You don’t need me to tell you about the state of the current economic environment. For most in business, times are tough. As directors, there is the risk that in certain circumstances you can become liable for the debts of your company. Accordingly, the question you should ask yourself is what do I need to do as director to avoid any personal liability?
The starting point for any director in running successful business is to understand what the financial position of the company is. This is not just today, but knowing what the projected cash flow is, what significant obligations are looming and how much work is in the pipeline. Only if director has good handle on this, can informed decisions be made on the best way for the business to act.
However, this isn’t just common-sense requirement. The Companies Act requires that directors ensure their company keeps proper accounting records to enable the preparation of financial statements that comply with the Financial Reporting Act. What if accounting records aren’t kept or financial statements prepared? If the company is insolvent and placed in liquidation, the Court may order that any or all of the directors be held personally responsible for the company’s unpaid debts if the failure to keep accounting records or prepare the financial statements contributed to failure of the company.
The greatest risk of personal liability is where company is insolvent or is approaching insolvency. Directors have duty not to allow the business to be carried on in manner likely to create substantial risk of serious loss to the company’s creditors, known as reckless trading. Similarly, directors must not allow company to incur an obligation unless the director believes at the time that the company will be able to perform the obligation when it is required to do so. It is these duties liquidators allege have been breached when seeking to have directors held personally liable for the unpaid debts of company.
When company approaches insolvency, its directors must be very careful in how they act otherwise they risk becoming personally liable for company’s debts. If you end up in this position, what can you do?
First, try to keep cool head. Decisions must be made as to whether the fortunes of the company can be turned around. If not, the options available are usually to try to sell the business before it fails or, if too late, cause the company to cease trading so that it does not trade recklessly. Directors have other duties:
• to act in good faith and in what the director believes to be in the best interests of the company;
• to exercise power for proper purpose;
• to comply with the Companies Act and the constitution of the company;
• to exercise the care, diligence and skill that reasonable director would exercise having regard to the nature of the company, the nature of the decision and the position of the director;
• to not use information obtained from the company except for the benefit of the company.
You might think the duties above don’t apply to you because, although you are director, you have limited involvement in the business of the company. Unfortunately, it doesn’t work like that. If you are director, you are responsible for the duties that position holds. You cannot totally delegate this responsibility away.
Not knowing what is happening in the company is not defence under the Companies Act. If you are not prepared to act as director and monitor the company and its management, you should resign.
And just because the Companies Office does not record you as being director might not prevent the Court finding that you are. The definition of director in the Companies Act also includes ‘shadow directors’. These include people in accordance with whose directions the directors of company may be required or are accustomed to act, or person who exercises or who is entitled to exercise or control the powers that would fall to be exercised by the board. This definition excludes people who act only in professional capacity (such as lawyers or accountants).
The risk of incurring personal liability by being director is nothing new. The key is to minimise the risk. You can do this by first ensuring you know exactly what the financial position of the company is. If it is near insolvency or is insolvent, be very careful. That is the time to seek advice so you are aware of your options and can ensure there are reasonable grounds for allowing the company to continue to trade.
Nicholas Scott is partner at Kensington Swan, specialising in restructuring and insolvency matters.
