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Directors: When insolvency knocks, protect yourself

By Angela Catanzariti DE Senior Litigation Lawyer.

Josh is the sole director of a plumbing company that has hit hard times. Josh is understandably worried about his liability as a director should the company be deemed insolvent.

When a new plumbing contract for a large-scale retail development was presented to Josh, he saw the opportunity to clear a number of pending company debts. However, to complete the contracted plumbing works, Josh was required to incur a further debt by purchasing some new equipment specifically for those works. Josh gave the matter considerable thought and decided to make the purchase, in the honest belief that at the end of the day, it would lead to a better outcome for his company.

Directors Defences 

With the recent changes brought about by the Insolvency Law Reform Act 2016, the list of defences available to Josh in the case of corporate insolvency has expanded and are now as follows: 

  1. The director can avoid personal liability if they can demonstrate that they had reasonable grounds to expect, and did expect, that the company was solvent and would remain solvent over time.
  1. The director had reasonable grounds to believe that a competent and reliable person (such as an accountant) was responsible for providing them with adequate information about whether the company was solvent.
  1. Due to illness or some other good reason, at the time when the debt was incurred, the director in question did not take part in the management of the company.
  1. The director took all reasonable steps to prevent the company from incurring debt.
  1. The newly expanded ‘safe harbour’ defence allows for the director to show that they took a course of action that was reasonably likely to lead to a better outcome for the company overall. This means that a director may not be deemed liable for certain debts incurred whilst the company was insolvent if, after suspecting insolvency, the director started taking a course of action reasonably likely to lead to a better long-term result and financial outlook for the company.

For Josh, this means that because he purchased the new equipment required to complete the newly contracted plumbing works for the retail development, he may be able to show that he had a reasonable belief that this would improve the financial position of the company overall despite incurring more debt in the short term.

Exceptions

Josh will not be protected in relation to incurring new debt (for the example the purchase of new plumbing equipment) if he did not believe the company could repay this debt in accordance with its terms. Directors will need to be mindful of this when negotiating the terms of any new financing.

Act Early

If your company is in financial difficulty due to changes in economic conditions, disruption from a new competitor or poor decisions, the board of directors should be proactive and act early.

Directors should obtain appropriate advice and engage with their stakeholders. This will maximise the chance of a successful restructure and minimise the risk of personal liability for insolvent trading.

To find out more on your options with respect to directors’ personal liability or corporate insolvency generally, please contact Angela Catanzariti, Senior Litigation Lawyer, for a full and frank discussion.