Directors: challengeable transactions prior to insolvency

board meetingThe responsibilities of directors and the types (and consequences) of director misconduct prior to insolvency.

Directors should act with caution if their business is at risk of becoming insolvent, or has become insolvent.

When the business is solvent, directors should act in the best interests of the shareholders. However, if the company becomes insolvent, the duty moves to acting in the best interest of creditors.

There are various laws to protect creditors and make sure that the directors put creditors’ interests first. There are also numerous penalties, fines and possible bans for directors who behave inappropriately.

Following a formal insolvency, such as liquidation, an investigation is carried out by the appointed insolvency practitioner. They will pursue any breaches of the Insolvency Act and report director misconduct to the insolvency Service.

The main areas directors need to be aware of are listed below. They only usually apply if the company goes into liquidation or administration.

Transaction at an undervalue

This means assets being transferred out of the company at below market value. An example would be a car or van given to an employee on leaving. The insolvency practitioner appointed will go after the recipient and ask for the asset or difference in value to be restored to the company.

Preferences

This means preferring and repaying one creditor over another, such as paying local rather than national suppliers, or trying to reduce a bank overdraft if it has been guaranteed by the directors.

The insolvency practitioner can ask for a repayment from the person or company that has been paid these funds to restore the company to its previous position.

Misfeasance

An all-encompassing claim for when directors have breached their duties, usually to their benefit. A common example is where directors have paid into a tax avoidance scheme. This money will be reclaimed by the insolvency practitioner on insolvency.

Wrongful trading

When the directors have traded at a loss for a sustained period and should have known better, and will be made to cover the losses. This claim can only be taken by a liquidator, not the creditors, and is a claim against the directors

Fraudulent trading

Similar to wrongful trading, but with clear intent. An example would be setting up a music concert and taking ticket sales with no real intention of holding the event. This would be a claim against the directors.

Illegal dividends

You can only pay dividends from accumulated profits. If you don’t have profits, the dividends are illegal and will be claimed back. They will be reclaimed from the shareholders by the insolvency practitioner.

Illegal use of a company name

You need the court’s permission to reuse a name, or to have followed a statutory procedure if you have started the business again with the same or similar name. Failure to do so is a possible criminal offence. This only applies to insolvent liquidation.

Insolvency is a complex area of law, and directors should take early advice if they are concerned about the implications of continuing to trade or entering into unusual transactions.

You don’t have to use the first licensed insolvency practitioner you meet. You may find it is worth getting a second opinion before you decide who to use, or asking for a reference from a previous client.

About the author

David Kirk is a chartered accountant and licensed insolvency practitioner based in the south west. Follow @kirksinsolvency, or visit www.kirks.co.uk.

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