When a company enters liquidation or administration, the director's conduct is placed firmly under a magnifying glass, and claims can often be brought against those directors personally.
Once appointed, the liquidator or administrator will investigate whether the directors' actions caused the business to fail or contributed to the company's liabilities. They will then determine whether personal claims can be pursued against the directors for the benefit of the company's creditors.
Whilst such claims are often brought against the company directors, they can also be pursued against various third parties, including associates, spouses, and other family members.
In our experience, seeking the right legal advice from specialist insolvency solicitors as soon as possible is the key to successfully defending these types of claims.
Two distinct causes of action can arise following an administration or liquidation.
- Causes of action that belong to the company; in other words, claims the company could have brought had it not entered liquidation or administration.
- Causes of action that only an office holder (i.e. the liquidator or administrator) can bring by virtue of the Insolvency Act 1986.
Common types of claims
Unpaid/Overdrawn director loan account
It is normal for directors to withdraw money from the company. However, anything other than a dividend or salary will be allocated to the director’s loan account. If at the point of liquidation, the loan account is overdrawn, this will need to be repaid to the company.
Unlawful dividends
Dividends can only be paid if there are sufficient distributable reserves available.
Even if sufficient reserves appear to exist, directors can be liable if they fail to account for future or contingent liabilities when assessing the company’s solvency and the funds available for distribution.
Fraudulent trading
Fraudulent trading occurs when a director carries out any business with the intention of defrauding the company’s creditors. It can have both civil and criminal penalties.
Anyone who is found to have committed a fraudulent trading offence, or anyone that has knowingly been a party to the fraud, can be personally liable for the losses caused by the fraudulent trading, sentenced to a term of imprisonment of up to 10 years and/or face being banned from acting as a director for up to 15 years
Wrongful trading
Wrongful trading (section 214 of the Insolvency Act 1986) allows a claim to be brought against a director for continuing to trade in circumstances where they knew, or ought to have known that there was no reasonable prospect the company would avoid going into insolvent liquidation.
Essentially, it holds directors personally liable for not minimising the losses to creditors when the company is heading towards insolvency or was already insolvent. In addition to personal liability for the debts incurred by the company during the period of wrongful a director may also be subject to disqualification proceedings.
There is a defence to wrongful trading claims. If the director can show that they took every reasonable step to minimise the potential loss to the creditors, they will be able to escape liability.
Examples of wrongful trading include:
- Intentionally allowing the company to accumulate debts when the company is insolvent or on the verge of insolvency.
- Paying yourself a substantial salary when the company cannot afford it.
- Taking delivery of goods which the company cannot pay for.
- Entering into credit agreements despite knowing that the company cannot meet the repayment terms.
- Breach of directors duties
The codified duties - fiduciary duties
The Companies Act 2006 (CA 2006) codifies certain common law and equitable duties that each director must comply with.
The seven general duties are:
- Duty to act within powers (section 171 CA 2006)
- Duty to promote the success of the company (section 172 CA 2006)
- Duty to exercise independent judgment(section 173 CA 2006)
- Duty to exercise reasonable care, skill and diligence (section 174 CA 2006)
- Duty to avoid conflicts of interest (section 175 CA 2006)
- Duty not to accept benefits from third parties (section 176 CA 2006)
- Duty to declare interest in proposed transaction or arrangement(section 177 CA 2006)
The uncodified duties
In addition to the above duties there are also uncodified duties that all directors should consider.
The "creditor duty"
In certain circumstances, directors will also have a duty to consider or act in the best interests of the company's creditors. This is sometimes called "the creditor duty".
The creditor duty arises when directors know or ought to know that either the company is insolvent or bordering on insolvency or an insolvent administration or liquidation is probable.
When the duty is triggered, the directors must act in the interests of the creditors of the company over and above the interests of the stakeholders.
Common scenarios that are likely to be deemed a breach of the creditor duty include:
- Excessive remuneration of directors.
- Directors prioritising the repayment of their lending to the company.
- Putting assets beyond the reach of creditors.
- Diversion of sale proceeds rightly due to the company to others.
- Improper payments or asset transfers to directors or related parties.
- Improper payments or asset transfers to group companies.
- Cash withdrawals that are not legitimately for the benefit of the company.
- Directors must ensure that they inform themselves of the company's affairs, including knowing and undertaking the roles and conduct of their fellow directors, to enable them to discharge their duties adequately.
Whilst directors are permitted to delegate certain duties provided it is reasonable to do so, that delegation does not permit the directors to absolve themselves of supervising the other directors to ensure that they are properly performing their duties.
A duty of confidence
To whom do these duties apply?
These duties apply to all directors, both 'de jure' directors, those formally registered at Companies House, and 'de facto' directors, those who assume responsibility to act as directors although never actually appointed as such.
These general duties also apply to 'shadow directors', defined as a person or persons in accordance with whose directions or instructions the company's directors are accustomed to act.
Consequences of breaching the duties
There are various consequences that can arise if any of the duties are breached, to include:
- Actions by the Liquidator
- Actions by the members of the company
- Actions by creditors of the company.
Misfeasance
Misfeasance claims can be brought under Section 212 of the Insolvency Act 1986 (in the context of a liquidation) or Paragraph 75 of Schedule B1 of the Insolvency Act 1986 (in relation to administrations).
Misfeasance claims belong to the company and any office holder pursuing a director for misfeasance will need to bring the claim in the name of the company.
Misfeasance will often relate to allegations that an officer of a company has:
- Misapplied, retained or become accountable for money or other property of the company.
- Breached a fiduciary or other duty in relation to the company.
- If a court finds that the defendant is guilty of misfeasance, the Court can make an order requiring the defendant to:
- repay, restore or account for the money or property or any part of it, with interest at such rate as the Court thinks just, or
- contribute such sums to the company’s assets by way of compensation in respect of the misfeasance or breach of fiduciary or other duty as the Court thinks fit.
Antecedent transactions
What is an antecedent transaction?
When a company has entered into a formal insolvency process, certain types of transactions entered into by the company prior to liquidation/administration may be challenged under various provisions of the Insolvency Act 1986. These claims are known as reviewable or antecedent transactions.
Types of antecedent transactions include:
- Preference claims: a preference claim arises where a creditor of the company is paid in preference to other creditors, or when steps have been taken to place a creditor in a better position than other unsecured creditors.
- Transactions defrauding creditors: a transaction can be set aside under section 423 of the Insolvency Act 1986 if:
- The transaction is entered into at an undervalue.
- The purpose of the transaction was to put assets beyond the reach other creditors or future creditors of the company.
- Transactions at an undervalue.
- This is where there has been a transaction (e.g. the transferring or selling an asset) between two parties for no consideration or at a consideration which is less than market value. The liquidator can pursue a claim to recoup the losses suffered by the company.
- Void transactions: once a company is in liquidation, any disposition of company assets or property will be void.
- Extortionate credit transactions: an extortionate credit transaction occurs when credit is provided to the company on unfair or unfavourable terms, such as exorbitant interest payments.
Investigatory powers of officeholders
Often, before a formal claim is instigated, a liquidator or administrator will contact a director to gather information about the company and potential financial claims that may be made against it. Responding in the right way to these early enquiries can dictate whether the claims are pursued. We always recommend that you seek specialist legal advice in dealing with these enquiries.
Do I have to reply to these enquiries?
Yes, in short you do. If you do not engage (in a meaningful way or at all), the officeholder has various powers that they can implement in forcing your engagement.
When a company is in administration or liquidation, certain people have a duty to give information to the office holder and to cooperate with their enquiries pursuant to section 235 of the Insolvency Act 1986.
The purpose of the duty to co-operate is twofold:
- To give the office holder information that they may reasonably require concerning the company and its promotion, formation, business, dealings, affairs or property.
- To attend on the office holder at such times as they may reasonably require.
Those required to cooperate include :
- Officers and former officers of the company.
- Anyone who has taken part in the formation of the company at any time within one year before the insolvency event (e.g. administration or liquidation)
- Employees and those who were employed within the year before the insolvency event who are capable of giving information required.
- Officers and employees of another company connected to the insolvent company.
A person who fails to comply with the duty to cooperate without reasonable excuse will be liable to a fine.
Section 236 Insolvency Act 1986
Powers conveyed on an officeholder under section 236 is closely connected to the duty to provide information to an insolvency office holder that arises under section 235.
Section 236 allows an officeholder to apply for an order requiring a person to provide information about the company or to attend a private examination in court.
The tool can be used to:
- Identify and recover assets.
- Put the affairs of the insolvent estate in order.
- Discover facts surrounding potential claims.
- Reconstitute the company's books and records.
- Investigate the causes of the company's failure and the extent to which a directors actions or conduct contributed to the failure.
- Obtain evidence for use in directors' disqualification proceedings.
Section 236 orders can be obtained against:
- Any officer of the company
- Any person known or suspected to have in their possession any property of the company.
- Any person supposed to be indebted to the company.
- Any person whom the court thinks capable of giving information concerning the promotion, formation, business, dealings, affairs or property of the company.
Failure to appear before the court (without having a reasonable excuse) can result in a warrant to being issued for arrest and seizure of any books, papers, records, money or goods in the persons possession.
Moreover, failure to comply with a section 236 order is also a contempt of court, which may result in a term of imprisonment being imposed.
Other claims
In addition to the financial claims referred to above, the demise of a company can also results in the Insolvency Service instigating a director disqualification investigation into the conduct of a director.
If a director is found to have acted in breach of their fiduciary duties, they can be banned from acting as a director for a period of between 2 and 15 years, and they may be made subject to a compensation order.
A liquidator can make a financial claim against a director if during the course of the winding up of the company, the director misapplied or retained, or became accountable for, any money or other property of the company, or was guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company.
In addition to the power to issue financial claims, the liquidator also has wide powers to compel a person to provide information about the company or attend court to be examined on oath.
Although one of the main reasons to operate a business as a limited company or LLP is to limit liability and personal exposure to the repayment of company debts, there are circumstances where directors may be personally liable for company debts. For example, if they are found to be guilty of misconduct or if they have breached their director duties.
If a liquidator issues a claim against you, and subsequently obtains a judgment, the liquidator can take enforcement action against you if that judgement remains unsatisfied. This can include the liquidator obtaining a charging order against any property you own to include your main place of residence or applying to make you bankrupt. In either case, the liquidator can apply for an order for sale and possession of your property if the debt remains unpaid.
In certain circumstances, even if the allegations of misconduct can be made out, a director may be excused from any liability if it can be established that the director acted honestly and reasonably and, in all circumstances, ought to be excused. This is known as the “Section 1157” defence.
The short answer is yes. The liquidator can sell or assign the claim to any third party. Often there is little by way of funds in a liquidation to enable the liquidator to cover the costs of pursuing a financial claim against the director of the company. In those circumstances the liquidator can sell the claim often for a small upfront sum, followed by a percentage of any net recoveries.
Yes, unless an investigation into your conduct gives rise to a director disqualification.
You cannot reuse the same name or similar names for up to five years post-liquidation unless certain exceptions apply. The consequences for breaching this rule (which is governed by section 216 Insolvency Act 1986) are extremely serious.
As well as personal liability there are also criminal implications.
This information is for guidance purposes only and does not constitute legal advice. We recommend you seek legal advice before acting on any information given.
