived obligations or that any person pay such amount to the administrator or liquidator in respect of benefits received from the company.

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