A recent court decision gives reason for all directors and their advisers to return to the concept of limited liability.
The familiar concept is that a company is a legal entity in its own right and therefore liable to pay its own debts. The directors run the business on the basis that they aren’t liable for its debts, only the company is.
There are though exceptions to the rule that directors aren’t personally liable for what happens to the company. Many will at least have heard of administrators and liquidators of insolvent companies demanding payment from directors: undervalue, preference, breach of duty and wrongful trading. Further a director of a company that enters insolvent liquidation or administration may be at risk of being disqualified from acting as a director. So far then nothing new to report.
Every director of a company owes certain duties to act in that company’s interests irrespective of their position within the company. For example the sales director may correctly say that finance director’s duties are more extensive in terms of money issues but the sales director is still subject to some level of responsibility. In addition a director’s focus must shift from the interests of the company itself (i.e. shareholders wanting a return on their investment) to the interests of the company’s creditors when that director knew or should have known that the company was insolvent or it was probable that company would become insolvent.
The traditional view has been that once the insolvent company goes into liquidation or administration the directors’ duties to act in its best interests of that company end. Perhaps they feel relief believing they can plan a future business, maybe in another limited company, similar to the business of the original company: they see themselves as free of the directorship of the insolvent company with the liquidator or administrator having taken over the reins. They have knowledge of the insolvent company’s assets and see themselves as front runners to make a bid.
That confidence now appears to be misplaced. In a recent case in the Insolvency and Companies Court the judge decided that the duties a director owed to the insolvent company pre liquidation/administration continue, that is despite (i) the liquidator/administrator having their own powers and duties and (ii) the law already setting out the obligations of directors of companies in liquidation and administration to co operate with the insolvency procedure. The judge had to consider the implications of a director of a company having bought a house from that company after it had gone into liquidation. There was clear evidence that the director paid much less than the house was worth and that the director knew that to be the case. Presumably the director took the view that so long as the house was sold to him by the liquidator (acting on behalf of the insolvent company) then that was that: he was acting on his own account, the company was acting by its liquidator and if the director bagged himself a bargain then lucky him.
In contrast (and probably this came as quite a shock to the director who thought his windfall was safe) the court decided that he still owed duties to act in the best interests of company and as the company was insolvent then those were duties were owed to the company’s creditors. Therefore whilst he was allowed to keep the price he had paid the rest of the value of the house was not his; it was to be used for the insolvent company’s creditors.
This court decision raises other interesting issues: for example in the event of an administration pre pack sale (where an agreement is reached for the sale of a business and as soon as the insolvent company goes into administration the sale is completed) directors of the insolvent company are often involved in the buying company. That director owes a duty to act in the best interests of the buying company (to get the lowest price) whilst also (according to this court decision) to ensure the selling company in administration gets the highest possible price: a challenging balancing act.
What for lawyers may be an interesting and novel issue to consider is probably very unwelcome for directors of an insolvent company. The standard man in the pub advice to that director “just put the old company under, start again and buy the assets at a knock down price” now looks more shakey then ever.
Stephen Wiles, Partner and Head of Corporate Recovery and Insolvency.
