Corporate Insolvency - Claims against Directors

Being a company director is a risky business. The limited liability company was devised as a way to promote trade and industry by freeing its owners from the risk of liabilities. This was open to a great deal of abuse and the legislature has stepped in to remove the protection of limited liability in a number of ways. The most frequently encountered of these come within the insolvency legislation and can cause problems for a director in the course of a corporate insolvency. Here is an outline of some of the main risks. Under section 214 Insolvency Act 1986 a liquidator can make a claim against directors on the basis of wrongful trading. In essence, if at some time before the start of the winding up a director knows or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation he is responsible for wrongful trading if he fails to do everything he can to minimise the potential loss to the company’s creditors. The director’s conduct is judged by what ought to be known and done by a reasonably diligent person having the knowledge, skill and experience that may be reasonably expected of a director as well as the general knowledge, skill and experience which the director in question actually has. If wrongful trading is proved the Court can order a director of an insolvent company to contribute such amount to the company’s assets as it thinks proper. The director therefore faces not only the loss of his business and livelihood because of the corporate insolvency but loss of personal wealth by having to put money into the liquidation to put the creditors in the position in which they would have been if he had done more to protect them. Section 239 covers preferences. A preference is simply placing one of the company’s creditors or guarantors in a better position than that in which it would otherwise have been and again the liquidator can apply to the Court for an order to restore the position to that it would have been if the company had not given the preference. Preferences often come up in the context of directors’ guarantees. The company has a bank loan backed by a guarantee. The business fails. However, if the director realises that things are going wrong and keeps on reducing the bank debt to reduce exposure under the guarantee thus preferring himself as guarantor and the bank as a creditor. The Court can order him to put the money back into the company or it can order the beneficiary of the preference to repay the money leaving it in a similar position to the other creditors and leaving the director liable for the full amount which he has guaranteed. Even in a straightforward insolvency directors should take legal advice. Insolvency advice from an administrator or liquidator is not enough. They owe their duties to the creditors.