DIRECTORS A GUIDE TO PROTECTING YOUR POSITION

Transcription

1 DIRECTORS A GUIDE TO PROTECTING YOUR POSITION

2 DIRECTORS DUTIES Contents Page no A THE NATURE OF DIRECTORS DUTIES 1 B CONSEQUENCES OF BREACH BY A DIRECTOR 5 C SAFEGUARDING THE DIRECTOR S POSITION 7 D INSOLVENCY 10

3 DIRECTORS DUTIES A THE NATURE OF DIRECTORS DUTIES Background The position prior to 1 October 2007 was that a director's general duties were based in common law; that is to say that they were developed through case law. Those common law duties included a duty to act in good faith in the best interests of the company as a whole; to avoid a situation of conflict; not to make a secret profit; to exercise independent judgment and to exercise skill and care. Concern that the lack of a comprehensive written statement of these duties made the law unclear and inaccessible to directors prompted the introduction of seven new statutory duties in the Companies Act 2006 (the 2006 Act ). A key aim behind the reform was to help improve standards of corporate governance. It should be noted that it is only the key duties that have been codified. Some are left uncodified (such as the duty to consider the interests of creditors in times of threatened insolvency) with the intention that they will continue to be developed by the common law. Further, whilst these new statutory duties replace the common law rules to which they relate, the Act states that they are to be interpreted and applied in the same way as the existing common law rules. Therefore, there will be an ongoing need to have regard to the existing common law as it may continue to be developed by the courts going forward. The key duties are discussed further below. By whom are directors duties owed? Directors duties are owed not only by those persons who are formally appointed as directors of companies but generally also extend, for example, to de facto directors (i.e. persons acting as directors without having been formally appointed or whose appointment is invalid). They also apply to shadow directors (i.e. those persons who are not directors but in accordance with whose instructions or directions the directors of a company are accustomed to act) where, and to the extent that, the corresponding common law or equitable principles apply. Further, these duties are owed to the same degree by both executive and non-executive directors as well as nominee and alternate directors. Duties owed by each director individually Although duties are owed by each director individually, as the directors are required to make corporate decisions as a body, the duties will tend to affect them as a body. Where several directors are liable for the same default, they may be jointly and severally liable.

4 To whom do directors owe duties? As a general principle directors owe their duties to, and accordingly must have regard to the interests of, the company as a distinct entity. In particular, therefore, where a director is also the sole or majority shareholder of the company it is not safe for him to disregard his duties as a director on the assumption that his actions will not be called into question. Similarly, where a director is a director of several companies in the same group, he must consider his duties to each company in the group separately. It is not enough for him to act in the interests of one group company to the detriment of another. Directors may, in the course of carrying out their duties, also be required to have regard to the interests of, or otherwise be found to owe a duty of care to, other persons, such as:- individual shareholders or possibly holders of certain classes of shares; employees; creditors (in particular where the company is or is likely to become insolvent); third party purchasers of shares in the capital of the company in particular in respect of negligent misstatement; and subscribers for securities (in connection with untrue or misleading statements in any prospectus or similar document). Furthermore, the statutory duty requiring a director to promote the success of the company sets out an express list of factors to which a director must have regard (see further below). Directors' general duties under the Companies Act 2006 The seven general statutory duties require a director: to act in accordance with the company s constitution and exercise powers only for the purposes for which they are conferred; to promote the success of the company for the benefit of its members as a whole; to exercise independent judgment; to exercise reasonable care, skill and diligence; to avoid conflicts of interest; not to accept benefits from third parties; and to declare an interest in a proposed transaction or arrangement with the company. Some of these duties are discussed in further detail below. Duty to promote the success of the company This duty provides that the director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so must have regard (amongst other matters) to a list of factors. 2

5 These factors are: the likely consequences of any decision in the long term; the interests of the company employees; the need to foster the company's business relationships with suppliers, customers and others; the impact of the company's operations on the community and environment; the desirability of the company to maintain a reputation for high standards of business conduct; and the need to act fairly as between members of the company. This list is non-exhaustive. The guidance makes it clear that it is not enough to pay lip service to these factors and, in having regard to them, the duty to exercise reasonable skill, care and diligence will apply. Conflicts of interest Previously, the common law required that a director did not put himself in a position where his personal interests or his duties to a third party conflicted with those of the company. Further, he had a duty not to make a secret profit out of his position as a director, unless the company expressly permits him to do so. If they were to be permitted, any conflicts had to be authorised by the members. In practice, however, a company's articles of association often relaxed these rules, for example, by expressly permitting a director to be interested in certain transactions with the company, usually so long as he had disclosed his interests. Under the 2006 Act, the general common law duty relating to conflicts of interests has been formulated into three separate duties which replaced the above general common law rules as from 1 October These three duties are: General duty to avoid conflicts of interest A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. The 2006 Act, for the first time, enables the directors to authorise these conflicts. In the case of a private company formed on or after 1 October 2008, the directors will be able to authorise a conflict so long as the company's constitution does not expressly prevent them from doing so. However, directors of public companies must be expressly authorised by the constitution. Similarly, directors of private companies formed before 1 October 2008 will need to be expressly authorised by the members. In each case, the authorisation is only effective if the interested director(s) is/are excluded from the vote and from counting as part of the quorum at the meeting in which authorisation is given. Duty not to accept benefits from a third party A director of a company must not accept a benefit from a third party conferred by reason of (a) his being a director, or (b) his doing (or not doing) anything as a director. This includes non-financial as well as financial benefits. However, this duty only extends to benefits which can reasonably be regarded as likely to give rise to a conflict of interest. 3

6 Unlike with the above general duty to avoid conflicts, approval of the acceptance of benefits has to come from the members; the directors cannot be empowered to authorise them. Duty to declare an interest in a proposed transaction or arrangement A director who is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company is required to declare the nature and extent of that interest to the other directors. This is similar to the previous disclosure requirement under the Companies Act 1985 but such disclosure now also extends to matters of which the directors ought reasonably to be aware and requires any disclosure that is made to be updated as and when necessary, at any time prior to the transaction being entered into, to ensure it remains accurate and complete. Once a director has made such disclosure, no further authorisation by either the members or the board is necessary. This is subject, however, to anything to the contrary in the company's articles. There is also a similar, but separate, obligation on directors in relation to interests in existing transactions or arrangements with the company. Specific statutory duties In addition to the above general duties, directors are subject to a range of specific statutory obligations. In particular, certain transactions between the company and a director require the approval of the shareholders, for example: a service contract between the director and the company for a term of more than two years; subject to some exceptions, any payment by the company to a director by way of compensation for loss of office; certain loans to directors; and the transfer to or from a director of non-cash assets exceeding a certain value (currently 100,000 or 10% of the company's net asset value). There are also numerous record-keeping and other administrative requirements laid down by the Companies Acts in relation to the maintaining of statutory registers and accounting records and the filing of certain information at Companies House. Failure to comply could result in a director being fined and/or imprisoned and, in more serious cases, being disqualified from acting as a director. Additional duties imposed by the Financial Services Authority Listing, Disclosure and Transparency Rules and Codes of Practice Further duties are imposed upon directors of listed public companies by the Financial Conduct Authority s Listing, Disclosure and Transparency Rules and other Codes of Practice, in particular the UK Corporate Governance Code (applicable for reporting periods beginning on or after 29 June 2010). Whilst these Codes do not have the force of law, they are widely observed under the practical threat of censure from the marketplace. 4

7 B CONSEQUENCES OF BREACH BY A DIRECTOR What are the consequences for breach of these duties? In addition to penalties laid down by statute for breaches of specific statutory provisions, the following remedies may be sought against defaulting directors, depending upon the nature of the breach of duty: 1. Damages Damages for loss suffered may be recovered from the director subject to the applicable general legal principles for showing loss. 2. Removal and disqualification An employee director may be summarily dismissed by the company if the breach of duty constitutes a breach of his employment contract. Alternatively the shareholders may remove the director by way of ordinary resolution involving a special statutory procedure or by any other method provided for in the company s articles of association. In certain cases of breach (e.g. persistent default in relation to 2006 Act filing requirements or certain offences in relation to an insolvent company) a director may be disqualified from acting as the director of any company for a specified period (see Section D below for further details). 3. Injunction An injunction may be sought against a director where a breach has been threatened but not yet committed (e.g. threatened disclosure of confidential information relating to the company). However this remedy is only available at the court s discretion. 4. Liability to account for secret profits Where a director has made a financial gain as a result of his breach of duty he may be held liable to account to the company for such sums. In such cases the director is deemed to hold such sums as constructive trustee for the company and the company may have the right to trace the monies, in certain cases even where they are no longer in the director s possession. 5. Transaction void or voidable A transaction entered into by the company involving a breach by the director of his duties may in certain circumstances and subject to certain limitations result in that transaction or contract being void or voidable at the instance of the company. The duties of directors and remedies available for breach in connection with an insolvent or potentially insolvent company are considered in Section D below. 5

8 Who can bring a claim against a director? As a general rule, as a director's duties are owed to the company, the only person who can bring a claim for that wrong is the company itself. Generally the company would only pursue such a wrong if its management, acting on a majority vote basis, decides to do so. However, where the majority shareholders have caused the company to commit wrongdoing, that majority will also be able to vote against pursuing a claim, leaving the company without a remedy. The common law came to recognise a type of claim brought by a minority shareholder in the name of the company, known as the derivative claim because it derived from the rights of the company. However, this common law claim was not often used. This was partly due to the fact that the circumstances in which a shareholder could bring a claim were limited generally to where there was a fraud on the minority. Also, as the claim was brought on behalf of the company, any damages or property recovered belonged to the company, rather than to the individual shareholder. For this reason, aggrieved shareholders tended to opt to pursue an unfair prejudice petition in respect of which they were able to achieve a personal remedy as opposed to one that benefits the company as a whole. As from 1 October 2007, the 2006 Act introduced a new statutory derivative claim which is wider in scope than the common law claim. In particular, a broader range of conduct is caught - covering any actual or proposed act or omission involving negligence, default, breach of duty or trust by a director. Further, any shareholder may bring a claim. There is no minimum shareholding requirement and it is not necessary that the claimant was a shareholder at the time of the alleged breach. There is a preliminary process designed to filter out groundless claims. Importantly, having commenced a claim, the claimant must apply to court for permission to continue it. If the claimant cannot establish a prima facie case the court will dismiss the application. Having established that the claimant has a prima facie case, the court will then go on to consider whether to grant or refuse permission to continue it, based on criteria set out in the 2006 Act. 6

9 C SAFEGUARDING THE DIRECTOR S POSITION 1. Practical steps which a director can take to safeguard his position A director will generally not be liable for the acts of his fellow directors solely by virtue of his position, but if he participates in the unlawful action, he will be liable. In practice participation is construed widely and could include, for example, a director merely signing board minutes approving an unlawful transaction. Further a director cannot escape liability by claiming ignorance as to the transaction in question if he ought to have supervised an activity which has been delegated, whether to a committee of the board of directors or a third party, or if he has otherwise neglected his duties as a director. It is therefore of prime importance that, from the outset of his appointment, a director (regardless of whether he is appointed to an executive or non-executive position), fully familiarises himself with his duties. The Government has published some high level guidance in relation to the statutory duties and guidance has also been published by industry bodies, notably the Institute of Chartered Secretaries and Accountants and the GC100 Group. More detailed information on the statutory duties and the guidance notes available can be found in our separate briefing note "Companies Act Memorandum on Directors' Duties". In terms of the actual day-to-day carrying out of his duties, there are a number of practical steps which a director should take so as to minimise the risk of liability for breach of duty, for example: 1.1 Where a director objects to a course of action which he considers to be unlawful or in breach of his duties but such action is nevertheless carried by the majority of directors, he should note his objection in writing to the board of directors and try to ensure that such objection is noted in the minutes of the relevant board meeting. 1.2 The director The director should ensure that he attends all board meetings wherever reasonably possible and should make himself aware of the day to day business of the board of directors, including functions which have not been specifically delegated to him. A director should also make reasonable enquiries into the nature of any documents which he is asked to sign and any business to be transacted at a board meeting so as to ensure that he can make an informed decision in relation to the exercise of his vote. The above is particularly important for a non-executive director or a nominee director who is less likely to be familiar with the day to day running of the company. 1.3 Where a director delegates any duties, either to another director, a committee of directors or a third party (including professional advisors) he must ensure that such delegate is competent and trustworthy and that the director keeps himself informed as to the activities which the delegate is carrying out. 7

10 1.4 A director should generally ensure that all formalities are observed, in particular that all meetings are properly minuted and all transactions properly documented. This is particularly important in relation to small companies or owner managed companies where business may tend to be conducted more informally or where the distinction between a person s respective capacities as shareholder and director might tend to become confused. 1.5 Where a director is in any doubt as to the due exercise of his duties he should seek relevant legal and other professional advice. 2 Court s power to relieve a director from liability The court has the power to relieve a director either wholly or partly (and on such terms as it thinks fit) from liability in any proceedings against that director for negligence, default, breach of duty or breach of trust if it appears to the court that the director has acted honestly and reasonably and that having regard to all the circumstances of the case he ought fairly to be excused. 3 Ability of a company to ratify an unlawful action by a director In most cases, a company can ratify a breach by directors by passing a members' resolution to that effect. However, the 2006 Act requires that any such resolution must be passed by the members without counting the votes of the director in breach (assuming he is a member) and any other member connected with him. This restriction is perhaps particularly significant for directors who are majority shareholders who should bear in mind that they may be at the mercy of a minority shareholder to secure a ratification for their breach. 4 Directors liability insurance and indemnity by the company The 2006 Act expressly prohibits a company (or any other member of its group) from entering into arrangements with a director or any other person exempting the director from or otherwise indemnifying him against any liability he may have for negligence, default, breach of duty or breach of trust in relation to the company. Any such arrangement whether contained in the company s articles of association or elsewhere is void. However, the company is not prohibited from granting an indemnity in respect of certain types of liability that a director may incur to third parties, so long as the indemnity satisfies the criteria for a qualifying third party indemnity provision as defined in the 2006 Act. This is effective even if the judgment ultimately goes against the director. Careful drafting is required because an indemnity that does not wholly satisfy the requirements in the 2006 Act will be wholly void, not merely to the extent that it goes too far. A company may also fund directors legal costs (for example, by way of loan) incurred in defending proceedings in connection with alleged negligence, default, breach of duty or breach of trust in relation to the company. Any loan made by the company to fund costs of 8

11 legal proceedings must be subject to a right of repayment exercisable by the company if the director s defence proves unsuccessful. Further a company is able to purchase insurance to cover the director s liability for negligence, default or breach of duty. In practice the articles of association of a company tend to contain provisions providing for these rights of indemnity and enabling the company to take out relevant directors and officers liability insurance. 9

12 D INSOLVENCY Summary checklist for directors of potentially insolvent companies This summary sets out a checklist of areas that a liquidator or other relevant insolvency officer would consider, in relation to the affairs of an insolvent company. A relevant officer would be looking at each of these areas in order to (a) consider whether he might be able to make recoveries from any party, including the directors, to increase the assets of the company and (b) consider the conduct of directors for the compulsory report to the Secretary of State which, if a sufficiently damaging report is made, can lead to disqualification proceedings. Sections 1 to 4 below deal with actions to undo various transactions with third parties (which may include directors). Sections 5 to 9 below deal with a director s potential personal liability. 1. Transactions at an undervalue 1.1. There is provision in the Insolvency Act 1986 ( the Insolvency Act ) to allow a liquidator or administrator of a company to challenge a transaction entered into by that company as a transaction at an undervalue where the company received significantly less value than it gave (for example it sold an asset at a knock down price) A liquidator or administrator can only challenge transactions entered into up to two years before the onset of liquidation or administration. If a liquidator or administrator believes there have been transactions at an undervalue but is prevented from pursuing them because they are out of time, they may consider pursuing an action under the related provisions designed to prevent defrauding creditors (see section 4 below) The court can make a wide range of orders if there has been a transaction at an undervalue. The intention of any order is to restore the position to what it would have been if the company had not entered into the transaction. In practice, this usually means either an order to re-vest property in the company or to pay compensation to the liquidator or administrator for the benefit of the company s estate However, the court will not make an order unless it can be shown that the company was unable to pay its debts as at the date of the transaction or became unable to pay its debts as a result of the transaction. An inability to pay debts is defined in this context to include being insolvent on a balance sheet basis (i.e. where the company s liabilities, taking into account its contingent and prospective liabilities, exceed its assets) or a cash flow basis (i.e. where the company is unable to pay debts as they fall due). Inability to pay is presumed where the transaction is entered into with a connected party. Connected party is widely defined but includes, for example, directors and shadow directors of the company, relatives of those directors or shadow directors, shareholders holding more 10

13 than 33% of the shares in the company, and other companies which have one or more directors in common with the company Moreover, no order will be made to set aside the transaction at an undervalue if the court is satisfied that the transaction was entered into in good faith, for the purpose of carrying on the company s business and that at the time the transaction was entered into there were reasonable grounds for believing that the transaction would benefit the company. This might be the case if the company sold assets at an undervalue in order to effect a quick sale and raise cash, or if the company considered a transaction necessary to avoid litigation or to prevent the termination of a valuable trade relationship The entry by a company into a transaction at an undervalue does not, of itself, result in personal liability for the directors; but if the director caused the company to enter into such a transaction it may lead to an action for breach of duty of good faith (see section 5 below) and/or to disqualification proceedings (see section 6 below) If directors are concerned that a transaction might be challenged as a transaction at an undervalue, they could consider obtaining an independent valuation of the assets that are to be sold to ensure that the price to be paid is equivalent to market value. 2. Preferences 2.1. A liquidator or administrator can challenge a transaction as a preference if (a) a creditor is put in a better position than they would be in on an insolvent liquidation and (b) the company was influenced by a desire to put the creditor in that better position In the case of transactions with connected parties, a liquidator or administrator can only challenge transactions entered into up to two years before the onset of liquidation or administration. In the case of unconnected parties, a liquidator or administrator can only challenge transactions entered into up to six months before the onset of liquidation or administration Putting a creditor into a better position that they would be in on an insolvent liquidation can include situations where the company, for example, pays the whole or part of a debt in priority to other debts, grants security for an existing debt, or repays a director s loan account The meaning of influenced by a desire has been closely examined by the courts. The test is a subjective test and there must be a positive wish on the part of the company, or, in practical terms, the directors of the company, to put the creditor in a better position. However, it does not matter if this desire is not the primary desire; there only has to be an element of desire to be caught by this section. If a connected party is put in a better position then it is presumed that the company had the relevant desire. However, it is open to the company to prove the contrary. 11

14 2.5 As with transactions at an undervalue, the court can make a wide range of orders if there has been a preference. The intention of any order is to restore the position to what it would have been if the company had not given the preference. In practice, this usually means either an order to re-vest property in the company, to pay compensation to the liquidator or administrator for the benefit of the company s estate, or to release any security that the company has given. 2.6 However, the court will not make an order unless it can be shown that the company was unable to pay its debts as at the date it gave the preference or became unable to pay its debts as a result of giving the preference. There is, however, no defence on the grounds that the preference was in good faith, or for the purpose of carrying on the business or that the preference would benefit the company. 2.7 The giving by a company of a preference does not, of itself, result in personal liability for the directors; but if the director caused the company to give a preference it may lead to an action for breach of duty of good faith (see section 5 below) and/or to disqualification proceedings (see section 6 below). 2.8 Paying any debts at all in circumstances where a company is in financial difficulty can give rise to a real risk of transactions being attacked as preferences. Directors should seek professional advice at the earliest possible opportunity if they are in any doubt as to their position. 3. Invalid floating charges 3.1. A floating charge over a company s assets which is created in respect of existing debt only is invalid if, in the case of a connected party, it was created up to two years before the onset of the liquidation or administration, or, in the case of an unconnected party, it was created up to 12 months before the onset of the liquidation or administration. So, a floating charge will only be valid to the extent of new monies advanced at the same time as, or after, the creation of the floating charge. However, a floating charge granted to an unconnected party will only be invalid if it can be shown that the company was unable to pay its debts as at the date it granted the floating charge or became unable to pay its debts as a result of granting the floating charge Where the floating charge falls foul of the above section, the floating charge is automatically invalid and there is no need for the liquidator or administrator to apply to court for an order to set it aside Again, the creation of an invalid floating charge does not, of itself, result in personal liability for the directors; but if the director caused the company to grant the floating charge, it may lead to an action for breach of one of the statutory duties (see section 5 below) and/or to disqualification proceedings (see section 6 below). 12

15 4. Provisions against debt avoidance 4.1. There are special provisions in the Insolvency Act which enable any victim of a transaction or the administrator or liquidator of a company to apply to set aside transactions which were intended either to put assets beyond the reach of any creditor (including future and contingent creditors) or to prejudice the interests of any creditor. These provisions apply without limit as to time but the applicant must prove that the transaction was at an undervalue (as discussed in section 1 above) and that the transaction was entered into with an intent to put the assets beyond the reach of creditors or to prejudice creditors interests. There is no need for there to be any insolvency proceedings in place for a victim to make an application Again, the order a court would make would be designed to restore the position to what it would have been if such a transaction had not been entered into Neither a declaration of a dividend nor the creation of a charge, of itself, could be a transaction at an undervalue for this purpose There is no defence to this action on the ground the company was solvent at the time the transaction was entered into and there is no defence on the ground that it was in good faith and in the interests of the company However, there is protection for anyone who has entered into a transaction with the company in good faith and for value. Such a person must not have any knowledge of the relevant circumstances which include the fact that the transaction is at an undervalue and the fact of the company s intention A director who causes the company to enter into such a transaction will be exposed to an action for breach of one of the statutory duties (see section 5 below) and/or to disqualification proceedings (see section 6 below). 5. Breach of the statutory duties 5.1. As mentioned in Section A above, the directors have a general duty to act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and not to act in their own interest or the interest of another, albeit connected, company. This can lead to difficult questions of conflict of interest. Clearly, however, it is not likely to promote success, for example, to deprive a company of all its assets or diminish its assets, reserves of cash or working capital so that it cannot continue to trade An action for breach of the duty to promote success will result in the guilty director having to pay compensation to the liquidator or administrator for the benefit of the company s estate A breach of any of the provisions mentioned in sections 1-4 above might also be a breach of the duty to promote success. The general limitation period of six years applies to ordinary actions for breach of duty. So, even if there is a transaction which could not be attacked 13

16 because of the time limits in sections 1-3 above, the directors might be exposed to a personal action for breach of duty if proceedings are commenced for recovery of a monetary sum within six years from the date of breach In addition, if there is fraud or if money or property has come into the director s hands which he has disposed of improperly, there is no time limit to an action by or on behalf of the company to recover from the director. 6. Directors disqualification 6.1. If a director is found to have been unfit in the conduct of a company then that director can be disqualified from acting as a director of another company for a period of between two and fifteen years. Administrators, liquidators and receivers are obliged to make a report to the Secretary of State upon the conduct of all the directors of any company over which they are appointed. This report is confidential but may lead to disqualification proceedings being commenced by the Secretary of State for the Department for Business, Innovation and Skills. This may lead to a court making a disqualification order against a director. However, since implementation of the Insolvency Act 2000 in 2001, it is possible for a director to provide the Secretary of State with a disqualification undertaking as an alternative to going to court for a full trial. A disqualification undertaking has the same effect as if it were a court order but is a quicker and more cost effective process There has been a multitude of directors disqualification cases since this legislation came into force in There are now established a wide range of offences amounting to unfitness in the case of directors. For example, if a director was guilty of any of the matters at sections 1-5 above or 7-9 below, that would amount to unfitness It should also be borne in mind that if a director may have been responsible for the company entering into a transaction at an undervalue, a preference or creating an invalid charge but that transaction cannot be attacked because of the time limits, the liquidator, administrator or receiver s belief that the director was in some way at fault can still form part of the report. So, a liquidator, receiver or administrator will investigate each of the lists of identified transactions and consider whether any conduct by the directors in relation to those transactions should be mentioned in his report. 7. Wrongful trading 7.1. Directors can be ordered to contribute personally to the assets of a company if they allowed the company to continue trading when they knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding an insolvent liquidation and they failed to take every step a reasonably diligent person could be expected to take to minimise loss to creditors. 14

17 7.2. In determining whether or not a director knew or ought to have known that insolvent liquidation was inevitable, both the actual knowledge, skill and experience of the individual concerned and that which may reasonably be expected of somebody carrying out the functions carried out by that person will be taken into account (i.e. the court will apply both a subjective and objective test). In this way, a person with financial responsibility in relation to the affairs of a company (who is ignorant of the extent of its difficulties but who would have been aware of those difficulties if he had ensured that adequate systems were in place) will be liable It is not sufficient for the directors simply to consider the net asset position; the directors must also consider management information and consider whether the company can continue to meet its debts as they fall due. If the directors foresee, or even if they ought to have foreseen, that the company could not continue to meet its debts as they fell due then they may be exposed to a wrongful trading action. This provision applies without limit as to time and is, of course, judged with hindsight A liquidator will seek to determine a moment in time when the directors ought to have concluded that insolvency was inevitable. He will then consider the directors actions after that trigger date to see if they took every step they ought to have taken to minimise the loss to creditors. Case law demonstrates that taking every step means doing all that is within the power of the individual concerned to cause that company to stop all operations which would have the effect of worsening the overall position of creditors Ordinarily, once directors form the view that the company is inevitably insolvent they will take immediate steps to place a company into a formal insolvency process. In deciding what is the appropriate form of insolvency process, directors should consider whether there are any positive steps that can be taken to rescue all or any part of the business. Also, it is permissible for directors to consider whether any form of informal rescue package, further investment or sale of the business may be possible in the foreseeable future. 8. Fraudulent trading 8.1. The provisions relating to fraudulent trading allow a liquidator to seek an order against directors who were knowingly parties to the carrying on of a business within intent to defraud creditors, or for any fraudulent purpose It can be sufficient to show that a company continued to carry on business and to incur debts at a time when there was, to the knowledge of the directors, no reasonable prospect of those debts being paid. It is therefore important for a director to be confident of the ability of the company to meet its liabilities. If the company is relying upon the continued support of one or more of its fund providers and its directors become aware of an intention to withdraw or discontinue that support, there would be a prospect of fraudulent trading if new liabilities are undertaken (in the absence of any alternative available funding). 15

18 8.3. However, these applications are very rare because, in nearly all cases, such fraudulent trading by a director will also be caught by the wrongful trading provisions, which does not have the higher burden of proof to overcome. 9. Criminal penalties 9.1. There are various provisions in the Insolvency Act allowing for directors to be prosecuted, for example, if directors engage in fraudulent transactions (or other fraud) in anticipation of winding-up, or make false representations to creditors. These only apply in the case of a liquidation. For further assistance, please contact Keith Syson, Tim Carter or your usual contact at the firm. The information contained in this article is designed to provide a general introductory summary of the subject matters covered. It does not purport to be exhaustive or to provide legal advice, nor should it be used as a substitute for such advice. Stevens & Bolton LLP