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Directors' duties in relation to Insolvent Companies

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?Where a company is or may be about to become insolvent, then the duties of the directors change significantly. In these circumstances the directors? duty to the creditors override all other duties?.? We are, as the Government keeps reminding us, in the middle of ?difficult times?. Most people would in fact simply say that we are in the midst of a global economic crisis, precipitated by the credit crunch, and that the UK economy is in recession. As a result, many previously profitable companies are teetering on the brink of insolvency. Where a company is or may be about to become insolvent, then the duties of the Directors change significantly. In these circumstances a director?s duty to the creditors overrides all other duties. The company?s assets must be managed to give priority to the creditors. These principles have been set out repeatedly in the case law and in the insolvency legislation, the starting point for which is the Insolvency Act 1986. If a company is insolvent then the director?s duty is owed to all creditors, not just one or more specific creditors. The directors cannot dispose of any of the assets of the company or make any payments to shareholders, if provision for the interests of the creditors has not been made. If the company is indeed insolvent then in reality such provision will not be possible and therefore those types of payment should not be made. A failure by the directors to obey that overriding duty can give rise to a number of claims against them by an insolvency practitioner acting as liquidator or administrator, if the company does go into some kind of formal insolvency procedure. The officeholder may bring a claim against the directors for misfeasance which essentially are claims for breach of duty. The duties can be those owed to the creditors, but also those owed more generally to the company, as listed above. The insolvency legislation also provides for possible claims by an officeholder against directors who have been guilty of wrongful trading. Many directors fall foul of this provision of the Insolvency Act because they believe (unrealistically) that the company can trade out of it?s difficulties. The legislation provides that once a director concludes there is no reasonable prospect of the company avoiding insolvent liquidation, the directors then have a duty to take every step which a reasonably intelligent person would take to minimise the potential loss to the company?s creditors. The test is a mixture of the objective and subjective. So a director must act as a reasonably diligent person would, but such a person is imposed with the actual skill, knowledge and experience of the director in question. Directors should also be alive to the risks of falling foul of other provisions in the insolvency legislation including carrying out transactions at undervalue or allowing payments to creditors which constitute preferences. Officeholders can pursue these monetary claims against directors to increase the assets of the insolvent company. Care must therefore always be taken in particular in relation to payments which might constitute preferences, ie paying one creditor in preference to another one, or putting one creditor in a better position than he would be in if the particular arrangement was not put in place. Directors should seek advice from an Insolvency Practitioner or an Insolvency Lawyer if they are in any doubt at all as to the solvency or insolvency of the company. This step is useful for two reasons. Firstly the insolvency professional can give practical advice and assistance together with an objective view upon the company?s position. Secondly, the very fact that a director or a board of directors has taken professional advice may form a defence to any of the claims which are set out above, for example wrongful trading. Faced with an insolvent company, directors cannot necessarily just resign ? there is a duty to take positive steps to resolve the situation even if those steps are simply to put the company into the hands of an insolvency practitioner. If the objective view formed by the Directors is that the company is indeed insolvent, they therefore need to take professional advice from an insolvency practitioner or an insolvency lawyer. No director should shy away from reaching that conclusion and taking the appropriate steps.

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