It’s a challenging time for any business with many directors having to make quick and difficult decisions. In certain circumstances directors can face personal liability as a result of their acts and omissions, which is an even greater burden on top of everything else. Here are some practical points for company directors to bear in mind when taking decisions generally, but in particular about payments, cash flow and business resilience.
What if we get it wrong?
Claims always come after the event and are made with the benefit of hindsight – which is something that was not available to the directors when taking the decision in question. The absence of contemporaneous evidence to show the how and why of the particular decision makes it more difficult to defend (sometimes years) after the event.
The consequences of a breach by directors of their duties to the company that cause a loss to the company can be an order of the court that they personally make good the loss to the company.
Whose interests should the directors focus on?
Where the company is solvent the directors must act in a way they consider, in good faith, would most likely promote the success of the company for the benefit of its members as a whole.
Where the company is ‘probably’ insolvent the focus turns to protecting (by not prejudicing) the interests of the company’s creditors. Directors of a company which is probably insolvent are not free to take decisions about the company and its business without first considering whether the proposed course of action would reduce the number or value of assets available to meet the creditors’ claims, or whether the proposed action would add to the company’s liabilities. If the outcome of the decision could, or is likely to have, a negative impact on the position of creditors, the directors must proceed with caution or maybe take a different course of action.
What if we cannot pay everyone everything when it is due for payment?
If the company enters into liquidation or administration, the liquidator or administrator could claim back payments, or undo acts or decisions. An act or payment will be at risk of challenge if:
- it took place within six months (where the creditor or guarantor is not connected with the company), or two years (where the creditor or guarantor is connected with the company) of the commencement of the liquidation or administration; and
- in making the payment or doing the relevant thing, the company wanted (“desired” to use the word from the Insolvency Act 1986) to put the creditor or guarantor for its debts in a better position in the event of the company’s liquidation/administration.
This is known as a ‘preference’ or ‘preferring’ a creditor and the beneficiary of the preference can be ordered to repay the money or benefit received. The key point to a preference payment being set aside is that the company actually wanted to improve the creditors’ position in the event of insolvency, not simply that the improved position of the creditor was a consequence of the payment or act. For example:
- Repayment of loans to shareholders or directors when trade creditors or employees are not being paid is likely to amount to an unlawful preference. In this instance there is no valid reason for putting the interests of one unsecured creditor above the interests of another.
- Making a payment to a creditor to enable some business-critical service or supply to continue, or to procure the withdrawal of a properly presented winding up petition, may not be an unlawful preference. This is because the company has taken the step to enable the business to continue or to avoid greater damage – not to improve the position of the creditor. In this case it may be said the company had no real choice but to act or make the payment.
How can we help?
Directors need not take difficult and far-reaching decisions in a vacuum.
Specialist insolvency and restructuring solicitors or insolvency practitioners can act as sounding boards and advisors to ease the burden on directors and reduce the risk of personal liability. The Insolvency and Restructuring Team at Stephens Scown has many years experience of advising directors at difficult times and is available to help.
You might also find useful our COVID-19 Insights Hub which covers many questions about employees, leases, contract terms and other aspects of business life and continuity.