What are directors’ duties?
Company directors are “fiduciaries” for the companies they manage – i.e. they occupy a position as trustee with the company as beneficiary. As such, they owe the company certain duties, for which they can suffer personal liability in the event of a breach.
Ss 171 – 177 of the Companies Act 2006 (“CA06“) codified these directors’ duties as follows:
- Duty to act within powers
- Duty to promote the success of the company
- Duty to exercise independent judgment
- Duty to exercise reasonable care, skill and diligence
- Duty to avoid conflicts of interest
- Duty not to accept benefits from third parties
- Duty to declare interest in a proposed transaction or arrangement
When a company enters an insolvency process, the office-holder (usually a liquidator or administrator) will investigate the directors’ conduct and, if it appears that any of the above duties were breached, may seek to bring a claim on behalf of the company for loss caused by that breach. Directors therefore need to consider their actions and the decisions they make very carefully when a company appears to be in financial distress.
S172: the Duty to Promote the Success of the Company
Of particular concern to directors of companies in financial distress will be s 172 CA06, which places a duty on company directors to promote the success of the company and act within its interests at all times. When a company is solvent and trading comfortably, acting “within its interests” is generally considered to mean acting within the interests of the company’s shareholders (which will in most cases include the directors, at least in some form).
However, case law has determined that when a company is insolvent or close to insolvency, the duty to act in its interests and “promote its success” will extend to considering the interests of a company’s creditors. If a company’s directors continue to trade a company past the point where it has no hope of returning to solvency, and thereby increasing the deficit to creditors in the process, an office-holder may hold the directors responsible for that loss. As such, when a company is in financial distress, directors must consider the interests of creditors in all decisions they take.
When does the “duty to creditors” bite?
Much ink has been spilt over precisely when a director’s duty to consider creditors’ interests crystallises, and every case will turn on its own facts. Various authorities have spoken of the duty biting when a company is “close to” or “on the verge of” insolvency, with the most recent major authority – BTI v Sequana SA and others [UKSC 2019/0046] – asserting that directors should consider a company’s creditors when there is a “real risk of insolvency”, rather than when insolvency is “probable, imminent, or a reality”. As such, when the interests of shareholders and creditors conflict, the creditors should be prioritised in circumstances where liquidation is likely.
How will the directors’ liability be quantified?
To the extent possible, insolvency practitioners will attempt to quantify the damage caused by reference to specific transactions – for example, if directors continue to pay themselves remuneration at the expense of the Company’s creditors, or pay a creditor they are personally connected to in preference to the Company’s general body of creditors.
However, if the company continued trading for long enough and caused a big enough deficit, it may be possible for office holders to claim general trading losses on behalf of the Company: in the recent BHS Group Limited v Chappell, Hennington & Chandler, it was held that the directors’ liability could be quantified by reference to the increase in the deficit between assets and liabilities caused by the misfeasant transactions, rather than the value of the transactions themselves. That has the potential for directors to expose themselves to very significant liabilities for breaches.
What defences are available and how can directors protect themselves?
S 172 provides a defence to breach of directors duties in that if the directors took their decisions in good faith acting reasonably, they will be absolved of liability for breach of this section. As such, directors of distressed companies would do well to consider taking some or all of the following actions:
- Ensure all financial records and book-keeping is up-to-date, with detailed cash flow forecasts running across the following three months.
- Avoid paying any creditor connected to the Company.
- Hold regular board meetings for each affected company with accurate minutes recording the proceedings, at which all financial projections and costs base are reviewed in detail (with a view to keeping such projections realistic).
- Keep banks and institutional lenders informed of all relevant matters and progress throughout.
- Develop a policy for paying creditors and ensure equal treatment where possible; including engaging with creditors that threaten legal action to avoid winding up petitions being issued.
- Seek advice from insolvency practitioners of insolvency lawyers as early as possible and give an open account of the company’s finances and records of decisions.