Directors’ responsibilities are constantly evolving as legislation and case law develops. PwC has created a guide to help directors navigate uncertain waters.
Company directors have clear responsibilities to their stakeholders and can be exposed to substantial risk if the business fails. Directors’ responsibilities have increased considerably in recent years and continue to evolve. The responsibilities of directors have recently been clarified by a Supreme Court case which outlines the duties when a company may be approaching insolvency.
As a result of this case, the primary responsibility of directors shifts from shareholders to creditors when a company is at real risk of insolvency. If directors fail to spot that the company is in trouble early enough, they could face significant personal exposure if the company becomes insolvent.
As the economic situation becomes increasingly challenging, businesses are more vulnerable. Management teams need to assess whether poor financial performance or a drop in liquidity is a temporary blip, or a sign of underlying weakness making the business no longer viable.
We have created a guide for directors that highlights the well-known – and less obvious – warning signs of a company in trouble, and the steps that they can take to protect the company, and themselves.
Company directors should be aware of the warning signs of insolvency – and recognise when their responsibilities shift from shareholders to creditors
Directors’ primary responsibility is to shareholders, until the company is or is likely to become insolvent. Generally, directors are required to shift their focus from protecting members to looking after the interests of the company’s creditors when the directors ‘know or should know that the company is or is likely to become insolvent’. This applies to all directors of each legal entity in a group, and they must consider the creditors of each individual entity, rather than on a group-wide basis.
The recent Supreme Court case of (BTI v Sequana SA and others) clarified that directors should act in the interest of the company’s creditors when a company is at real risk of insolvency, rather than when insolvency is probable, imminent, or a reality.
This means that when the interests of creditors are not the same as the interests of shareholders, creditors’ interests should come first if liquidation is inevitable. Before the company reaches that stage, its directors should balance the interests of shareholders and creditors, taking the degree of distress of the company into account.
Directors need to be aware of the warning signs that a company is in distress – and some of these will be more obvious than others.
But there are other signs that also indicate that the business in in trouble such as:
Paying attention to these indicators and acting early could give you the time you need to develop a solution that saves the business.
When a company goes into an insolvency process, the insolvency practitioner will look closely at the actions of everyone who has acted as director over the previous three years (including de facto and shadow directors). The findings of the insolvency practitioner are sent to the Insolvency Service, which could decide that a director be disqualified from acting as a director in the future.
The insolvency practitioner is also obliged to assess whether wrongful trading has taken place. According to the Insolvency Act, a director (including a de facto director or shadow director) is guilty of wrongful trading if they knew, or should have known, that the company was likely to become insolvent, but failed to take the necessary steps to minimise the losses of creditors.
There’s a two-stage test of wrongful trading: An objective test assesses what a competent director in the director’s position should have known, and what action they should have taken. A subjective test is then applied to the director’s own knowledge, skills, and experience.
If a director is found guilty of wrongful trading, they will be personally liable for the debts the company incurred.
Our teams are available to help and support directors of any company through difficult times. We have extensive experience of guiding companies through crises, and of advising company directors of the best way to protect the company and themselves. For more information, please get in touch.
Restructuring and Insolvency Partner, UK Head of Insolvency, PwC United Kingdom
Tel: +44 (0)7974 332659