On 28th March 2020, the Government revealed fresh steps to aid struggling businesses during the COVID-19 pandemic. The Government plans to modify insolvency regulations, allowing companies a period of relief to continue operations while considering rescue options. It will also temporarily halt the wrongful trading rules, retrospectively effective from 1st March 2020 for three months. Further details can be found here. Directors should remain aware of their duty to creditors and shareholders, and seeking early advice is the most effective shield against potential criticism.
Actions against directors: assignment of claims to a third party
Recent legislation designed to safeguard the interests of creditors implies that, as a director, you face an elevated risk of personal responsibility. An adjustment made in the Small Business, Enterprise and Employment Act 2015 allows various legal actions against directors, such as wrongful and fraudulent trading, to be transferred to third parties.
So, what does this mean for you as a director?
A primary concern is the potential establishment of companies solely to gain profit by aggressively pursuing legal claims against directors. Even without this specific threat, the expansion of actions that can be initiated by administrators, in addition to liquidators, heightens your overall exposure to risk.
The cost of taking action is a factor
One reason administrators or liquidators might not always take legal action is the uncertain cost and burden of proof required for a successful case.
Even with sufficient evidence, administrators may choose not to proceed due to the time-consuming nature of such cases.
However, the ability to sell these actions to creditors, either individually or collectively, is likely to increase their prevalence.
So, what specific types of legal action are we referring to?
- Wrongful trading: Mismanagement of the company without a deliberate intention to defraud may include actions such as neglecting to submit statutory returns or permitting the accumulation of tax arrears.
- Fraudulent trading: This might involve intentionally engaging in transactions with suppliers, knowing that payments won’t be fulfilled, or drawing a substantial salary from the business despite evidence indicating it cannot be sustained.
- Preference: Granting a third party or connected party a more advantageous position than would have occurred if the company were to face insolvency.
- Transactions at undervalue: Permitting a transaction to take place at a value below the market rate, benefiting either the recipient or the business.
Significant losses to creditors
If creditors endure significant losses due to the directors’ management of the business, it’s understandable why they would be inclined to escalate the issue. Former employees, who have lost their primary income source, may unite with other creditors facing substantial losses.
The sense of grievance naturally fuels creditors’ motivation to pursue action, surpassing that of an insolvency practitioner who considers the involved time and unpredictable costs. Even more concerning is the possibility of claims firms taking on cases, established solely to exploit this amendment to legislation.
Assigned litigation to claims firms
These new measures could potentially give rise to an entire industry. The assertive pursuit of directors by claims firms established for this purpose poses a notable new threat to company directors.
The government’s objective is to bring forth more cases of unlawful trading and wrongful trading against directors, aiming to enhance transparency in business and bolster confidence in the insolvency process overall.
The promotion of civil claims is likely to lead to precisely that – an increase in claims against directors, which, if successful, could lead to:
- Director disqualification for a maximum of 15 years
- Fines
- Personal liability for some or all company debt
- A prison sentence in the most severe cases of unlawful trading
Read More:
- My insolvent business has ceased trading
- Understanding the new standalone moratorium for insolvent companies
- My company is facing an Employments Tribunal Action
- What Happens When a Director Cannot Afford to Pay Their Personal Tax
- How to handle soaring overhead costs
Avoiding the risk of claims against you
As a director, you bear a legal responsibility to prudently manage the company. This encompasses fulfilling statutory obligations, making timely payments, and, most importantly, staying informed about the company’s financial state, ready to take swift action if needed.
If you suspect insolvency is imminent, safeguarding creditor interests becomes crucial to avoid allegations of wrongful or unlawful trading. The increased obligation for insolvency practitioners to report on all directors to the Secretary of State heightens the risk of potential action against you.
In the face of financial challenges, seeking professional advice to understand your position as a director is crucial. It’s strongly advised to do this well before insolvency becomes a pressing issue – a few minor adjustments to cash flow management may be all it takes to steer your business back on course.
Contact our team to schedule a free, same-day consultation.
I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.