The two sources of director duties
As a director of a UK company there are two main sources of duties: the Companies Act 2006 (CA 2006) and the Insolvency Act 1986 (IA 1986).
Under CA 2006, there are fiduciary and statutory duties to the company, such as to act in good faith, to exercise reasonable care, skill, and diligence, and to avoid conflicts of interest. These duties are owed to the company as a whole and by extension to the shareholders, who are the owners of the company.
However, when the company is insolvent or is likely to become insolvent, the situation changes dramatically. The interests of the creditors, who are the ones who have a claim on the company's assets, must be considered. This is known as the shift in the duty of loyalty or the duty to “act in the interests of the company's creditors.”
A director under IA 1986 may also face personal liability for wrongful trading or fraudulent trading if they continue to trade when the company is insolvent, or has no reasonable prospect of avoiding insolvency, and the director fails to take every step to minimise the potential loss to creditors.
Wrongful trading is a civil offence that may result in a director being ordered to contribute to the company's assets, while fraudulent trading is a criminal offence which can result in imprisonment and/or a fine.
Therefore, directors of a UK companies facing financial uncertainty and potential insolvency, must act with caution and good judgment and seek professional advice if necessary to avoid breaching duties and exposing themselves to personal liability.
Practical steps to take:
- Regular board meetings for each legal entity impacted, with accurate minutes taken. This will help to monitor the situation, make informed decisions, and demonstrate acting in good faith and with due diligence.
- Engage with banks and other stakeholders and get advice from a restructuring professional if unsure. This helps to maintain trust, communication, and cooperation with key partners, and enables the exploration of workable solutions and alternatives.
- Develop a clear policy for paying creditors and stick to this approach. This will help to avoid preferential payments, which may be challenged by other creditors or by the liquidator, and to manage cash flow and working capital.
- To work out how much cash is available to pay creditors, maintain a detailed 13-week cash flow forecast to calculate a "survival runway", which will bring clarity around cashflow needs and solvency prospects.
- Engage with creditors who are threatening legal action or who have issued CCJs, to avoid escalation, negotiate payment plans, and demonstrate willingness to cooperate and act in the interests of the creditors.
- Talk to experienced and appropriately qualified financial and legal advisers who can provide support.
- Take independent legal advice, specifically in respect of wrongful trading from experienced insolvency lawyers. They can help ascertain and clarify exposure, defences, and obligations, and to avoid making mistakes that could worsen a position.
- Accurate financial information is key, so financial records need to be up to date.
- Create robust financial projections to enable decision making based on sound evidence and assumptions.
- Undertake an immediate review of cost base and identify areas where savings can be made. This will help to reduce overheads, improve profitability, and preserve cash.
How we can help
Facing the possibility of insolvency is not easy. The first step is to acknowledge the situation and seek help, which is often the hardest but also the most crucial. The second, is to act early on to ensure more options are available and heightens the likelihood of being able to overcome challenges and emerge stronger and more resilient.
We are on hand to provide restructuring guidance and support in creating effective solutions for your business.
