Thu, 09 Feb 2023
their obligations and potential liabilities in relation to companies in financial difficulties, including liability for wrongful trading and the director’s disqualification regime
This paper will address directors’ duties alongside the potential liabilities arising from a company facing financial difficulties; including wrongful trading and the directors’ disqualification regime.
When presented with a company in financial difficulty a director will have to consider a number of issues, which often overlap:
- What can they do to keep the company trading without committing an offence or incurring personal liability?
- At what stage must the decision be made to cease trading?
- Once a decision has been made to cease trading, what insolvency procedure should the company invoke?
Critically, as soon as it is realised a company faces financial difficulty directors ought properly to seek external advice.
Similar considerations apply to both directors of limited liability companies and limited liability partnerships.
I WRONGFUL TRADING
Only directors can be liable for wrongful trading. “Director” is widely defined by the Insolvency Act 1986 to include any person occupying the position of director, regardless of what title they hold, section 251 IA 1986. Further, the Act prescribes “director” extends to include shadow director, under section 214. It follows a shadow or de factor director may also be liable for wrongful trading.
Fundamentally the individual must be a director of the company at the time he knew or concluded that there was no reasonable prospect of the company avoiding insolvent liquidation or insolvent administration.
Liability only arises under section 214 if, on a net basis, it is shown that the company is worse off as a result of the continuation of trading, Re Marini Ltd (the liquidator of Dickenson and others)  EWHC 334. Further, the directors will not be required to contribute to the liquidator’s costs and expenses incurred in investigating and pursuing any wrongful trading claim, Re Ralls Builders Ltd (in liquidation)  EWHC 1812 (Ch).
The court will not make an order for wrongful trading if, knowing there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration, the director took every step with a view to minimising the potential loss to the company’s creditors as he ought to have taken, sections 214(3) and 246ZB(3) IA 1986.
The quantum of a director’s liability for wrongful trading under section 214(1), and the scope of the defence under section 214(3) has been considered in cases including Re Produce Marketing Consortium Ltd (1989) 5 BCC 569, Re Purpoint  BCC 121 and Re Kudos Business Systems  EWHC 1436 (Ch). In Grant and another v Ralls and others (Re Ralls Builders Ltd)  EWHC 243 (Ch) the High Court reiterated the position as follows:
- The court will measure the increase in the company’s net deficiency of assets over the relevant period, that is from the time when the directors first realised (or ought to have done so) that there was no reasonable prospect of the company avoiding an insolvent liquidation up to the time when the company went into insolvency liquidation;
- Section 214(1) measures the loss to the company, and accordingly the court will not make any order if, over the relevant period there is no increase in the net deficiency of the company’s assets. If there is an increase in the net deficiency of assets over the period, the maximum quantum of any liability for wrongful trading will be the amount of that increase;
- The availability or otherwise of the defence under section 214(3), that the director took every step with a view to minimising the potential loss to creditors, can take into account loss, or disproportionate loss, caused to individual creditors so that, for example where trading has continued and pre-existing creditors have been paid over the period but unpaid debts incurred to new creditors, the defence may not be available. If, however, the defence does not apply, the quantum of loss caused to any creditor or group of creditors will be irrelevant to the maximum liability for wrongful trading: the fact that disproportionate loss may have been incurred by one of the creditors may however mean that other creditors have been preferred and remedies for preference under section 239 of the IA 1986 may need to be considered.
The analysis in Re Ralls Builders Ltd should also apply in relation to wrongful trading in the context of administration under section 246ZB of the IA 1986.
In Philip Anthony Brooks and Julie Elizabeth Willetts (Joint Liquidators of Robin Hood Centre plc) v Kieron Armstrong and Ian Walker  EWHC 2289 (Ch) the court clarified that once it had been established that a director knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, the onus, in establishing the defence under section 214(3) that he had taken every step to minimise the potential loss to the company’s creditors fell on the director; it was not for the liquidator to establish that he had not taken the necessary steps. The case also provides a useful dissection of the elements of a wrongful trading claim. (The decision in this case was overturned on the facts on appeal, however, in Philip Anthony Brooks and Julie Elizabeth Willetts (Joint Liquidators of Robin Hood Centre plc in liquidation) v Kieron Armstrong and Ian Walker  EWHC 2893 (Ch): the court found that the liquidators had not established that the wrongful trading in this case had caused any increase in the company’s net deficiency.)
In interpreting sub-sections 214(2) and (3) and 246ZB(2) and (3), the facts that a director of a company ought to know or ascertain, the conclusions that he ought to reach and the steps that he ought to take are those that would be known or ascertained, or reached or taken, by a reasonably diligent person having both the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and the general knowledge, skill and experience which that director has (section 214(4) and section 246ZB(4)). The test under sections 214(4) and 246ZB(4) is therefore both subjective and objective.
Dishonesty is not required and accordingly there is a lower burden of proof than that required to prove fraudulent trading under section 213 and 246ZA of IA 1986. It is therefore in principle considerably easier for a liquidator or administrator to obtain an order for wrongful trading than for fraudulent trading.
Nonetheless, to bring a successful action, in practice, a liquidator or an administrator will need to undertake a significant amount of work and expense. For example, the liquidator or administrator will need to produce evidence not only of the director’s wrongful trading but also that the wrongful trading resulted in loss to the creditors that they would not otherwise have suffered.
Accordingly, in practice, the theoretical risk of personal liability for wrongful trading is often greater than the practical likelihood of an action being brought, or being brought successfully. Indeed, the relevance of wrongful trading to directors is often more in the context it sets for a restructuring than in the risk of proceedings. Frequently, the directors of a company will seek professional advice aimed at ameliorating the theoretical risk of wrongful trading and this advice often influences the timetable by which a restructuring proceeds.
Additional mitigation of a director’s liability may be available by reason of provisions contained in the Corporate Insolvency and Governance Act 2020, arising from the Covid-19 pandemic.
What is “insolvent liquidation” or “insolvent administration” for the purposes of wrongful trading?
The balance sheet basis for insolvency is used for the purposes of wrongful trading:
- For the purposes of section 214, a company goes into insolvent liquidation if it goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up, section 214(6)n IA 1986
- For the purposes of section 246ZB, a company goes into insolvent administration if it goes into administration at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the administration, section 246ZB(6)(a) IA 1986.
Although the balance sheet basis for insolvency is the sole insolvency test used for the purposes of wrongful trading, the ability of the company to pay its debts as they fall due (the “cash-flow” test) is nevertheless of some relevance. This is because if a company cannot pay its debts as they fall due, a creditor may be entitled to wind the company up in a petition based on section 123(1)(e) IA 1986: compulsory liquidation will trigger a forced realisation of the company’s assets and the circumstances of a sale in such circumstances will often realise proceeds significantly below the directors’ expectations: the liquidation may therefore give rise to a balance sheet insolvency: the directors should keep such valuation issues in mind as they consider their positions.
Who can bring an application under section 214 and 246ZB?
Sections 214 and 246ZB respectively contemplate that an application for an order requiring a director to contribute to the company’s assets (sections 214(1) and 246ZB(1), IA 986) be made by either the liquidator or administrator.
A liquidator or administrator is however entitled under section 246ZD IA 986 to assign the right of action (including the proceeds of an action) for wrongful trading. The most obvious circumstance in which a wrongful trading claim might be assigned is where a creditor wishes to pursue a claim that the liquidator or administrator does not wish to, or has no funds to, pursue.
The nature of amounts recovered under sections 214 and 246ZB
Any recoveries made by a liquidator or administrator do not form part of the net property that is available for the holders of floating charges (section 176ZB IA 986 applying to liquidations and administrations commencing on or after 1 October 2015). Recoveries are therefore not part of the property from which the prescribed part is paid, but should be paid into the pool of assets that are available for distribution among the unsecured creditors.
The proceeds of a cause of action under section 214 are not capable of being charged by the company to a secured creditor. This is because the cause of action arises under statute and as a function of the appointment of the insolvency office-holder, rather than being a chose in action that belongs to the company. Case law on this point (such as Re Yagerphone  Ch 392) has been decided mainly in the context of liquidations but the same reasoning is likely to apply to the proceeds of a cause of action accruing to an administrator under section 246ZB. The principle that recoveries from a liquidator’s or administrator’s actions for wrongful trading do not enure to the benefit of a charge-holder has been codified in respect of floating (but not fixed) charges by section 176ZB of the IA 1986.
Company Directors Disqualification Act 1986
A person held liable under sections 214 or 246ZB of IA 1986 may also be the subject of a disqualification order under the Company Directors Disqualification Act 1986 [CDDA 1986]
Advising directors on wrongful trading
Directors are at risk of liability for wrongful trading at any time after, applying the subjective and objective standards required by sections 214 and 246ZB, they knew or ought to have known that the company could not avoid insolvent liquidation or insolvent administration. Identifying the precise point at which the financial position of the company means that insolvent liquidation or insolvent administration is effectively inevitable and the point at which the directors should have realised that this is the case for the purposes of sections 214 and 246ZB is difficult in practice. Accordingly, directors who are concerned about the financial position of a company are wise to seek specialist advice on their legal duties and the financial position of the company at an early stage.
The directors’ fear of wrongful trading may sometimes cause them to consider instituting insolvency procedures before they are really necessary or when they are premature: precipitate action can be as damaging to creditors in some circumstances as waiting until the situation becomes clearer. Providing commercial legal advice in this area can be tricky due to its imprecision in determining how far directors have to go to avoid liability for wrongful trading.
- Follow best practice at directors’ meetings.
It is crucial that regular full board meetings are called if the company is in financial difficulties and that the commercial decisions of the directors are reported in full in the company minutes. It is also important that the directors reach their commercial decisions at board meetings independently, on the basis of the financial and legal information and advice available to them.
Where the company is a member of a group of companies and the companies have one or more common directors, the board of each company should consider its position individually. Conflicts of interest, and issues relating to the due performance of fiduciary or statutory duties, may arise for directors who are nominee directors or directors of more than company in the group.
- Always have up to date financial information
Directors must ensure that they have up to date financial information at all times. Directors should not wait for an event such as a creditor’s claim, a winding up petition or administration application or a failure to meet sales or cash flow forecasts to alert them to the fact the company is in financial difficulty. In particular, directors should be careful to monitor compliance with financial covenants contained in any arrangements with lenders.
A liquidator or administrator who is considering whether a director is liable for wrongful trading will look to see what a particular director knew and what a reasonable director should have known in the circumstances. Factors such as the size of the business and the director’s function and position will be taken into account (for example, finance directors will be expected to show greater financial awareness of accounting matters than, perhaps, creative directors).
Evidence of insolvency that any director should have known about might include:
- Increasing pressure from creditors
- Late filing of accounts
- Insolvency on the balance sheet
- Only paying creditors when proceedings or statutory demands have been issued and judgments entered into against the company
The directors should consider not only the company’s balance sheet, and balance sheet solvency, but also the company’s ability (current and expected) to pay its debts as they fall due: if the company cannot pay its debts as they fall due, or is likely to cease to be able to do so, this will increase the risk that a creditor may attempt to wind the company up: a liquidation may affect the likely realisation proceeds achievable from the company’s assets and thus its balance sheet solvency.
As soon as a director is aware that there is no reasonable prospect of avoiding insolvent liquidation or insolvent administration, or fears that is the case, he must raise the problem with the rest of the board with a view to taking immediate independent financial advice. Further credit should almost certainly not be incurred pending such advice. The board of directors would be well advised to seek advice from an insolvency practitioner at this point.
Is it time to cease trading?
Liability for wrongful trading cannot arise unless there is, on an objective basis, no reasonable prospect that the company can avoid going into insolvent liquidation or insolvent administration. Directors must then take every step to minimise potential loss to creditors and cannot simply avoid the issue by resigning as a director.
To avoid wrongful trading, directors may have to cease trading if they are not able or willing to rely on the defences under section 214(3) or 246ZB(3) of the IA 1986 that during any continuing period of trading they are taking every step with a view to minimising the potential loss to the company’s creditors as they ought to take (the loss minmisation defence).
Tension can arise between the positions of creditors and directors as to whether it is appropriate or necessary to cease trading. For example, a financial (rather than trade) creditor may wish the company to continue to trade while rescue negotiations or negotiations for a trade (possibly pre-packaged) sale are allowed to continue: such a creditor may suggest to the directors that it is premature to cease to trade, or even potentially damaging to its (and other creditors’) position to do so: in such circumstances, the creditor may urge the directors to continue to trade on a limited basis and rely on the loss minimisation defence (so acknowledging that an insolvent liquidation is inevitable).
In some circumstances, a financial secured creditor may be prepared to fund the ongoing trade if necessary. The borrowing of monies on normal commercial terms has (at least at the point of borrowing) no effect on the company’s net assets, and so should have no direct impact upon wrongful trading considerations, but in considering whether to accept any such funding, the directors should consider the following issues and risks:
- Whether, if the company does ultimately proceed into an insolvent liquidation, liabilities which are incurred in reliance on the promised funding might remain unpaid (as this may affect the availability of the loss minimisation defence and the possible quantum of any liability for wrongful trading as a result).
- Whether any constraints placed upon the use of funds, or the manner in which they will be used, could later be challenged as (for example) a preference of any creditor or a transaction at an undervalue (as this may be of relevance to the directors in relation to possible disqualification under the CDDA 1986
- Whether the funding is likely to achieve its purpose
A company can simply cease to trade without resorting to a formal insolvency procedure, but unless the company is solvent and can pay off all its debts (actual, contingent and prospective) the directors should consider pre-empting any action by an unpaid creditor, and definitively bringing to an end any period for which they might be found liable for wrongful trading, by themselves causing the company to implement a formal insolvency procedure, such as administration or liquidation.
In Re DKG Contractors Ltd  BCC 903 it was held that as soon as the directors knew that a creditor had refused further supplies because of lack of payment and that other creditors were pressing, they should have introduced some financial controls, which would have shown the inevitability of insolvent liquidation. The directors were therefore liable for wrongful trading from that time. The fact that their own knowledge, skill and experience was “hopelessly inadequate” did not protect them.
Resignation is not generally looked on favourably by the insolvency profession or the courts, as it may be regarded as an abrogation of the director’s responsibilities, rather than as a performance of them: a court may therefore regard a resignation as a step insufficient to enable a director to avail himself of the loss minimisation defence under sections 214(3) or 246ZB(3) of the IA 1986.
However, if a director comes to the conclusion that there is no reasonable prospect of the company avoiding an insolvent liquidation but fails to persuade the majority of the board of that despite his best efforts, it may be sufficient if they resign as a director. It would be good advice for them to seek independent advice, have their concerns noted in board minutes and communicate their concerns clearly in writing to the rest of the board on resignation. The onus on the rest of the board will then be all the greater.
A director who resigns from office may still be liable for any wrongful trading that took place during the director’s time in office. Once the director has resigned, the director should step away from any executive function entirely, to avoid the risk of being considered a shadow director of the company
The Government announced on 28 March 2020 that it was to suspend the operation of rules relating to wrongful trading for a period of initially three months from 1 March 2020.
Legislative provisions were enacted in the Corporate Insolvency and Governance Act 2020 and subsequently renewed by the Corporate Insolvency and Governance Act 2020 (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 (SI 2020/1349)). These provisions operate by requiring a court to assume, in determining the amount, if any, that a director should be ordered to contribute to the assets of the company on a finding of wrongful trading, that the director is not responsible for any worsening of the financial position of the company or its creditors that occurs or occurred from 1 March 2020 until 30 September 2020 or from 26 November 2020 to 30 June 2021.
It is worth noting that:
- The court is granted no discretion in relation to the operation of these provisions
- There is no consequent or equivalent amendment to sections 213 and 246ZA IA1986 or in relation to misfeasance actions in liquidation under section 212 IA 1986.
II FRAUDULENT TRADING
What is fraudulent trading?
If, in the course of the winding up or administration of a company, it appears that any business of the company has been carried on with the intent to defraud creditors, or for any other fraudulent purpose, the liquidator or administrator can seek a court declaration that anyone who was knowingly party to the fraudulent business make a contribution to the company’s assets. sections 213 and 246ZA, IA 1986. This is known as fraudulent trading.
Section 246ZA of the IA 1986 came into force on 1 October 2015. Authorities on section 213 of the IA 1986 are likely to be highly persuasive in cases relating to section 246ZA.
Liability for fraudulent trading
Only those who were knowingly parties to the fraudulent trading are caught by this section. Case law has shown that it is not enough for fraudulent trading to show that the company continued to run up debts when the directors knew that it was insolvent; there has to be “actual dishonesty, involving ... real moral blame” Re Patrick and Lyon Ltd  Ch 786.
It is not only directors who may be held liable for fraudulent trading. Anyone who is knowingly party to carrying on the business with intent to defraud may be liable for fraudulent trading. In Bank of India v Morris  EWCA Civ 693, the Court of Appeal held that a bank was a party to fraudulent trading by virtue of its employee’s knowledge.
Who can bring an action under sections 213 and 246ZA?
Only a liquidator or an administrator (or an assignee under section 246ZD of the IA 1986) can apply to the court under sections 213 and 246ZA respectively for an order requiring a director to contribute to the company’s assets, sections 213(2) and 246ZA(2) IA 1986.
The court may order the respondent to make such contribution as the court thinks proper, although the amount of contribution cannot include a punitive element, Morphitis v Bernasconi and others  EWCA Civ 289. In setting the level of contribution, the court can take into account a liquidator’s unreasonable delay in bringing the claim, Re Overnight Ltd  EWHC 1587 (Ch); the same principles are likely to apply to an administrator who brings a fraudulent trading claim.
Per Goldfarb v Higgins and others (No2)  EWHC 613(Ch) where more than one person is liable for fraudulent trading the court should apportion liability between the defendants by reference to:
- The degree of control that each party had over the company’s affairs;
- The benefit (if any) that each party obtained from the fraudulent trading.
When does the cause of action for fraudulent trading accrue?
In Re Overnight Ltd; Goldfarb v Higgins and others  WLR (D) 49 it was held that the cause of action for fraudulent trading under section 213 arises on the day the winding-up order is made and not, for example, when either the winding-up petition is presented or a provisional liquidator is appointed. Section 213 contains two essential conditions, apart from the need to prove that the business of the company has been carried on with intent to defraud the creditors, namely that:
- The company was in the course of being wound up;
- The application was made by the liquidator.
This means that the cause of action under section 213 cannot accrue before the making of the fraudulent winding up order because, until then, there is no one to whom it could accrue.
Similar principles are likely to apply to an administrator who brings a fraudulent trading claim under section 246ZA.
Recoveries under sections 213 and 246ZA
Any recoveries made by a liquidator under section 213 or an administrator under section 246ZA of IA 986 are paid into the general pool of assets available for distribution among unsecured creditors, and are treated in the same way as recoveries under claims for wrongful trading.
Companies Act 2006
Fraudulent trading is also a criminal offence under section 993 Companies Act 2006 [CA 2006]
Company Directors Disqualification Act 1986
A person held liable in respect of fraudulent trading under sections 213 or 246ZA of the IA 1986 may also have a disqualification order made against him by the court under the CDDA 1986
III Personal guarantees
The directors of a company are generally not personally liable for the debts of a company. However, if a director has given a guarantee for the liabilities of the company, the director may be personally liable under the guarantee.
IV Misfeasance or breach of fiduciary duty
If, in the course of a winding up, it appears that a present or former director has misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty, the court may order the director to repay, restore or account for the money or property with interest or contribute such sum to the company’s assets by way of compensation as the court thinks just (section 212, IA 1986). Section 212 also applies to any present or former officer of the company and any person who is or has been concerned, or has taken part, in the promotion, formation or management of the company. The definition of “director” includes any person occupying the position of director, by whatever name called (section 251, IA 1986 (and thus includes de facto directors)).
V Fraud and misconduct offences
Additional offences under IA 1986 that can apply to directors (and in some cases shadow directors) are:
- Fraud in anticipation of winding up (section 206)
- Transactions in fraud of creditors (section 207)
- Misconduct in the course of winding up (section 208)
- Falsification of company’s books (section 209)
- Material omissions from statement relating to company’s affairs (section 210)
- False representations to creditors (section 211)
VI Breach of common law duties
Where a company is insolvent or on the verge of insolvency, the directors owe a duty to the company to act in the best interests of the creditors of the company West Mercia Safetyware Ltd v Dodd  BCLC 250. This duty is expressly preserved by section 172(3) of the CA 2006.
Directors cannot, for example, cause an insolvent company to enter into an agreement to repay shareholders’ debts or make distributions to shareholders out of the profit from company contracts if this effectively amounts to a winding up of the company and an attempt to distribute the company’s assets without proper provision for all the creditors Macpherson and another v European Strategic Bureau Ltd  BCC 39.
VII Reviewable Transactions
Commercial pressure on a company’s finances may lead to creditor demands, or commercial pressure, on the directors to cause the company to undertake actions which may be designed to ease the company’s day-to-day problems but which may constitute reviewable transactions, such as a preference or a transaction at an undervalue if the company later goes into liquidation or administration.
Example of actions which should be carefully considered to determine whether, in the circumstances, they may be later open to challenge, for example as a preference or a transaction at an undervalue, include:
- The granting of security to a previously unsecured supplier in respect of debts incurred for goods previously supplied.
- Acceding to new supply terms from an existing supplier on more onerous terms (such as to extend retention of title terms to include terms purporting to allow claims against goods where title has been retained to cover all sums outstanding, rather than merely the purchase price of those goods).
- The granting of security to a lender who is lending new monies where security required would create new security over, or increase existing security over, assets in respect of sums previously lent.
- Paying some unsecured creditors while leaving others unpaid. The payment of employee wages as they fall due is commonly effected (after taking advice on the issue) and justified by reference to an argument (supported by financial analysis) that the immediate cost to creditors is likely to be outweighed by the financial benefit to them from retaining the business in a configuration where it is capable of being, and likely to be, sold in any later insolvency process as a going concern. The payment of non-business critical suppliers, especially for supplies already made, is likely, however, to attract more scrutiny and criticism.
- The making of severance payments to senior employees or directors in any attempted business restructuring.
- Causing the company to repay any debt which has been guaranteed by a director (unless, perhaps, the debt is fully secured by a valid fixed charge over the assets of the company).
The participation of the company and the directors in any reviewable transaction has implications for the relevant directors in relation to disqualification under the CDDA 1986.
VIII Liability of directors for tax debts
Section 100 of schedule 13 to the Finance Act 2020 allow HMRC, with effect from 22 July 2020, to make directors and other persons involved in tax avoidance, evasion or phoenixism jointly and severally liable for a company's tax liabilities if there is a risk that the company may deliberately enter insolvency.
IX Directors of public companies
A Misleading the market
Directors of a public company whose shares are admitted to trading on either a regulated market (such as the Main Market of the London Stock Exchange) or a multilateral trading facility (such as AIM) must be aware of the UK Market Abuse Regulation (UK MAR), Listing Rules (LR), AIM Rules for Companies (AIM Rules), Prospectus Regulation Rules (PRR), the Financial Services and Markets Act 2000 [FSMA] and the Financial Services Act 2012 [FS Act] in particular the provisions on misleading the market.
Disclosure Requirements and suspension of listing/trading
- UK Market Abuse Regulation. A company whose shares are admitted to trading on a regulated market or on a multilateral trading facility must notify a Regulatory Information Service (RIS) as soon as possible of any inside information that directly concerns the company (Article 17(1), UK MAR). This obligation is likely to conflict with the directors’ instinct to keep the company’s precarious financial situation quiet until they have decided whether it is possible to continue trading and, if so, whether some form of “rescue package” is required. Premature publicity could put the package at risk. A balancing act is required, weighing the adverse consequences of uncertain and premature disclosure against the need for a fully informed market.
A company is permitted to delay disclosure of inside information provided that immediate disclosure is likely to prejudice its legitimate interests, the market is not likely to be misled, and the company is able to ensure the confidentiality of that information (Article 17(4), UK MAR). A company should not, however, delay disclosure of the fact that it is in financial difficulty or of its worsening financial condition and any delayed disclosure must be limited to the fact or substance of the negotiations to deal with such a situation (DTR 2.5.4G). Where a company fails to make the necessary disclosures under UK MAR, the Financial Conduct Authority (FCA) may suspend the trading of its securities (section 1221 FSMA). It may also impose other sanctions such as a fine or public censure.
- Listing Rules. The FCA may suspend the listing of a company’s securities admitted to the Official List where the smooth operation of the market is, or may be, temporarily jeopardised or it is necessary to protect investors (LR 5.1.1R).
Under LR 5.3.1R, the company may request a suspension of its listing if, for example, it is close to finalising a rescue package but there is a sudden material movement in its share price or risk of a leak. In those circumstances, the suspension would be framed in terms that the shares were being suspended for a short period pending an announcement by the company. A typical period of suspension is not more than 48 hours and the FCA is keen to discourage extensions beyond this.
- AIM Rules for Companies. An AIM company must comply with the disclosure obligations in Article 17 of UK MAR. In addition, under the AIM Rules it must notify, without delay, any new developments which are not public knowledge which, if made public, would be likely to lead to a significant movement in the price of its securities (Rule 11, AIM Rules). This would be likely to include a change in its financial condition or the performance of its business. Although suspension of AIM securities is relatively rare, it may be permitted if the company cannot make an immediate notification or it is concerned that such notification may be insufficient to properly inform the market.
Breach of the AIM Rules can result in the company receiving a warning notice or a fine, being publicly censured or its securities being cancelled from trading on AIM (Rule 42, AIM Rules).
- Prospectus Regulation Rules. Note that when a company issues a prospectus, the directors and any senior management must disclose certain information regarding their relevant management expertise and experience. This includes details of any bankruptcies, receiverships and liquidations with which the person has been associated during at least the previous five years (items 12.1, Annex 1 and 8.1, Annex 3, PRR App 2.1.1).
Misleading statements and impressions
Directors must have regard to the misleading statements and impressions provisions under the Financial Services Act. Under section 89 nit is a criminal offence for a person to either:
- Make a statement which it knows to be false or misleading in a material respect or is reckless as to whether it is false or misleading;
- Dishonestly conceal any material facts whether in connection with a statement made by that person or otherwise
The individual only commits an offence however if, in either of the above cases, they intend to induce or are reckless as to whether they may induce another person (whether or not the person to whom the statement is made or from whom the facts are concealed) to either
- Enter or offer to enter into, or to refrain from entering or offering to enter into, a relevant agreement.
- Exercise, or refrain from exercising, any rights conferred by a relevant investment.
For the offence of concealment to be committed there must be concealment and dishonestly. It is difficult however to see how either of these two elements could be satisfied in practice if the relevant disclosure and market conduct requirements have been met. On the other hand, if UK MAR or the AIM Rules require an announcement, failure to make one could constitute concealment. It will then be necessary to consider whether the concealment was made for the purpose of inducing others to deal or not deal, or whether the directors were reckless as to whether or not it might have such an effect. While the directors may be able to satisfy themselves that actions were not taken for the purpose of inducement, they may have difficulty in showing that they were not reckless, especially if they have been advised of the relevant disclosure requirements.
Section 90 of the Financial Services Act provides that a person who does any act or engages in any course of conduct which creates a false or misleading impression as to the market in or the price or value of any relevant investments commits an offence if they intend to create the impression and satisfies at least one of the following tests:
- they intend, by creating the impression, to induce another person to acquire, dispose of, subscribe for or underwrite the investments or to refrain from doing so or to exercise or refrain from exercising any rights conferred by the investments.
- they know that the impression is false or misleading or is reckless as to whether it is, and they (i) intend by creating the impression to make a gain (for itself or another person) or cause another person a loss or expose them to the risk of loss (a Relevant Result) or (ii) is aware that creating the impression is likely to produce a Relevant Result.
Directors (and others) must ensure that their behaviour does not amount to the civil offence of market abuse, otherwise they could be liable to an unlimited fine (section 123 FSMA)
Market abuse broadly covers behaviour that involves:
- Insider dealing, including recommending that another person engage in, or inducing another person to engage in, insider dealing.
- Unlawful disclosure of inside information.
- Market manipulation.
The market abuse regime runs alongside the criminal regime of insider dealing.
Directors of a public company whose shares are admitted to trading must tread a narrow path, balancing their desire not to hasten or, possibly render more certain, the demise of the company by premature announcement (which could cause suppliers and creditors to take action to protect their interests) against the need to protect the holders of the company’s shares and other traded securities, as well as potential investors. Close and frequent contact with the company’s financial and professional advisers at this stage is critical.
B Serious loss of capital
If a public company’s net assets fall to half or less of its called-up share capital, the directors are required, within 28 days of one of them becoming aware of the fact, to call a general meeting to consider what steps should be taken. The general meeting must be convened for a date no later than 56 days from the date on which such director became aware of the fall in net assets ( section 656, CA 2006).
There are various other provisions in the CA 2006 that are designed to ensure that both a private and public company’s capital is maintained, for example, the prohibitions on distributions out of capital, share buybacks (except in accordance with Part 18 of the CA 2006) and a public company or its subsidiaries giving financial assistance in connection with a purchase of the public company’s shares or those of its holding company, except in limited circumstances.
X Executive, non-executive, nominee and group directorships.
A Non-executive directors
Insolvency law does not formally recognise any distinction between the duties and liabilities of executive directors an non-executive directors. However
- Non-executive directors are not subject to certain employee issues associated with executive directors
- A non-executive function may affect the evaluation of the general knowledge, skill and experience that might be reasonably be expected of the director and of someone carrying out that role under sections 214(4) and 246ZB of IA 1986 in relation to wrongful trading.
B Executive Directors
Executive directors work for a company on a full or part time basis and are remunerated for their services as an employee of the company.
C Nominee directors and directors on the board of two or more companies in the same group
Problems can arise for a person who becomes a director of a company as a nominee director of a lender or shareholder or who is a director of more than one company in the same group.
These problems may include:
- Where the director is a nominee, that he may have knowledge of the intentions of the shareholder or lender for whom he is nominee: that may place him into a position of potential conflict of interest in relation to his statutory or fiduciary duties owed to the company or companies on whose board he sits. Knowledge, for example, that a lender has decided to withdraw, or is considering withdrawing, its facilities may place him in a position where he has a duty to communicate his knowledge immediately to the rest of the board, perhaps even where the parent company or lender has not yet formally made up its corporate mind.
- Where the director is a director of more than one member of the group, the director will need to consider the position of each member of the group separately: this may give rise to irreconcilable differences in the actions and decisions required of the director in order to comply with his duties owed to each company.
Effect of a formal insolvency on director powers
When a company goes into compulsory liquidation, its directors lose their powers to control the company’s affairs or conduct acts in the company’s name (Measures Brothers Ltd v Measures  2 Ch 248). Any purported exercise by the directors of their former powers is, consequently, void (see, for example, Park Associated Developments Ltd and another v Kinnear and others  EWHC 3617 (Ch).
In a voluntary liquidation, the directors lose their powers upon the appointment of the liquidator (section 91, IA 1986 (members’ voluntary liquidation); section 103, IA 1986 (creditors’ voluntary liquidation)).
In an administration, an officer of the company may not exercise any management power without the consent of the administrator (paragraph 64, Schedule B1, IA 1986).
XI Directors Disqualification: Overview
Under the Company Directors Disqualification Act 1986 (CDDA 1986), a court may make a disqualification order against a person that he shall not, without leave of the court, be a director of a company or in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of a company for a specified period beginning with the date of the order (section 1, CDDA 1986). “Director” is widely defined to include any person occupying the position of director, by whatever title (section 22CDDA 1986).
Disqualification orders and insolvency
Upon the initiation of the Secretary of State, a disqualification order may be made by the court against a director or shadow director of a company that becomes insolvent, if his conduct as a director makes him unfit to be concerned in the management of a company (sections 6 and 7, CDDA 1986). For these purposes, an English company is insolvent if it has gone into an insolvent liquidation, administration or had an administrative receiver appointed.
When assessing conduct, (under section 6 CDDA 1986) the court is entitled to judge a director unfit on the strength of his conduct regarding:
- The insolvent company alone or taken together with the director’s conduct as director of any other company or companies (including overseas companies)
- Any matter connected with or arising out of the insolvency of any such company (including an overseas company)
The minimum period of a disqualification order is two years and the maximum is 15 years ( section 6(4), CDDA 1986). It is open to a disqualified director to apply to the court for leave to act as a director or manager of a company (sections 1(1)(a) and 17, CDDA 1986).
Duty to report on delinquent directors
Liquidators, administrators and administrative receivers are required to submit reports about directors (including shadow directors) to the Secretary of State if it appears to them that the conditions for disqualification are satisfied in relation to a person who is or has been a director of the company for which they have been appointed ( section 7, CDDA 1986): with effect for insolvencies starting on or after 6 April 2016, the obligation to report applies in respect of all directors and shadow directors (current and past within the previous three years), irrespective of their conduct (section 7A, CDDA 1986). They must submit their reports within six months of their appointment or (in insolvencies started on or after 6 April 2016, three months). On 6 April 2016 the reporting process moved online to a portal hosted by the Insolvency Service
Insolvency practitioners need to make difficult judgments, involving both commercial and legal considerations as to whether directors are unfit to be concerned in the management of a company and, in the case of shadow directors, whether they fall within that category or not.
The House of Lords has held that the powers of investigation conferred upon insolvency practitioners by section 236 of IA 1986 can be exercised solely or principally to obtain evidence for use in disqualification proceedings (Official Receiver v Wadge Rapps & Hunt (a firm) and another  UKHL 49
Factors in determining disqualification
In determining the question of unfitness, whether to make a disqualification order or the period of disqualification, the court shall have regard, in particular, to the matters set out in schedule 1 CDDA 1986 (section 12C CDDA 1986). These include:
- Any misfeasance or breach of any fiduciary duty by the director in relation to a company (or an overseas company)
- Any material breach of any legislative or other obligation which applies to the director as a result of being a director of a company (or an overseas company)
- The frequency of any conduct of the director falling within the above two matters.
Sanctions for acting whilst disqualified
It is a criminal offence if a person acts in contravention of a disqualification order (section 13, CDDA 1986) and that person will be personally liable for all the relevant debts of the company he is managing (section 15, CDDA 1986).
Sections 15A, 15B and 15C of the CDDA 1986 contain provisions relating to the power of the court to make a compensation order against, or accept a compensation undertaking from, a disqualified person. The court may do so where the conduct for which the person was disqualified has caused loss to a creditor or creditors of the insolvent company of which the person was a director.
Under section 1A of the CDDA 1986, the Secretary of State, instead of initiating disqualification proceedings, may accept a voluntary disqualification undertaking from a director to speed up the disqualification process. The advantage to directors of giving a voluntary disqualification undertaking is that they will not need to pay the costs of going to court and may also be given a discount on the length of any disqualification period.
If a director agrees to give a voluntary disqualification undertaking, the Secretary of State has a discretion whether to accept the undertaking or apply to court for a disqualification order. Disqualification undertakings will only be accepted where it appears to the Secretary of State that it is expedient in the public interest to accept an undertaking instead of applying for, or proceeding with, a court application for a disqualification order ( sections 7, 8 and 8A CDDA 1986).
A breach of the terms of the undertaking has the same criminal and civil consequences as a breach of a disqualification order.
Disqualification for fraudulent trading and wrongful trading
Under section 10 CDDA the court can make a disqualification order against a person if he has been found liable for fraudulent trading under section213 IA 1986 or wrongful trading under section 214.
Section 10 CDDA does not include reference to fraudulent trading or wrongful trading pursued under sections 246ZA or 246ZB, respectively, of IA 1986 in administration.
Person instructing disqualified director
Upon the initiation of the Secretary of State, a disqualification order may be made against a person (P) who instructed a director (or a former director but not a shadow director) who has had a disqualification order made against him or her or who has given a disqualification undertaking (the “main transgressor”) sections 8ZA and 8ZB, CDDA 1986).
A disqualification order can only be made against P if the conduct with respect to which the main transgressor was disqualified was the result of the main transgressor acting in accordance with P’s directions or instructions (unless given in a professional capacity).
The minimum period of disqualification under section 8ZA is two years and the maximum is 15 years although an undertaking may be accepted.
Compensation orders and undertakings
Sections 15A, 15B and 15C CDDA 1986 contain provisions introduced in 2015 providing for the payment of compensation by a disqualified person for the benefit of a specified creditor or creditors generally.
The Secretary of State may apply to the court for it to make a compensation order, or accept an undertaking to pay compensation, where a disqualification order has been made or a disqualification undertaking given, and the conduct of the disqualified person (on or after 1 October 2015) caused loss to one or more creditors of the insolvent company. The court may order compensation to be paid to the Secretary of State for one or more creditors or classes of creditor, or to be paid as a general contribution to the assets of the estate, or an equivalent undertaking may be accepted. Procedural rules in force from 1 October 2016 for applications for compensation orders are set out in the Compensation Orders (Disqualified Directors) Proceedings (England and Wales) Rules 2016 (SI 2016/890)
A compensation order (the first of its kind) was made under these provisions in Secretary of State for Business, Energy & Industrial Strategy v Eagling  EWHC 2806.
XII Dissolved companies
The Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021, in force from 15 February 2022 makes changes to the CDDA 1986 to allow disqualification orders to be made, disqualification undertakings to be given and compensation orders to be made, in respect of persons who were directors of companies that have been dissolved without entering insolvency proceedings first.
XIII Relief from Liability
Under section 1157 CA 2006, a court may relieve a director from liability for negligence, default, breach of duty or breach of trust if it considers that both the following apply:
- The director has acted honestly and reasonably
- Considering all the circumstances of the case, the director ought fairly to be excused.
A director may also apply for relief under this section in advance of any claim being made against him.