Michael Reid: Company in choppy waters? Directors take care

Michael Reid: Company in choppy waters? Directors take care

Michael Reid

Michael Reid, managing partner at Meston Reid & Co, discusses how company directors should act in moments of financial difficulty and what considerations they should have.

When consulting with a director about company matters, it is quite common for words such as “me” and “my business” to be used because a director often thinks/acts as if the entity is them and often requires to be reminded that a company is a separate legal entity.

Of course, being a separate entity is often good news because it means that, generally speaking, directors, shareholders and employees are not liable for a company’s debts and other obligations, although there are instances where that can change.

R3, the UK insolvency trade body (www.R3.org), issued guidance notes earlier this year about being a director and the personal liability that can arise therefrom. With due regard to the provisions of the Companies Act 2006, the R3 notes refer to seven statutory duties:

  1. Act within powers: a director must act within the powers assigned in accordance with the company’s articles of association, and only exercise these powers for their proper purpose. We are already seeing how this can be abused with regard to bounce-back loans, because the Director Disqualification Unit is already pursuing a number of individuals who acted as a director and borrowed money under the Covid-19 scheme, subsequently withdrawing the cash for personal purposes.
  2. Promote the success of the company: as one might imagine, a director must act in good faith and in a way that is most likely to promote the success of the company for the benefit of all stakeholder groups. This means that a director should have due regard to the interests of creditors when he knows that a company is, or is likely to become, insolvent. Thus, if a director thinks that the company is in financial difficulty and unlikely to recover such that all creditors will be paid, there is a duty to act sensibly rather than borrow recklessly and take inappropriate risks. Every business, no matter its size, should have a financial forecast for the next twelve months (at least) and be satisfied that there is an underlying business that either is, or can be, successful and solvent.
  3. Exercise independent judgement: whilst a director may delegate certain tasks to others with specialist expertise, every director must exercise his own independent judgement in deciding what to delegate and whether to follow the advice of whoever provides it. One cannot let a company sink and try to point the finger at external advisors. The buck stops at the director’s desk.
  4. Exercise reasonable care, skill and diligence: the director owes a duty of skill and care to the company and thus, someone who has experience in a certain industry is more likely to be a director of a company in the same sector rather than something completely different. The Companies Act 2006 provides that a director must exercise general knowledge, skill and experience that one might reasonably expect of a person performing the functions carried out. Simply “hoping for the best” is not good enough.
  5. Avoid conflicts of interest: a director must avoid situations where there is a direct or indirect interest of his that conflicts with the interests of the company. For example, if a company is experiencing financial difficulty, a director might be tempted to sell assets to either himself or a related party at undervalue in order to retain ownership once the company fails, or perhaps denude the company’s bank account by settling his loan account to the detriment of third-party creditors.
  6. Not accept benefit from third parties: a director must not accept any benefit such as a bribe from a third party. Even if a director contends that he is achieving statutory duty 2 above, his conduct and adherence to legislation such as the Bribery Act 2010 must be respected and recorded.
  7. Declare interests in proposed transactions: a director must declare any direct interest in a proposed transaction with other directors. This can be difficult if there is only one director but does not absolve someone from knowing the law and acting correctly.

Of course, a director will have to consider the provisions of the Insolvency Act 1986 in terms of the possibility of being guilty of either wrongful trading or fraudulent trading, which may impose personal liability on the director once a liquidator has been appointed.

Further, a director will need to be careful about any third-party obligation such as a bank or supplier, in whose favour such director has signed a personal guarantee. It is not unusual for a director to favour payment of those for whom he has signed a personal guarantee e.g. the bank, which, of course, can contravene the statutory duties detailed above.

The Finance Act 2020 can make a director personally liable for tax debts and of course, he can be pursued for unpaid taxes when the liability might arise from being involved in an activity that purposely seeks to avoid tax, or is deemed to be tax evasion.

Should liquidation incept, the implications of the Company Directors Disqualification Act 1986 also require to be borne in mind in terms of how a director acted prior to liquidation e.g. filing accounts and other statutory returns, leaving one creditor largely unpaid (typically HMRC), taking deposits without being able to provide the goods/services ordered, abusing a bounce-back loan, extracting a substantial salary that was disproportionate to the duties undertaken, drawing dividends in excess of retained profits, not keeping proper records etc.

When a company is entering choppy waters, it is important to be aware of the implications of one’s actions, documenting the situation in suitable form e.g. board minute, and be able to demonstrate that the highest level of honesty, integrity and probity have been brought to bear at all relevant times.

Clearly, any director who thinks that there may be trouble ahead should seek experienced advice at the earliest opportunity because failure to do so could result in more than just the loss of the company.

Michael Reid: Company in choppy waters? Directors take care

Michael Reid is managing partner at Meston Reid & Co.

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