Warning: Potential Personal Liability In An Insolvency
Managing Your Four Key Risks In a Turnaround - Part 2 Insolvency Risks
If you are the director of a business facing difficulties, you need to ensure that you take the appropriate steps to manage your personal risks in the situation. The previous article discussed how to deal with your normal responsibilities and the need to manage your personal mental health during a crisis. In Part 2 this article looks at insolvency specific risks.
The key risks that a company's directors face if it fails, and the parties involved in bringing the relevant action, are summarised below.
It's important to note however that for the purpose of most of what follows, directors include not only people who have been formally appointed as directors, but also shadow directors, people on whose instruction and direction the directors have been accustomed to act, and defacto directors, people who have been acting in the capacity of directors.
1 Insolvency Practitioner
Can act to set aside transactions made before the liquidation (and similar rules apply to sole traders and partnerships as well as to companies) in order to increase the assets in the pot available to all creditors, such as:
- preferences (you paid what was owed to Joe, your brother, but didn't pay any of the other creditors); or
- transactions at undervalue (you sold Joe the company Rolls Royce for 10 the day before the business went down).
Can act to make the directors personally liable to contribute towards the company's debts if he can prove:
- wrongful trading (continuing to trade past the point where you knew, or ought to have known, that an insolvent liquidation was inevitable); or
- fraudulent trading (trading in a way designed to defraud creditors).
Sole traders and partners are of course personally liable for all the business debts in a bankruptcy in any event.
2 Insolvency Service
Receives a report on the directors' conduct from the IP and can take action under the Company Director Disqualification Act to bar individuals from becoming company directors. In taking action they will take into account the degree of responsibility for the failure, the amount of 'Crown money' (PAYE, NI and VAT) kept by the business, as well as matters such as the adequacy of the books and records, and statutory filings.
Bankrupts are automatically barred from holding directorships during their bankruptcy.
3 Creditors
Can seek to recover money from anyone who has given a personal guarantee (PG) in respect of a company debt (such as where the company leased the premises but you personally guaranteed the debt).
Sole traders and partners are personally liable for all their business debts in the bankruptcy.
The basic steps you should take to protect yourself from any insolvency related recovery action by an insolvency practitioner or disqualification action by the Insolvency Service are to ensure that you are able to show that:
- you took the appropriate steps in the light of your knowledge at the time; and
- you took appropriate steps to ensure that your knowledge was as good as it could be.
In practice the way you do so is by demonstrating that you had:
- prepared and maintained accounts, trading results, and forecasts;
- if in any doubt, taken professional advice about whether you should continue to trade, and about any major proposed transaction such as refinancing or selling major assets, including having independent valuations done where appropriate;
- held and minuted board meetings to record decisions and the basis on which they were made including the forecasts available and the professional advice received.
And a very practical point here is that you need to remember to keep personal copies of all such documents in a safe place away from the business, as it's not much use wanting to rely on these in a case a year or more after a liquidation if they all only existed as files on a company computer that will then be long gone!
Liabilities under personal guarantees are a different matter. These arise as a result of a contract between you and the relevant creditor. The advice here is that if faced with a claim of liability under a personal guarantee it may be worth obtaining legal advice as the courts tend to construe liability under personal guarantees very tightly and there may be grounds under which you can dispute the liability.
Finally however, there are also some particular risks that you as a director can be held personal liable for arrears of Crown payments due to HMR&C, which can also lead to funding issues in relation to any future business you are involved with, and these will be covered in more detail in Part 3 of these articles.
Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and as these can have serious implications you should always seek appropriate professional advice on your own particular circumstances before taking any action.
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