How To Resolve Claims Against Directors Of Insolvent Companies

George Harrison August 21, 2024

There are a number of different ways in which claims can be brought against directors, and this often arises in relation to insolvent companies and includes concepts such as wrongful trading, fraudulent trading (as per section 213 of the Insolvency Act 1986 (“IA 1986”), and misfeasance. Parties that bring such claims may include creditors, shareholders, and possibly also the Insolvency Service.

In general, where a company is insolvent, the duties of the directors shift from acting in the interests of the shareholders, to acting in the interests of the creditors (and must act with a view to minimise losses). There is, however, a ‘twilight zone’ prior to insolvency, namely it is not exactly clear when this duty shifts across to the creditors at this stage. Such a shift is also not dependent on the company’s financial position ‘snapshot’ and is based wholly on the directors’ rational expectations of what may happen in the future.

Directors must take steps as soon as they become aware of the company being in financial difficulty, both collectively at both a board and individual level. Drastic consequences can occur if there is a failure of the directors to act appropriately at this stage, as claims could be made by the Insolvency Practitioner appointed, and there is also scope for possible personal liability of the directors, including liability for wrongful trading, fraudulent trading and misfeasance. In the most serious cases, director disqualification may also occur.

These issues are all set out under separate headings below.

Wrongful Trading

Where a claim is brought against a director for wrongful trading under section 214 of the IA 1986, the court may order a director to contribute to the company’s assets if:

The company has gone into insolvent liquidation or insolvent administration;
Before commencement of the winding up of the company, the director knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation; and
That person was a director of the company at the time.

Directors do have a defence available for wrongful trading, namely a director will not be liable for wrongful trading if they took every step with a view to minimising the potential loss to the company’s creditors as they ought to have taken. To determine as to whether the director’s conduct is caught by this defence, a two-part test must be applied. This test sets out the facts that a director ought to have known or ascertained, the conclusions that they ought to have reached and the steps which they ought to have taken.

The standard expected of a director is that of a ‘reasonably diligent person’ having both:

The general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company (objective test); and
The general knowledge, skill and experience that the director has (subjective test).

This test is similar to the one set out in section 174 of the Companies Act 2006 (“CA 2006”), namely the duty to exercise reasonable care, skill and diligence. Both tests enable the court to consider the director’s conduct as a whole and what it would be reasonable to expect from that director in their role.

There are a number of steps which directors can take to mitigate the risk of a successful claim for wrongful trading (and/or fraudulent trading). Directors should take care to ensure that:

professional advice is sought from solicitors and/or accountants at the very first sign of problems;
spending is limited;
the company’s accounts are checked regularly; and
records of the directors’ own actions are kept.

It is important to remember that directors will not be expected to have ‘expert level’ competence in every area related to running a company. However, they will be expected to have and maintain a basic level of competence.

A liquidator or administrator can bring a claim against a director for wrongful trading. Thus, only such claims can be brought if the company is insolvent and is in liquidation or administration. The court may order, as a remedy, that the director make a contribution to the company’s assets, increasing the amount of money that the company can pay its creditors.

Fraudulent Trading under Section 213 of the IA 1986

If, in the course of the company being wound up, it is apparent that the company’s business has been carried on with intent to defraud creditors of the company, creditors of any other person, or fraudulent purpose, a director will be liable for fraudulent trading.

In this scenario, the court may declare that any persons who were knowingly parties to the carrying on of the business of the company in such a manner are liable to make contributions to the company’s assets at the discretion of the court. In the same way as actions for wrongful trading, the liquidator or administrator will be responsible for bringing any such claims against the company in insolvent liquidation or administration.

Fraudulent trading claims are few and far between because the bar for such claims is set high. The liquidator or administrator will need to show intention to defraud in order for the definition of fraudulent trading to be met and it is usually difficult to find evidence of this. One of the most common examples of this occurring is when there is significant spending in the knowledge that the company’s creditors will not get paid. Proving this, however, is difficult for the liquidator.

Any director found liable for fraudulent trading is also at risk of criminal conviction, as set out in section 993 of the CA 2006. The maximum term of imprisonment for such an offence (if convicted on indictment) is 10 years.

Misfeasance

A breach of any fiduciary duty or other duty of the directors is misfeasance. Under section 212 IA 1986, whilst the company is being wound up directors may be ordered to contribute to the company’s assets by way of compensation in respect of the misfeasance. They may also be ordered to repay, restore or account for any money or property or any part of it that has been misapplied in breach of duty.

Disqualification of Directors

Where a director (or former director) of an insolvent company has been found to have engaged in conduct which makes them unfit to be concerned in the management of a company, the court has discretion to order that they be disqualified from being a director for between two and fifteen years!

How we can help

If you are concerned with the actions of a director or would like advice as a director seeking to navigate through a difficult period, we offer a no-cost, no-obligation 20-minute introductory call as a starting point and, in some cases where appropriate, a fixed fee appointment.

Please email wewillhelp@jonathanlea.net providing us with any relevant information ensuring that any call we have is as productive as possible. After this call, we can then email you a scope of work, fee estimate, and confirmation of any other points or information mentioned on the call.

This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited 2024.