Out-Law Legal Update | 15 Jun 2020 | 3:17 pm | 3 min. read
The High Court in Ireland will grant a restriction order against directors that fail to show that they acted honestly and responsibly before or after the insolvency of their company. Preferential payments will be taken into account when assessing directors' actions.
The High Court in Ireland has granted a restriction order against the directors of an insolvent company, Winning Ways Ltd. The order was requested by the liquidator of the business at the request of the Office of the Director of Corporate Enforcement (ODCE). The judgment confirms that the onus is on directors to prove that they acted honestly and responsibly when raising a defence against a restriction order under section 819 of the Companies Act 2014. When assessing the claim, the court will take into account the preferential payments to the directors that occurred prior to the liquidation.
The company was a wholesale trader of pet products and started to experience trading losses in 2013. In December 2014, the company lost a contract with a key supplier, which reduced its turnover by half. In August 2016, it was resolved that the company be wound up and the liquidator was appointed. The liquidator claimed that the respondents “failed in their obligations under the Companies Act 2014 and acted dishonestly in the management of the company”.
The court is obliged to make a declaration of restriction under section 819(1) of the 2014 Act, unless the directors can prove that they acted honestly and responsibly. It was emphasised by the court that under the established common law principle the onus is on the directors to prove that they acted honestly and responsibly. Whether an action is irresponsible should be assessed on an objective standard, according to the court, and the court must not "view the events in light of what transpired", but rather search for an element of recklessness in directors' decision making.
The court assessed a number of matters that were brought to its attention by the liquidator. In relation to the failure to place the company into liquidation in a timely manner, the court objectively analysed when the company became insolvent. It referred to the financial statements which reflected the company's insolvency a year earlier than claimed by the directors. The court then considered whether the delay in putting the company into liquidation amounted to responsible conduct.
The evidence provided by the directors in an attempt to justify the delay showed that the actions undertaken by them within that year could not be faulted because they did not achieve the required turnaround of the company’s fortunes. The court, therefore, concluded that when the directors became aware of the demonstrable insolvency of the company, they should have focused on protecting the interest of creditors to whom they owed fiduciary duties.
Additionally, the liquidator alleged that the company had been making preferential payments to its bank under credit facilities, one of which was an invoice discounting facility supported by personal guarantees of the directors. The directors claimed that payments under this facility were out of the company's control and that the amount was reduced in line with the company's decreased turnover. Despite not being able to establish preference, the court stated that the continuance of payments throughout the loss making years was an important factor in considering irresponsibility on part of the directors.
The court applied a similar reasoning to the substantial contributions by the company to the directors' pensions as well as payment of rent for the premises to the directors. The directors argued that the premises were charged to the bank and the payments were made by the company to the bank directly. Nevertheless, such payments had been reducing the directors' personal debt, which showed a clear benefit.
The court held that when clear financial information was available to the directors, they were under a duty both collectively and individually, "to acquire and maintain a sufficient knowledge and understanding of the company’s business to enable them to properly discharge their duties as directors". When faced with such information, the directors were not under an absolute obligation to initiate a liquidation of the company immediately. However, from the point in time when they were aware of the insolvency they were under obligations to have regard to the interests of the creditors of the company and to act accordingly. Based on the evidence presented, the court found they were not able to discharge the onus of proving that they acted honestly and responsibly. As a result, the court granted the restriction order under section 819 of the Companies Act 2014.
Interestingly and in the context of the current Covid-19 crisis, on 4 June 2020 the ODCE issued some helpful guidance on how it will approach its review of directors’ conduct when dealing with liquidators’ reports. The ODCE has said that it will have "due regard to the impacts of the pandemic" when reviewing directors’ actions. This indicates that the ODCE will not seek to have directors restricted where directors are deemed to have acted reasonably in the face of the COVID-19 crisis.