Amid economic uncertainty and a looming global recession, many senior executives are facing the prospect of leading businesses falling into financial difficulty or bankruptcy.
For many senior executives, being involved in a business that has failed will have long-lasting consequences. Apart from the reputational damage that can be caused to a person’s career, they will also be subject to an investigation by the relevant officer (depending on the type of insolvency process the business enters) and this can lead to personal liabilities.
In this article, we outline some advice for senior executives who find themselves working in a financially troubled enterprise.
Think about your role in the business
As a starting point, senior executives should consider whether they are directors of the business in question.
Once a business has entered into insolvency proceedings, the insolvency practitioner appointed in relation to the business will be tasked with investigating the affairs of the company. This includes an investigation into the events that led to the failure of the business. Officials have wide powers under the Insolvency Act 1986 to examine company directors.
It is important to note that “directors” in this context include:
- De jure directors: those directors who are formally appointed and registered as such at Companies House,
- De facto directors: those directors who are not formally appointed as such but are held as such by the business, and
- Shadow directors: persons who are not named as directors but with whose directors/instructions the directors of the company are supposed to be acting.
It is also important to note that no distinction is made between executive and non-executive directors.
Senior executives should carefully consider whether they fall into one of the categories above to assess whether they have any personal exposure to the company’s insolvency.
Be proactive
When a business faces financial difficulties, senior executives may be tempted to resign to avoid dealing with the consequences of a failed business.
In reality, resignation will not prevent a director from being scrutinized by an officer in the event of bankruptcy. When a company goes into bankruptcy, the official has a duty to report the conduct of the individuals. If, in the opinion of the office holder, the director in question has failed to fulfill the statutory and common law duties of directors, then the office holder may recommend to the Secretary of State that disqualification proceedings be instituted against the director in question.
In addition, for senior executives sitting on the board of companies in financial difficulty, they face the risk of personal liability for wrongful trading under section 214 of the Bankruptcy Act 1986 by continuing to trade with the company when they knew or should have known that there was no reasonable prospect of the company becoming insolvent. Section 214 of the Insolvency Act 1986 contains protection for directors in respect of any liability for wrongful trading where the director has taken all steps with a view to minimizing the potential loss to the company’s creditors.
It follows that taking a proactive approach by addressing the issues facing the business and seeking to resolve them through carefully considered steps (taking advice from third party professionals as necessary) often is a better alternative to simply resigning.
Document all decision-making accurately
For companies with sound corporate governance in place, comprehensive board minutes documenting board decisions are the norm.
When a company faces financial difficulties, there is an increased need to accurately record all decisions (and the reasons behind them), especially when such decisions affect the financial health of the company.
If the company goes into insolvency, having comprehensive board minutes setting out the reasoned decisions (ideally supported by financial information) will assist the director in any subsequent investigation and may also insulate the director against any potential risk from litigation.
Consider the extent of directors and officers insurance
Many businesses will have directors and officers insurance which is designed to protect the company’s employees against any legal claims.
For directors of companies facing financial difficulties, it is worth checking the extent of any directors’ and officers’ insurance to understand the extent of their protection should the business go into insolvency. Directors should consider:
- Regardless of whether they are specifically stated in the policy,
- The scope of the policy, as many policies specifically provide cover in respect of claims such as wrongful trading or abuse (as well as any crimes involving fraud) and
- The duration of the policy and the extent of any lapse cover, as many claims against directors are not brought until several years after the business has gone into insolvency (at which point the lapse cover may have lapsed).
Seek third-party advice as necessary
For those in charge of running a business, facing insolvency is likely to be an incredibly stressful time. Seeking advice at the earliest sign of financial difficulty from suitably qualified professionals, whether solicitors, insolvency practitioners and/or accountants, will ease the burden on the director in question and may help the business avoid insolvency.
Seeking objective advice from legal and financial experts is also evidence that the director has taken a prudent and prudent approach to dealing with the prospect of bankruptcy and can protect the director from future litigation.
If you require any further information on anything covered in this briefing please contact Eleanor Rowswell, Zaid Dada or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your particular circumstances.
© Farrer & Co LLP, April 2023