Directors in the Twilight Zone

Here you can download our Directors In The Twilight Zone 7 Frequently Asked Questions answered booklet. An example of the useful information you can find in the booklet is featured below.

Introduction

Directors of Limited Companies have primary duty under Section 172 of the Companies Act 2006 to promote the success of the Company. in respect of conventional limited liability Companies, this usually refers to making sufficient profit or acting in shareholders’ best interests to the exclusion of most other groups or categories or stakeholder in the Company.

However, when a Company reaches a point of insolvency and is unlikely to avoid an insolvent Liquidation (or other similar insolvency scenario) then Directors duties alter and they must prioritise the interest of creditors of the Company rather than the shareholders.

This has always been a historic position in case law but as from the Companies Act 2006 (which supported this theme, which already existed in the insolvency Act 1986) this became a stipulated fiduciary duty of Directors even before insolvency occurs.

A breach of such a duty can lead to claims for a Director breaching his fiduciary duties or, most commonly in insolvency proceedings, claims against Directors for Misfeasance, wrongful Trading and perhaps even Fraudulent Trading. Please see our website which holds booklets which deal with such claims.v

This booklet is designed to provide a brief guidance as to what Directors should do if their Company is struggling or appears to be on a path to failure, a scenario commonly referred to as the “Twilight Zone”.

1. What Is The Twilight Zone?

This is not a term defined by legislation but is a common reference to circumstances which define the final period of a Company’s trading pre insolvency. The “Twilight Zone” is often difficult to interpret until a Company has already failed and you are looking back at what should have occurred in the period leading up to failure (or rather what the Directors should have done during this period).

The Twilight Zone could, for example, commence once funding lines or applications have been exhausted or failed and the future looks uncertain. in such circumstances a Director may have to make a decision as to whether the Company should continue trading.

The insolvency legislation provides a remedy for Liquidators and Administrators to seek recovery of any assets distributed by Directors of a Company where such distribution is shown to have been for an undervalue sum (i.e. payment or goods given in exchange for other items or payment which were less than the value of such goods or monies, or no value was given) and for recovery of preference payments (where certain categories of Creditors have been paid in priority to others).

Please see our booklets entitled “Preferring Creditors” and “Undervalue Transactions” which deal with these areas.

All of these remedies in insolvency proceedings relate to Directors’ decisions made in the Twilight Zone.

2. What Are My Duties When In The Twilight Zone?

This is varied and, by way of example ( which applies to Directors generally ) they should comply with their fiduciary duties generally and as set out at Sections 172-177 of the Companies Act 2006. our booklet entitled “Breaches of a Director’s Fiduciary Duties” deals with these general requirements.

However, more importantly than a majority of these duties, is how a Director acts to protect third parties, particularly creditors, where a Company is at risk of failing.

As creditors are not generally associated to the Company, and are usually the biggest losers if a Company fails, the legal position is that as soon as failure becomes a realistic possibility, Directors should stop any assets leaving the Company, should hold off payment to all creditors (although this may be difficult) and should only allow the Company to continue trading where it is generating net profits.

3. Do These Duties Apply In All Circumstances Where The Company Is Insolvent?

The answer to this is no – although Directors do generally have to manage each and every situation and be able to justify decisions at a later stage (should matters deteriorate).

Companies are often insolvent, particularly when they commence trading, and so it is managing a way out or alternatively having a realistic strategy for the Company’s success that will determine the viability of any plans and the justification for any decisions to continue trading.

However, where insolvency occurs and looks like it is only going to get worse, or alternatively where the solvency of the Company is unknown (perhaps because of the state of the accounting records and management information) then Directors have to pay very real attention to the detail and be more careful when making decisions which could ultimately affect them personally.

4. What Situations Lead To These Circumstances?

Sometimes it may be that the Company is suffering a downturn in business but the Company’s business can be recovered by way of, for example, additional funding as a result of which insolvency proceedings may be avoided. This is not unusual for Companies and indeed many Companies go through this but it is for the Directors to perceive the difference between these events and a scenario where the Company cannot avoid Liquidation.

However, in circumstances where (for example) a large customer ceases to use the Company’s business, or legal changes have an unforeseen and severe impact on the Company’s business, the make-up of the Board changes or a very key sales Director, manager or otherwise resigns or is dismissed, where funding lines change or the bank withdraws certain types of facility, in all of these scenarios then Directors could find themselves in the Twilight Zone with the additional responsibility to safeguard the Company’s assets in the event of an insolvency process being commenced. These circumstances are too numerous to list, and so it is for the Directors to interpret when such events have altered their responsibilities.

Quite often, a well-run company will already have made provisions for such circumstances (particularly if it is audited regularly) which may include the relevant insurance policies (including key man insurance and credit insurance) and in such circumstances the risk is mitigated.

IN ORDER TO FIND OUT MORE ABOUT THIS SUBJECT AND THE ANSWERS TO THE QUESTIONS LISTED BELOW, DOWNLOAD OUR HANDY TIPS BOOKLET HERE.

ALTERNATIVELY, CONTACT THE TEAM ON 020 7841 0390

5. What Level Of Accountability Do Directors Have?

6. What Risks Do I Face As A Director?

7. What Is Best Practice For A Director In The Twilight Zone?

Should you require any further assistance at all with these matters, then please contact one of our corporate specialists on 020 7841 0390 and we will be happy to discuss this with you.