Jane Henderson, solicitor, outlines directors’ responsibilities when dealing with company assets.
In the UK, if a company is close to becoming insolvent, it is important that directors are aware of their duties and potential issues that could arise, especially when dealing with company assets.
The Companies Act 2006 sets out the general duties owed by UK directors. These can be summarised as to act in the best interests of the company. Duties are owed not just by registered directors, but also by shadow and de facto directors.
If the solvency of the company is doubtful, the directors’ duties shift and it is the interests of the creditors, not the shareholders, that the directors must promote. If the company does enter a formal insolvency process, the conduct of the directors in the period leading up to insolvency will be considered, and the company’s transactions investigated.
Misfeasance, fraudulent trading and wrongful trading
When selling or otherwise dealing with company property, directors should be aware of the provisions of the Insolvency Act 1986 (the Act). If those running a company are found to have misapplied company property or money, carried out any business of the company for any fraudulent purpose, or engaged in wrongful trading, court action may be taken against them.
Previously, wrongful and fraudulent trading actions could only be raised against directors whose companies had gone into liquidation, but changes brought into effect in October 2015 by the Small Business Enterprise and Employment Act 2015 have extended the scope, and action can now also be taken against directors whose companies have entered administration.
If the conditions set out in the Act for misfeasance, fraudulent or wrongful trading are satisfied, directors can be ordered by the court to make a contribution to the company’s assets. The aim here is to try and restore the company to the position that it would have been in but for the inappropriate dealings.
In the lead up to insolvency when a director is selling company assets, it is important that they are not transferred for less than their true value. If it is found that assets were sold at undervalue, or transferred for no consideration at all, the court may order the transaction to be set aside and steps taken to restore the company to the position that it would otherwise have been in.
In Scotland, action can be taken to challenge transactions in the two-year period before the commencement of formal insolvency proceedings or, if connected parties are involved, the period of challenge is extended to five years. In addition, common law challenges can also be brought at any time. Where a challenge is brought, it is for the party who wants to uphold the transaction to prove that adequate consideration was made, or that at the time of the transaction (or any time after the transaction) the company’s assets exceeded its liabilities. It is also possible to argue that the alienation was a gift that was reasonable for the company to make.
In England and Wales, the position is more or less the same, although different time limits apply. Transactions carried out in the six-month period prior to the onset of insolvency can be challenged, and the period is extended to two years if the transaction involved a connected party.
Under Scots law if, in the six months before the commencement of liquidation or administration, a creditor is given a preference that prejudices of the general body of creditors, the court can make an order to set aside the transaction or to restore the company to the position it would have been in had that preference not been given.
The court will not make an order where:
- the transaction is in the ordinary course of trade or business
- is a payment in cash for a debt due
- the parties were undertaking reciprocal obligations
If the challenge is brought under common law, there is no time limit.
Again, the position is similar in England and Wales, but with different time limits. Where the dealing is with a connected person, a challenge can be brought in the two-year period ending with the onset of insolvency.
Creditors’ interest takes priority
Where a company is facing financial difficulty, it may be tempting to have a ‘fire sale’ and take other steps to raise funds and protect interests. But it is important to remember that when a company is approaching insolvency, it is the creditors’ interests that take priority.
If the company does enter a formal insolvency process, the conduct of directors and the transactions entered into will be scrutinised. Directors could be held personally liable and ordered to make a financial contribution to the company. They could also face director disqualification.