Your responsibilities as a director if your company is facing insolvency
If you are a company director, you will know you have a ‘fiduciary duty’ to act in best interests of the company and its shareholders – this is your primary obligation as a director. You might also be aware that, in times of financial strife when there’s the potential for the business to become insolvent, that duty shifts.
Don’t risk being struck off!
When insolvency beckons, your focus should be on protecting the interests of the company’s creditors rather than its shareholders. Failing to meet this obligation to creditors can have serious repercussions for a director, even potentially resulting in you being ‘struck off’ and unable to act as a director for any other UK company.
All businesses occasionally have tricky periods when cash flows out of the company faster than it’s flowing in. One of the challenges for a director is working out when this is just part of the ebb and flow of normal business life, and when the difficulties the business faces are genuinely likely to result in insolvency.
Pulling the plug on the business too early can result in the loss of jobs, revenue, shareholder value and (ironically) payment to creditors, whereas leaving it too late can result in personal liability for the directors who ignored the ‘writing on the wall’.
Know your duties as a director.
In the recent case of BTI v Sequana, the Supreme Court has provided guidance to directors wondering where to draw this particular line. The Court has stated that the Creditor Interest Duty, that is, the duty of company directors to take into account the interests of the company’s creditors when the company becomes insolvent or is at risk of insolvency, is only triggered when there is a real risk of insolvency, and not just a theoretical risk.
So how do you decide whether the risk of insolvency is real or purely theoretical?
Crossing the line from risk to insolvency.
There is no magic rule to determine at what point a company crosses the line from theoretical risk to genuine risk of insolvency. It will depend on all sorts of things – how well the company is able to manage and defer the demands of its creditors (including HMRC), how quickly it is able to collect outstanding sums due to it, whether long-promised orders will arrive in time… there are many factors to consider, and the particular combination will be unique to each individual business.
However difficult it may be, it is important to ensure the directors take seriously their responsibility to consider the risk of insolvency in order to protect the company, the creditors and the directors themselves.
Assessing the risk.
This means, for example, talking to legal and financial advisors regularly to help you monitor, identify and assess risks – and, essentially, carefully minuting the decisions made and the reasons you reached those conclusions. While a court examining your decisions in the future may not necessarily agree with your conclusions, being able to demonstrate that you acted responsibly and carefully considered all the relevant information will go a long way to protecting you from claims that you have breached your duties as a director. And this, in turn, may shield you from personal liability in the event it all goes wrong.
Read more in the full judgment of the Supreme Court BTI 2014 LLC v Sequana SA  UKSC 25.