With the suspension of wrongful trading laws coming to a close, Jonathan Cole explains how a director must act if a business is verging on insolvency.
When business is good and a company is clearly solvent, a director's legal duties focus on acting in the best interests of the company and promoting its success for the benefit of its members. When a crisis event occurs and the company is insolvent or is verging on insolvency, there is an important shift in a director's legal duties, from promoting the company for the benefit of its shareholders to protecting the interests of its creditors. This shift in duty takes place in the context of other continuing duties, such as duties to avoid conflicts of interest and duties to promote the success of the company.
A failure to properly observe the shift in the legal duties of directors can result in directors falling foul of the wrongful trading laws. These laws impose personal liability on directors if they: i) knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration; and ii) they did not take every step with a view to minimising the potential loss to the company's creditors.
In order to prevent the liquidation of normally solvent companies during the pandemic, the wrongful trading laws were suspended with effect from 1 March 2020. However, this suspension is due to expire on 30 June 2021 and other checks that ensure directors fulfil their duties and act with integrity continue to remain in force.
With pandemic-induced financial uncertainty continuing, here are practical steps to assist directors of hospitality businesses with balancing their duties in troubled times.
Six steps in the face of insolvency
1 Implement effective credit control
Cash flow can be so important in determining and preventing insolvency. In the circumstances, it is very unlikely that a director will be criticised for implementing robust and effective measures to control outgoing cash and enhance collection from debtors, where such action is in the interest of both the members and the creditors.
2 Take professional advice (and act on it)
Directors should arm themselves with the requisite financial and legal knowledge to assist them in making informed decisions during any period of financial insecurity. This might include:
- Instructing accountants to report regularly on the current financial position of the company.
- Seeking legal advice on their own responsibilities, particularly in relation to any proposed transactions.
- If necessary, instructing an insolvency practitioner to advise on the options available to the company.
3 Document decisions
A clear written record of thought processes behind a particular business decision should be maintained. The most effective way of doing this is to hold regular board meetings and to keep detailed minutes of those and any advice received from accountants, lawyers and insolvency experts.
4 Regular creditor communication
The support of creditors could be crucial to the ongoing survival of a company during troubled times. Consequently, directors should report to and keep in regular contact with the company's major creditors from an early stage.
5 Do not resign
Unless it is absolutely necessary to do so, a director should not resign from a company in financial difficulties, until they have been resolved or the company enters formal insolvency proceedings. The courts will often view a resignation when the company is in financial difficulties as compounding the issue.
6 Commence timely insolvency proceedings
Directors should try to maintain the company and its business as a going concern, but if insolvency is unavoidable, they should take steps to commence insolvency proceedings in a timely fashion.
Jonathan Cole is a solicitor at Goodman Derrick LLP
Photo: Theethawat Bootmata/shutterstock.com
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