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Directors' duties when a private company is in financial difficulty

View profile for Matthew Fretten
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Under Company Law, directors are subject to certain duties contained in sections 172-177 of the Companies Act 2006 and in times of financial crisis these should be strictly adhered to.

Commercial Partner, Matthew Fretten, says “Where a company is facing insolvency the directors owe a duty to the company to act in the best interests of the creditors and not the shareholders, under section 172(3) of the 2006 Act. They must act honestly, diligently and for a proper purpose and not in their own personal interests, as their conduct is likely to be scrutinised by a future liquidator or administrator. Any situation that conflicts with the company’s interests is to be avoided. Directors should not deal more favourably with one set of creditors over another.”

The law on wrongful trading is quite clear – if a director allows a company to continue trading and taking credit from suppliers whilst knowing insolvency could not be avoided, he could be made personally responsible for those additional liabilities. To avoid this situation there are some practical steps that can be taken:

  • Ensure there is up to date financial information
  • Take independent professional legal and financial advice
  • Do not take goods and services on credit if you know the company is in difficulty
  • Make sure that any decisions made to continue trading are carefully minuted and documented by the Board.

If the company’s prospects are such that insolvency proceedings can be avoided, the Board should formulate a viable strategy to restore the company to a healthy financial position. An action plan may contain any of the following:

  • Maximising existing asset values
  • Cutting overheads
  • Alternative trading strategies
  • Additional outside finance
  • Converting short term debt to long term

Paying employees salaries when other creditors are not being paid may seem wrong. If this is done because the future viability of the company depends on employee support, then payment can be made, providing the Board believes the company can survive.

For advice on this issue, call Matthew or his Team on 01202 499255.

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