Are you a director who is being chased for debts by liquidators?
When a company is under financial distress, a director must be extremely careful when moving money out of the company or, if the company becomes insolvent, a liquidator may attempt to claw back funds from them.
Below, we consider some of the common questions that a director will have when being chased by a liquidator for a company debt after the company has been wound up. This is not intended as a substitute for legal advice. If you find yourself in this situation it is important that you seek specialist legal advice tailored to your individual circumstances.
When might a director be held liable for company debts?
Of particular interest to a liquidator during their investigations are transactions made by a director that may have undermined the position of an unpaid creditor. They include the below.
This is when one creditor is paid in favour of others, creating what is described as a ‘preference’. This can mean a recipient may be required to repay the money. Whilst there is a statutory defence of 'good faith' which usually independent third parties can rely upon given their degree of separation from the company’s affairs, it can be quite tricky for a director to defend preference actions. The reason being is that they must rebut a presumption of the desire to prefer themselves over other creditors if the transaction has been made within six months before the company is wound up.
There are various factual circumstances where a director can successfully defend a preference (even if the elements of the action are established by a liquidator). A court has the power not to make an order for the repayment of a preference when it is unjust to do so. A liquidator ultimately has the burden to establish what effect the preference has had on the interests of other creditors. For example, where a director has used money from their own pocket for legitimate business expenses of the company in attempt to keep the company afloat for a longer period, it is usually more difficult for a liquidator to convince the court that other creditors were disadvantaged. It would be a different situation if a director personally paid for the company’s business expenses before a detrimental event occurred to the company (i.e. a default event by a customer or some other wrongdoing ultimately contributing to the company’s demise).
If a director is trying to keep the company afloat after the default event by paying for some business expenses personally and then repays themselves for the debt owing by the company (i.e. attempting to keep the company solvent until the default event is remedied and has firm reasons to be believe this will occur), it will be difficult for a liquidator to prove that it caused any disadvantage to the creditors as had the director not dipped into their own pocket, the company would have just been wound up earlier when it could have been recoverable. It is important though that a director does not continue to accrue trading loss if the company is hopelessly insolvent.
Transactions at an undervalue (section 238 of the Insolvency Act 1986)
If an asset has been sold for less than its true value, it diminishes returns for creditors and a liquidator may ask the court to reverse the transaction. In some situations, a liquidator may wrongly chase the director for a debt and threaten to bring a transaction at an undervalue claim when in fact the money paid from the company to the director prior to its demise is merely a reimbursement of a legitimate business expense where the value of the reimbursement is justified.
There is a further common law defence available to directors whereby the transaction(s) in question is the result of a series of linked transactions. This defence involves an analysis of the consideration referable to a transaction at an undervalue and allows the taking into account of consideration payable under linked transactions.
Overdrawn directors' loan account (section 212 of the Insolvency Act 1986)
An overdrawn director’s loan account will be considered an asset of the company in liquidation, and subject to immediate repayment by the director. To be clear, this does not include a salary, dividend or expense repayments.
If you are a company director, you may have a director’s loan. A director’s loan account can be considered as being at a zero level in the circumstances where no monies have been removed from the company. Directors may also choose to put their own money into a company in order to cover the companies’ expenses or costs in respect of purchasing specific assets which would lead to the director’s account being in credit. In this situation, the director is a creditor of the company.
The complexities only arise once a director’s loan account becomes overdrawn. It is important to note that a director may be accused of misfeasance in circumstances where they have not acted in the company’s interests (e.g., if they cause the company to lend them money at a time when the company is struggling financially and needs the money most). A company’s loan to the director may also have increased because of company assets being transferred to the director’s name. A liquidator will almost always check if there was an independent valuation which establishes the true value of the asset and investigate whether there was a reason for transferring the asset to a director for no consideration. In most cases, it will be difficult to justify the transfer of a company asset for no immediate consideration.
A director may wish to think carefully before continuing to contribute money to a struggling company. There are of course still instances whereby a director can present a reasonable defence. One example is in a situation where a director reimburses themselves monies paid into the loan provided that such reimbursement is for the same monetary amount as the contribution made. As this is a debt due from the company to the director personally, this may offset any misfeasance claim made by the liquidator. However, such an offset is only valid if the director contributed to the loan and reimbursed themselves after the company was scuppered by any wrongful activity by a customer/supplier etc. (otherwise, as above, the liquidator can alternately pursue the director for a preference).
Unlawful dividend payments
Dividend payments are only lawful when there are sufficient distributable profits available to support them, so drawing a dividend when the company is insolvent is likely to lead to a demand for immediate return of the payment/s in full.
Civil fraud proceeding can be commenced by a liquidator. Providing misleading or inaccurate information on a finance application is just one example of a fraudulent act and carries with it serious ramifications for directors (including potential criminal liability).
The practicalities of pursing a director
A practical point that can deter a liquidator from pursing action against a director in relation to any of the above antecedent transactions is if the director does not own any significant assets.
A liquidator’s primary duty is to realise as much money as possible for the creditors of the Company. Commercially speaking, a liquidator will not usually exhaust funds from the company’s asset pool if the director has provided a financial position statement and supporting evidence confirming same. For obvious reasons, there is no real point in a liquidator pursuing action to claw back any transaction(s) if the director has no means of paying any judgement awarded by the Court in favour of the liquidator. If they do so, they would be breaching their primary duty to creditors. Thus, choosing to disclose your asset pool early may work as a practical defence to prevent a liquidator pursing any threatened claim(s).
What preventative steps can a director take?
Being able to demonstrate that creditor losses have been minimised is crucial, at least initially. A liquidator will usually look for the following during their investigations into director conduct and these preventatives should always be at the forefront of a director’s mind if their company is starting to become a going concern:-
- As soon as directors become aware the company may be insolvent, they should seek advice from a licensed insolvency practitioner. Apart from demonstrating responsibility and compliance with the requirements, this offers a director the greatest reassurance that any future action is correct, and that creditors won’t incur further losses.
- The company must normally cease trading as soon as it becomes insolvent. Increasing the company’s debt situation may result in personal liability for those additional debts.
- Directors must ensure other officers of the company, shareholders, and employees, do not take any actions that might diminish returns for creditors as a whole.
If a liquidator decides to bring any of the above action(s) and is successful, consequences of a director not trying to minimise their liability of company debts at the outset, can include personal bankruptcy (and/or the loss of their home) if a director has insufficient funds to repay what is owed. Directors can also be disqualified from directorship for up to 15 years and if fraudulent activity is proven, directors can possibly face criminal conviction and a possible prison sentence.
If a claim is asserted by a liquidator you should seek urgent specialist legal advice. Many claims will be defensible or capable of resolution by negotiation. Our team of specialist insolvency lawyers are able to assist in these circumstances.
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Articles are intended as an introduction to the topic and do not constitute legal advice.