If a company is insolvent and cannot pay its debts, it can go into liquidation—a procedure whereby the assets of the company are sold and used to settle the creditors, and ultimately, the company is wound up. Although the emphasis is usually placed on the company and its money, it is just as important to think about the effect on the directors of the company. This piece explores the role and liability of company directors in liquidation, their possible legal repercussions, and how they can defend themselves.
Knowing Liquidation
Liquidation is a legal process that closes down a company’s business and can be either voluntary or involuntary. In a voluntary liquidation, the directors and shareholders mutually agree to close down the company. This is normally affected by a Creditors’ Voluntary Liquidation (CVL) or Members’ Voluntary Liquidation (MVL) if the business is solvent. In compulsory liquidation, the business is compulsorily liquidated, which is commonly affected by a creditor or court of law, termed Compulsory Liquidation. Irrespective of how a business comes into liquidation, the directors’ functions and duties change substantially throughout this period.
Directors’ Duties Pre-Liquidation
Directors of a firm have certain fiduciary duties, such as:
- Operating in the best interests of the company and its stakeholders
- Prevention of conflicts of interest
- The exercise of due diligence and prudence in relation to money
- Maintenance of accurate records
These responsibilities become even more complicated where a company is approaching insolvency. If directors continue to trade when they are aware (or ought to be aware) that the company cannot pay its debts, they risk being accused of wrongful trading.
Wrongful Trading
Wrongful trading happens when directors let their company carry on trading even when they are aware that it is insolvent. The consequences of wrongful trading are severe, ranging from personal liability for the company’s debts. The courts treat this very seriously, as creditors who are not paid can be hurt by this. When a company is liquidated, the licensed insolvency practitioner (liquidator) who has been appointed will look into the behavior of the directors before the liquidation.
Fraudulent Trading
While wrongful trading is unintentional, fraudulent trading is intentional. Fraudulent trading involves directors knowingly misleading creditors by carrying on business with no intention of paying back debts. Fraudulent trading is a criminal offense and can result in severe penalties, such as fines and imprisonment.
Preferences and Transactions at Undervalue
Besides wrongful trading, directors need to be careful about the dangers of giving preferences to some creditors or entering into transactions at undervalue.
Preferences: This refers to a situation where a firm prefers one of its creditors as compared to other creditors when it is insolvent. If during liquidation a liquidator establishes that a company paid a creditor an amount exceeding what it owed, such an amount can be recovered.
Transactions at Undervalue: Whenever a director sells company property below its value or disposes of assets without payment of fair value, such a transaction can be objected to under liquidation.
Duties During Liquidation
The moment a firm goes into liquidation, the directors’ roles change. The major responsibilities fall now on the liquidator to oversee the company’s dissolution and the equitable treatment of all the creditors. Still, directors also have certain functions to perform while the process takes place.
Assistance to the Liquidator
Directors are bound by law to assist the liquidator by furnishing all information about the company’s affairs, assets, and accounts. Refusal to cooperate can lead to legal action against the directors and can also delay the process of liquidation.
Disclosure of Creditors and Financial Records
Directors have to prepare, make public, and help in preparing lists of creditors and assets. This serves to ensure that every claim is catered to and that asset distribution is made equitably. Disclosure is imperative throughout bankruptcy, and any misstep in keeping things under wraps can be disastrous.
Employee and Tax Obligations
In liquidation, directors are required to make sure that employees are notified of their rights and that wages in arrears, redundancy payments, and other employment debts are dealt with appropriately. Directors are also required to assist HMRC in paying off any tax debts.
Possible Consequences for Directors
1. Personal Liability: Perhaps one of the main worries for liquidating directors is personal liability on behalf of the company’s debt. If, during liquidation, a liquidator finds evidence that the directors have been conducting wrongful trading, they can bring them to liability to pay for the company debts. This tends to be mainly applicable to debt accumulated after a company has already become insolvent.
2. Disqualification from Directorships: Directors may be disqualified from acting as directors of other companies as a result of improper conduct during the process of liquidation. The duration of disqualification may be varied, but it may range between 2 and 15 years based on the seriousness of the breaches.
3. Legal Action: Creditors or the liquidator can also file legal action against directors for actions prior to liquidation. This can lead to lawsuits or damages claims, inflicting financial losses and possible bankruptcy on the directors themselves.
4. Criminal Charges: In cases where fraudulent action is detected, directors can face criminal charges and fines, or even imprisonment.
5. Damage to Reputation: Apart from legal repercussions, directors can suffer reputational loss as a result of the insolvency of the company. Opportunities for future business may dwindle, and it might be difficult for directors to restore stakeholders’, investors’, and business partners’ trust.
Mitigating Risks: What Directors Can Do
Because the consequences can happen, directors have to make active efforts to fight against risks in liquidation. Some steps directors can initiate in order to protect themselves are as follows:
1. Seek Legal Advice
- Directors can consult the services of an insolvency professional to keep themselves updated on their liabilities and responsibilities. Professionals can be used by directors to deal with the complexity of liquidation and obtain recommendations on how they can retain personal immunity.
2. Maintain Proper Records
- Maintaining the proper company and financial records is essential. All decisions, grounds on which those decisions were made, and steps taken to avoid insolvency of the company must be preserved by the directors. Proper records ensure that the directors acted reasonably in good faith and tried to manage financial problems in a reasonable way.
3. Cease Trading if Insolvent
- If the business is insolvent, directors ought to stop trading immediately in order to avoid further loss and wrongful trading accusations. Business as usual can be totally catastrophic.
4. Act in Creditors’ Interests
- When insolvency becomes apparent, directors have to act in the interests of creditors, not shareholders.This involves steering clear of preferential payments and equal treatment of all creditors.
5. Appoint an Insolvency Practitioner Early
- Having an early-licensed insolvency practitioner may be such that alternatives to liquidation are provided, including Company Voluntary Arrangements (CVAs) or pre-pack administration.These may provide for the recovery of the business without entering into liquidation completely.
Conclusion
Liquidation is a stressful and uncomfortable experience for company directors. Knowing their duties, avoiding misfeasance, and seeking professional advice can allow directors to navigate insolvency’s intricacies without utmost legal and fiscal risks. Liquidation, either voluntary or compulsory, has to be done in transparency, wisdom, and according to the law to facilitate the equitable settlement of creditors and to protect directors against excessive liability..