Directors´ Liabilities In Times Of Financial Difficulties

Directors of companies need to be aware of the particular risks of trading through financially difficult times.

This short briefing focuses on the risk of directors incurring personal liability for their company's debts through wrongful trading and outlines some practical steps to mitigate that risk.

Given this and the risk of other potential liabilities, directors (including shadow directors) should seek external advice as soon as they are aware that the Company may be in financial difficulties (this step is endorsed by the UK Department for Business, Enterprise and Regulatory Reform.

Wrongful Trading

Wrongful trading occurs when directors incur debts or liabilities on behalf of the Company at a time when they knew or ought reasonably to have concluded that there was no reasonable prospect of the Company avoiding going into insolvent liquidation.

There is no requirement to show intent, dishonesty or fraud in order to establish liability. The consequences if liability for wrongful trading is established are:

• the risk of personal liability; and
• the risk that a disqualification order will be made against the director.

A director owes a duty to the Company to act in the best interests of the creditors of the Company if the Company is, or is on the verge of becoming, insolvent. His other duties (e.g. to promote the success of the Company for the benefit of its shareholders as a whole) are subject to this duty in favour of the creditors.

A director has a defence to a charge of wrongful trading if, once he knew (or ought in the circumstances to have concluded) that there was no reasonable prospect that the Company would avoid going into insolvent liquidation, he is able to demonstrate that he took every step with a view to minimising the potential loss to the Company's creditors as he ought to have taken.

The standards of skill and judgement expected of a director in judging the reasonableness of the prospects of the Company avoiding going into insolvent liquidation are those of a reasonably diligent person. This includes having the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by the director in relation to the Company and the general knowledge, skill and experience that he actually has.

Wrongful Trading - Practical Step

The following is a non-exhaustive list of steps that a director should take in order to minimise his risk of personal liability. However, professional advice should be sought in each case based on the particular circumstances.

1. Seek external advice as soon as the director is aware that the Company is in financial difficulties. The advice that is sought and given should be minuted or otherwise properly recorded.
2. Keep up to date with the Company's latest financial information at all times and be aware of its implications for the Company. Do not wait for an event to arise in order for problems to be highlighted. Instead be pro-active, for example by producing accurate cash flow projections and monitoring projected compliance with financial covenants in arrangements with funders.
3. Hold regular Board Meetings and ensure that the decisions taken (and the reasoning behind those decisions) are fully recorded.
4. Reach decisions independently taking into account the available legal and financial advice and information.
5. Do not simply resign to avoid the issue. If fellow directors disagree with a director's more pessimistic views on the Company's prospects, resignation may be appropriate but advice should be taken and, again, the decisions taken (and the reasoning behind those decisions) should be fully recorded.
6. If there is no reasonable prospect that the Company will avoid going into insolvent liquidation, take every step with a view to minimising the potential loss to the Company's creditors as the director ought to have taken. A director who is concerned about the steps that should be taken in these circumstances to protect him from liability should also seek specific legal advice in this respect.
7. If a director believes that there is no reasonable prospect of the Company avoiding insolvency then he should immediately bring this to the attention of the Board and the Company should take independent advice as a matter of urgency. In these circumstances, almost without exception, the Company should not incur new liabilities unless and until it has been appropriately advised otherwise.

Other Potential Directors Liabilities

While the risk of wrongful trading is the most common concern, there are other issues that can also arise in difficult financial times. In brief, these include

1. A director should be fully aware of the fiduciary duties he owes to his company and its various stakeholders. These now include the duties set out in the Companies Act 2006 such as a duty to act in good faith to promote the success of the company having regard to the company's employees, business relationships, community and environmental impact. Further information can be found here.
2. A director should be cautious of giving any form of personal guarantees or of allowing his company to rely on personal guarantees without taking proper advice as to the implications.
3. Directors of listed public companies should be familiar with the additional specific duties and obligations derived from the listing rules relating to the market upon which their company is listed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.