A director’s duty to a company is to act in the interest of the company and its body of shareholders. However, a company director must take great care in conducting business when the company enters into insolvency in which case the interests of creditors take priority. In the event that a company in financial difficulty continues to trade, its director may become liable for “wrongful trading”.
In the course of the winding up of a company, if it appears that the company has gone into insolvent liquidation and at some time befor e the commencement of the winding up of the company, and if the director of the company knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, then the director may become liable for wrongful trading upon which the director may personally be made to contribute to the company’s assets.
For the above purpose, a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for: the payment of its debts and other liabilities such as expenses of the winding up. Wrongful trading is a breach that may only be committed by a dir ector of a company pursuant to Section 186 of the Insolvency Order, 2016. The liquidator of the company may make an application to the court for the company’s director to become liable for wrongful trading.
A director who took every step with a view to minimising the potential loss to the company’s creditors as he ought to have taken may avoid becoming liable for wrongful trading assuming the director to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation. Any function of the company which have been entrusted on the director shall be included for consideration even if the director does not carry such function out.
A director of a company for the above purpose need not onlybe the executive director of the company. Any executive or non-executive director may become liable for wrongful trading. There are also persons who are not appointed directors of the company but have acted as if they were or upon whose orders the other directors are accustomed to obeying would become liable for wrongful trading as well.
Notwithstanding the above, there are circumstances that a director may not become liable for wrongful trading when a company is allowed to continue trading while it is insolvent. If a director had reasonably believed that the company’s fortunes would have reversed, and the interests of its creditors eventually protected then continuing to trade may be the appropriate decision made by the director thus absolving him from any wrongful trading.
AVOID WRONGFUL TRADING
Many successful companies enter into short periods of insolvency before fully recovering, and the directors of such companies do not reactively wind up their companies at first glimpse of insolvency as a default step for fear of wrongful trading. Instead, directors of such companies take several steps to protect themselves from becoming liable for wrongful trading. Dir ectors of companies should keep full documentation of how their companies have conducted business during periods of insolvency which reflects great care to protect the rights of creditors. Directors should also convene board meetings on a frequent basis and keep comprehensive minutes of meetings which reveal their board decisions in navigating the company during insolvency whilst keeping in mind all payment obligations to the company creditors.
Another strategy of avoiding wr ongful tr ading is to proactively involve creditors in the company’s business operations and keeping the creditors informed of any anticipated payment delays so as to obtain the support and forbearance by the creditors.
At the same time, directors who discover that the company’s ability to pay creditors may no longer be feasible should consider seeking advice from qualified professionals so as to prove that they have taken every step with a view to minimise potential loss to the company’s creditors. Directors who ignore creditors’ rights and who fail to seek professional advice amidst a spiralling insolvency may be held liable for wrongful trading. Concurrently, directors should consider corporate rescue mechanisms which have been described in the previous article as one of several practical means of resolving the company’s insolvency with the ultimate decision of winding-up used as the final alternative step for the struggling company.
For more information, kindly contact us at Yusof Halim & Partners.
*The contents of this newsletter are intended to convey general information only and not to provide legal advice or opinion*