Contentious insolvency and the UK director – the civil implications for a director’s many roles in an insolvent liquidation

According to the Guinness Book of Records, a Mr. Johnson George from India holds the world record for the most roles played by an actor in a film. He played 45 roles, including Gandhi, Leonardo da Vinci and Jesus. Business leaders don’t have as many roles and are not as high.

In this article, Tim Syme examines each of the roles frequently held by administrators in the English jurisdiction. Tim also examines how these roles can become toxic to the reckless director if the company goes into formal insolvency such as liquidation.

Administrator as trustee

This is probably the most recognizable role for a director and the one that can get them in the hottest water in a formal insolvency.

Prior to the Companies Act 2006, the fiduciary duties of directors were found in case law developed by judges over time. The Companies Act 20026 changed all that. Now, the various obligations are clearly defined in sections 171 to 177 of the Companies Act. Importantly, the case law that developed these duties remains effective for the purpose of interpreting the provisions contained in the Act. These duties are:

  • Act within the limits of its powers
  • To promote business success
  • Exercise independent judgment
  • Exercise reasonable care, skill and diligence
  • To avoid conflicts of interest
  • Do not accept benefits from third parties
  • To declare an interest in a proposed transaction or arrangement

These rights are due to the company. This is until the company becomes insolvent or approaches insolvency. At this point, the rights become due to the creditors. Until then, directors can seek forgiveness for their wrongs from shareholders through a ratification process. However, once the duties are transferred to the creditors, the shareholders’ pardon, even if granted, offers no protection or comfort.

Once the company is put into liquidation, the conduct of the directors will be thoroughly investigated by the liquidator to identify any violations. Any violations that have caused losses to the company will be reported to the administrators with a “request” to repair those losses or face legal action.

Administrator as quasi-fiduciary

A director’s position as a trustee of a company’s assets stems from the fiduciary nature of a director’s relationship with the company. If a director disposes of company assets to use for himself or otherwise derive benefit from, he is in breach of trust. Additionally, there is no statute of limitations for a breach of trust by a director, leaving him looking over his shoulder indefinitely.

Director as employee

The functions of administrator and employee are distinct, as are the duties imposed by each of these roles. As noted above, a director is subject to legal obligations as a fiduciary. However, an employee will also be subject to duties and responsibilities, not only written in the service contract, but unwritten. These implied terms may endure beyond the administrator’s employment and therefore be subject to the scrutiny of a liquidator.

Director as agent

When a director enters into a contract on behalf of a company, he does so as its agent. A director must act within the framework of the mandate entrusted to him. A director should only do on behalf of the company what the company has authorized him to do.

The extent of the administrator’s general powers will be specified in the company’s articles of association. They may also be granted more specific powers in their separate capacity as employees.

If the director exceeds the powers of his agency, he may be personally liable to a third party. When a director signs a contract on behalf of the business, it creates another contract between that director and the third party promising or “guaranteeing” that the director is authorized to enter into the main contract and bind the business.

When the company then refuses to perform the contract because the manager was not authorized to enter into it and the company is therefore not bound, there is a breach of guarantee of authority. The third party then has recourse against the administrator personally.

Such a breach may occur when, for example, the financial director contracts on behalf of the company the sale of goods which should have been carried out only by the commercial director.

The liquidation of the company will not appease a director faced with a breach of guarantee of authority. This could mean worse news: the liquidator can also sue the administrator for losses caused to the company as a result of this breach.

Director as shareholder

Entrepreneurs will often have a stake in the business and, in smaller businesses, they may be the outright owners. For tax reasons, the directors of these companies are known to receive a modest salary combined with stock dividends. Dividends are often taken out by the company in the form of loans initially, and these loans are then compensated by a dividend declared at the end of the financial year.

This can prove to be a problematic way of doing things once the company goes into liquidation. First of all, unless the dividend making it possible to extinguish or reduce the loan has been declared before the liquidation of the company, the loan will constitute a debt of the director and cannot be compensated by any undeclared dividend. . Second, even if a dividend has been declared, if there has been insufficient profit (usually by reference to the previous accounting year – a fact that even accountants sometimes forget), it will have no effect; the loan will still be due.

Guarantor Administrator

Even if the director has scrupulously complied with his fiduciary, fiduciary, employee and agency duties, he may still become personally liable for certain debts of the company as a guarantor.

The posting of a personal guarantee by a director may be a requirement before lenders advance funds to a business, especially start-ups. When the business goes into insolvent liquidation and cannot pay its debts, the lender will turn to the manager personally.

With this fear in mind, a director may rush to pay off corporate debts that he has guaranteed. Unfortunately (for the guarantor manager) this is unlikely to work, as it may amount to an illegal preference which the court can overrule.

Director as entrepreneur

It is not uncommon for the liquidator to discover that substantial “consulting” fees have been charged by the administrators or their subcontracting companies for advisory fees, without sufficient or non-existent evidence of the purpose of these services or of the fact that they were provided.

If the manager cannot justify these fees, they will be challenged as an undervalued transaction on the grounds that there is a significant mismatch in the amount of fees paid in relation to the services rendered. They may also constitute a breach of the administrator’s obligation to reimburse all or part of the advisory fees, plus interest.

Conclusion

The modern director must juggle a range of roles, each with different responsibilities and consequences. As long as the business trades as a viable business, these roles generally remain benign. However, once the company is in insolvent liquidation, anything the director has done that is inconsistent with any of these roles, or that has triggered liability under them, could haunt him far beyond the immediate liquidation of the company.

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