Lecture 9: Directors, disqualification, wrongful and fraudulent trading Flashcards
What are the duties of directors to creditors?
Under the Companies Act 200, directors have a statutory duty to
- promote the success of the company
- Fiduciary duty to act in the best interests of the company (usually shareholders)
The matter is open to the courts however as to the nature and content of the duty owed specifically to creditors
- Courts have viewed the duty to creditors as part of the duty to act in the best interests of the company and also as an independent, specific duty to creditors
- Duty to exercise reasonable skill, diligence and care (have to be independent in their decision making)
Some people see the duty of care being required for both shareholders and creditors collectively, others say that there is a specific and direct duty that the director must act in the interest of the creditors.
Why is there an issue over who directors owe their duty of care to?
Difficult to apply in practice - what do directors do when creditors’ interests conflict with shareholders’ interests.
Also the issue of whether the duty is owed to creditors in general (this is vague - obligation to act fairly in relation to all the creditors, law doesn’t really function as it is meant to), or specific classes if creditors or creditors as individuals (more problematic).
The more vague the law is, the less effective it becomes.
- Recent indications suggest that duties owed to creditors may be part of traditional duty to act in the company’s best interests
- However, still problematic issues regarding treatment of creditor interests relative to other company interests
- Some evidence from case law suggesting that it is on the approach to insolvency that creditors’ interests should be prioritised.
- Should we wait until the company is insolvent? - need to think of managerial incentive - managers will want to delay formal insolvency whilst creditors positioning is worsening.
What is the issue with determining when the duty to creditors arises?
- Does the duty arise all the time, as the company approaches insolvency or when the company becomes insolvent?
- Need to account for managerial incentives in financial distress
- Perhaps most support for the ‘approach to insolvency’ position
Some evidence from case law suggesting that it is on the approach to insolvency that creditors’ interests should be prioritised.
• Should we wait until the company is insolvent? - need to think of managerial incentive - managers will want to delay formal insolvency whilst creditors positioning is worsening.
How do you define the “approach to insolvency” (for when duty is owed to creditors)?
• Very difficult to determine precisely when a company cannot pay its debts when they fall due
• Plus need to consider when the directors should have identified the prospect of insolvency
• Expecting a minimum level of competence on the part of directors
• From the moment they knew or ought to have known that company solvency was doubtful.
Defining the actual point of insolvency is difficult.
Some point between prospect and insolvency that directors must have known that insolvency was unavoidable.
What is directors diligence?
Competence from directors - what a diligent person ought to know.
What types of director are there?
De jure directors - properly appointed
De facto directors - not properly appointed, but performs the functional role of director.
Shadow directors - capable of exercising real influence over a majority of board members (although not appointed to the board)
And anybody else who was a de jure director, de facto director or shadow director in the 3 years before the commencement of insolvency proceedings
What are the two perspectives on the logic underpinning the Company Directors Disqualification Act 1986 (CDDA 86)?
A ‘rights’ approach - business enterprise perspective
A ‘privilege’ approach - social responsibility perspective
What is the ‘rights’ approach to The Company Directors Disqualification Act 1986?
Business enterprise perspective.
Running a company is a valuable, commercial endeavour.
Directors should be free to take and manager business risks and it is not the court’s place to second guess these decisions.
Disqualification is viewed as a punishment for directors - negative stigma, removing status.
Courts will only interfere when they can prove culpability - have to show that directors are to blame.
What is the ‘privilege’ approach to The Company Directors Disqualification Act 1986?
- Limited liability is a privilege (being a director is a privilege)
- Directors have a duty to act in the public interest
- Disqualification is seen as a means of protecting the public.
How are directors disqualified?
A director can be disqualified (under section 6 of the CDDA 86) from acting as a director for unfit conduct.
Liquidators, receivers and administrators must send a report to the Secretary of State (the Disqualification Unit - part of the insolvency service) within 6 months of the appointment.
The Disqualification Unit review the reports and the Secretary of State decides which ones to take forward for investigation and subsequent court proceedings
• Secretary of state has 2 years to begin proceedings
Key consideration is ‘public interest’ (for secretary of state) – is there sufficient unfit conduct. Need adequate evidence
Disqualification is by the Court
Disqualification is for between 2 and 15 years
Director cannot remain or become a director or be included in the promotion, formation or management of a company
What are the current issues with the disqualification unit in the insolvency service?
• Concerns raised that the Insolvency Service (IS) is investigating too few cases due to resource constraints.
Focus on easy wins which require less investigation time.
- No. of reports filed by IPs is increasing (3,539 in 2002-3. 7,030 in 2009-10)
- No. of reports that result in directors being disqualified (45% in 2002-03. 20% in 2009-10).
What are disqualification undertakings?
This is where the directors voluntarily put themselves forward for disqualification - to try and reduce the costs of the process for both the directors and insolvency services
- Introduced by the IA 2000
- Secretary of State will accept a disqualification undertaking from the director
- Must be in the public interest to accept the undertaking
- Aim is to reduce enforcement costs by avoiding the need to go to Court
- Lower profile of cases
- Potential issues of plea bargaining
- The Insolvency Service is acting as the investigator, the prosecutor and the judge.
What is unfit conduct?
Taking unwarranted risks with creditors’ or shareholders’ money.
Taking unfair advantage of the position of director.
Breaches of commercial morality.
- Directors receiving money from the company.
- Authorisation of payments to the director himself
- Failing to pay over pension contributions
- Any action that was not in the proper interests of the company or which worked against the creditors, employees or members.
Important to consider the materiality of matters - how much damage has been done to creditors as a result of directors doing these things.
What are other reasons for disqualification?
- Persistent failure to comply with statutory duties.
- Importance of maintaining accounting records (need to consider material omissions, Would deficiency in financial information have caused directors to be uninformed about company’s financial position?, wer auditors’ reports qualified?)
- Causes of failure and insolvency (commercial decisions of directors, trading without regard for interest of creditors)
- Transactions at undervalue (disposal of assets for less than full value)
- Preferences (one creditor has benefited at the expense of others)
- Directors might have personal guarantee, so they’ll clear those loans off prior to insolvency.
• Courts need to consider all the available information such as the belief that new capital would be received or a viable restructuring plan would be approved.
What is phoenixism?
- S216 of the IA86 restricts re-use of a name (“prohibited name”) previously used by a company that has gone into insolvent liquidation
- The prohibited name is a name by which the liquidated company was known at any time in the 12 months immediately before the liquidation.
- Restriction is for 5 years and breach of rule is a criminal offence
- One exception to the rule is where the business is sold by a licensed IP (have to give notice in the Gazette)
