A large proportion of businesses in the UK are owner managed with common directors and shareholders. It is this relationship between ownership and control and the conflicts of interest that arise that can cause problems for directors when businesses become insolvent and enter “the twilight zone” which may end in formal insolvency.
Said Gerald Irwin of Sutton Coldfield based Licensed Insolvency Practitioners and Business Advisers, Irwin Insolvency, “Directors have to be exceptionally cautious if their business enters the twilight zone as any erroneous actions can expose them to personal liability. The test of their actions will be based on reasonable commercial judgement”.
Most company failures can be attributable to some form of incorrect business decision or action by its directors, rather than some external catastrophic event that was totally unforeseeable. As a rule of thumb, therefore, what is required of directors is that they act honestly and in what they believe to be in the best interests of creditors and the business.
“Can we ask or demand any more of directors other than to act honestly and fairly? If the answer is yes and we accept that most business failures are as a result of wrong decisions, the majority of directors involved in failure are going to find themselves personally liable for the debts of such businesses. This is a wholly unsustainable position as it would lead to the economy grinding to a halt as a result of directors’ fears of making a wrong decision” commented Mr. Irwin.
So how can directors protect themselves from personal liability?
Mr. Irwin stresses it is important to realise that, in the twilight zone, the business is insolvent and, therefore, directors must act with a view to minimising the potential loss to creditors as opposed to acting in the best interests of shareholders. In owner managed businesses, this can give rise to a conflict of interest. However, directors must act honestly and reasonably and not with reckless abandon. Directors must definitely not continue to trade on the basis that there may be some light at the end of the tunnel. If a director causes a business to incur credit during this period and knowingly goes beyond what a reasonable business man would regard as honest, he will find himself personally liable for the credit incurred.
Well advised directors will seek independent professional advice in respect of accounting and legal issues. It is fair to say that directors who act honestly, in the best interests of creditors and who take professional advice will rarely, if ever, be personally liable for the debts of their insolvent business.
However, a note of caution, this is constantly being raised and directors must be continually vigilant in respect of their duties and responsibilities.