When a Company enters into a formal insolvency process, such as Liquidation, the Directors can often find that limited liability may not be quite what they had in mind. A Liquidator has the ability to pursue Directors personally for misfeasance, wrongful trading and debts owed to the Company.
The most common debt owed to the Company is the Director’s overdrawn loan account. Many of these have come about because directors have taken drawings which historically they have rectified by way of a dividend. This was all well and good when the company was profitable and would have been tax efficient.
When the company’s trading slowed and profits disappeared often in order to maintain the Director’s lifestyle the situation continues in the hope that better days are coming. However dividends can only be drawn legally from profits or distributable reserves, otherwise the dividends are illegal and the only choice is to put them to the loan account, making them overdrawn.
Putting aside tax considerations and breaches of the Companies Act, if the Company fails the Liquidator will look to the Director to repay the overdrawn loan account. If the illegal dividend payment has not been transferred to the loan account then again in the absence of profits or distributable reserves these illegal dividend payments will also be pursued.
A Liquidator is required to undertake certain investigations into a company’s affairs. It is no use for the Director to look to reduce the debt by voting a bonus or writing it off against the profit and loss account. If the Company goes into Liquidation then a Liquidator may claim the monies personally against the Director as misfeasance, a preference or transaction at an undervalue.
If these actions cannot be defended successfully then the Director may have to consider their own financial position and may face insolvency themselves, additionally a Liquidator is required to report on the conduct of directors and that report can lead to proceedings under the Company Directors Disqualification Act 1986.
Of course the sums involved might not be significant or the Liquidator may not consider recovery to be cost effective. However that may not be the end of the matter as HM Revenue and Customs can then take up the reins. They will have a lot of information to hand and more often than not will be a creditor to the Company. One option open to them is to pursue the director personally for either untaxed earnings in the case of an outstanding loan account or failure to pay over PAYE/NIC if a bonus has been voted but the tax is not paid.
As can be seen the trend for Directors to opt for dividends and a reduced salary can have its downsides in the situation where the company faces insolvency.
When a Company is facing financial difficulties it is important that Directors take their own legal advice. The Company solicitor and accountant may be able to assist to an extent, however as insolvency approaches the Director’s duties begin to change, the personal position of the Director is not the same as the Company, there may be a conflict in advising the Company and the Director. After a winding up order is made the Liquidator has wide power to gather in information about the Company’s affairs including the files held by the professional advisers to the Company.
We offer specialist advice to Directors and it is in their interests for them to take advice at an early stage, when more options may be open to them. Our specialist Insolvency Department can offer advice to Directors about their duties as well as avoiding and defending claims for:
- Wrongful Trading
- Fraudulent Trading
- Illegal Dividends
- Directors Disqualification
- Transactions at an Undervalue
In relation to the Director’s personal position we can assist in:
- Defending bankruptcy proceedings
- Advising on the consequences of Bankruptcy
- Negotiating with Banks regarding Personal Guarantees
Moving forward we can assist Directors in purchasing assets from Liquidators, Re-use of Prohibited Names and in the event that a Director is disqualified applications to Court for permission to act as a Director following disqualification.
By Darren Stone
Related: £500 Cash Loan.