Is ignorance bliss? Corporate failure

In relation to corporate failure, there are some common misconceptions about the liability of company directors.  Operating as a limited liability company does provide a level of protection to shareholders; however company directors can be held personally liable for debts of the company if they have breached their director’s duties.  These duties are set out in Sections 131 – 137 of Part 8 of the Companies Act 1993.

When a company is placed into liquidation, the liquidator will examine whether the company’s directors have breached their duties, including the duty to avoid trading recklessly, and the duty to avoid incurring debt unless there were reasonable grounds at the time to conclude that those debts would be met by the time they fell due.

The objective test for reckless trading is if the business has been carried on in a manner likely to create substantial risk of serious loss to the company’s creditors. This does not have to be a deliberate intention.  It can be through simple carelessness, which is commonly demonstrated by a director continuing to operate while insolvent.

When considering the duty to avoid incurring debt that the company is unable to subsequently pay, the question that needs to be considered is ‘were the actions that the directors took (or neglected to take) reasonable in the circumstances?’  Directors often neglect to meet this duty of care if they have put their head in the sand and not closely monitored the financial health of the company.

When weighing up whether to take an action against a director, the liquidator will consider the value of the loss (total amount of the company’s creditors) compared with the value of the potential gain (amount recoverable from the director personally and potentially their associated trusts).

Failing to comply with ‘director’s’ duties leaves directors exposed to financial claims and can result in the loss of their personal assets or worse, being adjudicated bankrupt.  Any such claim is generally capped at the value of the company’s total creditors.

If you are a director of a company, ignorance is no excuse.  You need to know your duties as you could be personally accountable for the company’s debts. If you know, or suspect, a company is insolvent, always seek competent advice as to how this may affect you.

Published Summer 2013.

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