Directors owe a number of statutory and fiduciary duties to the company. However, once a company is insolvent, the interests of creditors intrude and directors owe a duty to act in good faith, and show skill, care and diligence to all creditors. Desperate economic conditions have led to an influx of insolvent companies undergoing liquidation proceedings. Once the formal insolvency procedure begins, directors can be exposed to significant personal liability if they acted dishonestly or irresponsibly in the course of their duties.
The Office of the Director of Corporate Enforcement now closely examines the conduct of directors in insolvent liquidations. This has led to a number of cases where directors have been found personally liable to creditors. The following actions are the most common:
Reckless and Fraudulent Trading. A director who knowingly carries on the business in a reckless manner or carries on the business with the intent to defraud creditors or for any fraudulent purpose can be made personally liable, without any limitation of liability, for all or any part of the debts or liabilities of the company. A director can also be deemed to have acted recklessly in certain circumstances and the only defence is to show that he/she acted in an honest and responsible manner. (Companies Act 1963, Section 297A). It is not sufficient for a director to allege that they did not take part in the affairs of the company as the failure to exercise proper control may itself amount to recklessness.
If a company being wound up is insolvent and has failed to keep proper books of account in accordance with Section 202 of the Companies Act 1990, the Court may impose personal liability on any director who is found to be in default of this obligation. The contravention must have either contributed to the company’s inability to pay its debts or resulted in substantial uncertainty as to the assets and liabilities of the company or substantially impeded the orderly winding up of the company. The Court will look at the extent to which there was financial loss as a consequence of the contravention when imposing personal liability.
Misfeasance – Section 298 of the Companies Act 1963. A Court can compel a director to repay money, restore property or compensate the company if it is found that the director misapplied or retained any money or property of the company or is guilty of any misfeasance or any other breach of duty or trust in relation to the company.
Restriction and Disqualification Orders – (Companies Act 1990, Sections 150 and 160). There is a mandatory obligation to impose a Restriction Order on a director of an insolvent company (or a person who is a director within 12 months prior to the commencement of the winding up) unless the director can satisfy the Court that he acted honestly and responsibly in relation to the conduct of the affairs of the company and there is no other reason why it would be just and equitable that he should be subject to restriction. Essentially, a Restriction Order prohibits a person from being a director or secretary or being involved in the formation of a company for a period of 5 years unless the company is adequately capitalised.
A Disqualification Order is more severe and is a total prohibition on acting as auditor, director or any other officer or being in any way, directly or indirectly concerned in the promotion, formation or management of any company. Directors will be automatically disqualified if convicted of certain offences. Furthermore, the Court has the discretion to make a Disqualification Order if a director is found guilty of fraudulent or reckless trading, breaches of duty and failure to keep proper books of account among other reasons. The period of disqualification is at the discretion of the Court and the gravity of the offence will be considered carefully.
If a director disobeys a Restriction or Disqualification Order, they are guilty of an offence and can also be made personally liable for the debts of the company incurred while the director was acting.
In a climate where there is increased regulation by the Office of the Director of Corporate Enforcement and people are more prepared to make claims against directors as a result of the economic crisis, directors should be extremely vigilant in how they deal with the company’s insolvency. The safest course of action is to take steps to put the company into creditors’ voluntary liquidation. Directors should know immediately when the company is insolvent or near insolvent and if they continue to trade, directors should be cognisant of their obligations to creditors. Otherwise, significant personal exposure could arise for the directors should the company ultimately go into liquidation.