DIRECTORS: PREPARE FOR INSOLVENCY
JULIAN TURNER
PARTNER, REED SMITH
LAST week the Insolvency Service released its statistics for the third quarter, showing that the number of company insolvencies – including liquidations, administrations and receiverships – were slightly lower than they were for the second quarter of the year, but significantly higher than for the same period in 2008. There were approximately 4,700 liquidations and 1,600 other corporate insolvencies.
Obviously, company directors will do everything to avoid things reaching this stage, but they need to be prepared for the worst.
Even if the business itself can be saved, the loss of the corporate entity is likely to have serious consequences.
For directors, the concern is that if the company does ultimately fail, their conduct will be reviewed. Once a company faces financial difficulties, directors’ duties shift from being owed to the company and its shareholders to being owed to its creditors, and directors could be exposed to potential liability for wrongful trading.
Wrongful trading refers to a section of the Insolvency Act which penalises directors if they “knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation”, and thereafter continue to trade. If the company subsequently goes into liquidation, the liquidator may bring proceedings against a director, seeking a financial contribution to the assets of the company. Essentially, this means that the directors must keep a review at all times of the financial position of the company, and in particular what its prospects of survival are.
Furthermore, directors also need to ensure that should the company find itself in financial difficulties, they take every step they can with a view to minimising the potential loss to the company’s creditors.
Dealing with these issues is often complex and the circumstances of each case will differ. As companies continue to face challenges brought on by difficult economic times, directors need to bear in mind that they can reduce the risk of liability by identifying problems early on and remembering that the duties they owe are primarily to the company’s creditors – not its shareholders.