Personal liabilities for financial difficulties and insolvency

Out-Law Guide | 09 Jul 2007 | 3:08 pm | 4 min. read

This guide is based on UK law as at 1st February 2010, unless otherwise stated. It is part of a series on Financial difficulty and insolvency . In cases of insolvent liquidation, a director or shad...

This guide is based on UK law as at 1st February 2010, unless otherwise stated. It is part of a series on Financial difficulty and insolvency.

Wrongful trading

In cases of insolvent liquidation, a director or shadow director (see our Wrongful trading FAQ) can be required to contribute towards the debts or liabilities of a company. This provision does not merely apply to ‘trading’ activity: any act, or failure to act, that either increases or does not minimise losses to creditors can lead to liability.

The level of personal contribution will be determined by the court; it will reflect the extent to which the company’s assets have been depleted by the director’s conduct.

A court may make a contribution order if a liquidator can show that before winding-up began the person knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation. The only defence open to a director in these circumstances will be that they took every step they could to minimise the potential loss to a company’s creditors. The onus will be on the director to prove this defence.

The other main points about wrongful trading litigation are covered in our Wrongful trading FAQ.

Disqualification

The Company Directors Disqualification Act 1986 (CDDA) provides that a director can be disqualified for a minimum period of two years for:

  • general misconduct in connection with companies;
  • conviction for an indictable offence in connection with the promotion, formation, management or liquidation of a company;
  • fraud in winding-up proceedings;
  • persistent breaches of companies legislation. An example would be persistent default in filing any return, account or other document with the Registrar of Companies;
  • unfit conduct as the director of a company that has at any time become insolvent (i.e. gone into liquidation, administration or receivership).

The object of disqualification is twofold: to mark the court’s disapproval and to protect the public. The corollary is that a director can attempt to show that their continued ability to act as a director would carry no risks to the public.

Sometimes, people are allowed to continue to act as directors subject to certain safeguards. There could, for example, be conditions that:

  • no cheque or financial agreement on behalf of a company is signed or executed by the director alone;
  • any loan owed by a company to the director is not repaid unless all creditors of a company are paid first;
  • the director shall not grant or accept any security over a company’s assets.

'Phoenix' syndrome

Legislation stipulates that the directors of an insolvent company must not, without leave of the court or approval of creditors, be directly or indirectly concerned in the promotion, formation or management of another company with a similar name within five years of the date of liquidation. These provisions relate to a name or trading name used by the liquidated company at any time in the 12 months before the liquidation.

If the business is acquired from an insolvency practitioner it can trade under a similar name provided a notice is sent to creditors making clear who from the old company is involved and what they are doing in the phoenix company. This notice must be circulated before a director of the insolvent company has any involvement with its 'namesake', but it does not provide a guarantee that the director will escape personal liability for the debts of the phoenix company. In many cases, a director in this situation should be advised to seek leave of the court before becoming directly or indirectly concerned with the 'new' company.

Misfeasance

Under the Insolvency Act, office holders and people involved in the promotion, formation or management of a company can be sued for misfeasance – the misapplication or retention of the company’s assets or a breach of a fiduciary or other duty.

Misfeasance actions are brought in the name of the company. This distinguishes them from claims made under the provisions for wrongful trading, transactions at an undervalue and preferences – all of which are brought by a liquidator in their own right.

They are often seen as a simpler and, therefore, speedier means of bringing delinquent directors to book and of assessing compensation and damages.

Fraudulent trading

If any company carries on business with the intent to defraud creditors or for any other fraudulent purpose, a liquidator of the company can apply to a court for a contribution order against any person who was knowingly a party to the offence. Since they require fraudulent conduct – i.e. a deliberate intention to act to the detriment of another party – these types of claim are rare. Nonetheless, they remain a risk for directors who allow a company to continue to trade and incur liabilities when they know there is no real prospect that these will be paid.

Pensions

The Pensions Act 2004 includes provisions that could make a director personally liable for a pension scheme deficit. The so-called “moral hazard” provisions allow the pensions regulator to serve contribution notices on certain third parties in addition to the company itself. These notices can impose liability for all or part of an occupational pension scheme’s deficit and can be served on people (e.g. directors) who have attempted or been involved in an attempt to:

  • prevent the recovery of the whole or any part of a debt that was due, or might become due, from the employer in relation to the pension scheme;
  • prevent such a debt becoming due or compromise or reduce it (unless they acted in good faith).

While the pension fund itself is an unsecured creditor of a company, any deficit is likely to be large: it should never be ignored. Directors must also be aware of the possibility of conflict of interest where they sit on the trustee board and the board of the company.

Personal guarantees

Generally, directors are not personally liable for company debts. If, however, they have given personal guarantees on company loans, personal liability will be incurred. In some cases, bankruptcy orders may even result.