Directors Responsibilities
Directors have a duty to monitor the financial position of their company and to act responsibly if financial difficulties arise. There are three key questions directors should regularly consider when assessing the financial health of their business.
The Three Key Questions
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Is the company able to pay its debts as they fall due?
(The “Cashflow Test”) -
Are the company’s assets greater than its liabilities, including contingent and prospective liabilities?
(The “Balance Sheet Test”) -
Is there a reasonable prospect that the company will avoid going into insolvent liquidation?
If the answer to question one or two is “no”, the company may be insolvent.
Where a company is insolvent, or is likely to become insolvent, the directors’ primary duty shifts from promoting the success of the company for the benefit of shareholders to protecting the interests of creditors.
Directors’ Duties in an Insolvent Situation
There is extensive legislation governing the conduct expected of directors when a company is experiencing financial difficulty. Directors must act prudently, responsibly and in good faith.
Directors are expected to demonstrate the knowledge, skill and experience that could reasonably be expected from someone in their position. Any additional specialist knowledge or experience held by the director will also be taken
into account.
In relation to the third question above, legislation considers whether directors knew, or ought reasonably to have concluded, that there was no reasonable prospect of the company avoiding insolvent liquidation. Directors are therefore judged using both objective and subjective standards. For example, a Finance Director may be expected to demonstrate greater financial awareness than an Operations Director.
Potential Consequences
If a company subsequently enters a formal insolvency procedure, the conduct of the directors will be reviewed. Where directors are found to have fallen short of the required standards, this may be taken into account in director
disqualification proceedings.
A director can be disqualified from acting as a company director for up to 15 years.
Acting Early
Where insolvency has occurred, or may occur in the future, directors must carefully consider whether the company has
a realistic prospect of survival. Continuing to trade without reasonable prospects of recovery may place creditors at risk.
Directors should:
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Carefully monitor and record board decisions, including minutes of discussions regarding financial position
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Seek specialist insolvency advice at the earliest opportunity
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Consider potential solutions such as:
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Raising additional finance
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Disposal of assets
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Business restructuring
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A Company Voluntary Arrangement (CVA)
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Early action often provides more options and a greater chance of achieving a positive outcome.
Lender Support
Where the company relies on bank or lender support, it is important for directors to maintain open and ongoing dialogue regarding the terms of continued funding. If that support is withdrawn or becomes uncertain, directors must urgently review the company’s financial position and consider alternative funding options or restructuring measures.
Wrongful Trading and Other Risks
Even if a company currently appears able to pay its debts or has a positive balance sheet, if directors conclude that there
is no reasonable prospect of avoiding insolvent liquidation, they must take every reasonable step to minimise potential losses to creditors.
Failure to do so may result in personal liability for wrongful trading.
If the company’s deficit to creditors increases after this point, directors may be personally responsible for that increase.
Directors may also face potential personal liability in circumstances involving:
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Fraudulent trading
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Misfeasance
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Obtaining credit by misrepresentation
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Secret profits or breaches of duty
Seeking early professional advice can help directors understand their responsibilities and make informed decisions when
a company is experiencing financial difficulty.