Are we Insolvent?
One area that is left untouched by the new regime of directors’ duties is the responsibility of directors when they believe the company is facing insolvency. This has long been a tricky area, but CA 2006 does not clarify directors’ duties in this regard.
The starting point is that if the company is solvent then the standard directors’ duties apply (under s171 and s172CA 2006). However these new duties are expressed to be subject to any enactment or law requiring directors in certain circumstances to consider or act in the interests of creditors of the company (s172 (3). Thus if it is believed that the company is facing insolvency the existing duties on the directors to consider or act in the interests of creditors take precedence. In practice, the difficulty is recognising when the duty switches from being owed to the company to being owed to the creditors.
Note that the issue of determining whether a company is insolvent remains unaltered from the prior position. England has two independent tests for determining insolvency: the cash flow test (i.e. company cannot meet its debts as and when they fall due), and the balance sheet test (i.e. company’s liabilities exceed its assets). The need for directors to obtain specialist advice as to the financial position of the company remains as crucial as ever. If the company is insolvent, the director’s duty is owed to the creditors under s172(3), but if it is not insolvent then the duty is owed to members under s171. The problem is that there is no neat dividing line, or clear guidance, as to how directors should assess that situation. If a director concludes (or ought to conclude) that there was no reasonable prospect of avoiding insolvent liquidation, but then continues to trade, then the director may be personally liable for further debts incurred. The reality, of course, is that directors should err on the side of self-preservation if there is even the smallest possibility that they could face personal liability. The end result is that directors may be encouraged to decide too early that they owe their duty to creditors as opposed to shareholders. On the other hand if the directors act too hastily, they may leave themselves exposed to a claim by shareholders that they have not fulfilled their duties under s171 and s172! Something of a balancing act.
As discussed above, we are therefore likely to see increasing focus on comprehensive minutes and formalised note-taking processes to show the considerations and decision-making processes of directors.
Jeremy Lederman, Partner – Commercial Dispute Resolution Department
