Directors Duties - Where a Company is Facing Insolvency

It is well established that the fiduciary and statutory duties

of directors are, in the main, owed to the company alone. However,

where a company is insolvent or is threatened with becoming

insolvent, this fundamental principal changes and the duty to act

in good faith and to show the utmost care, skill and diligence in

such circumstances, is owed to the creditors. This principle was

outlined by the Supreme Court in Re: Frederick Inns

Limited1.

This does not mean however that the directors of a company must

choose to close down the business and liquidate at the first sight

of economic difficulty. Having recognised a situation of

insolvency, the directors may have no choice but to recommend that

the company is placed in liquidation and that the remaining assets

realised and distributed for the benefit of the creditors; however,

this may not always be the case. It may be that by trading forward

a recovery is possible or that a more favourable outcome for

creditors could be achieved through realising the assets on a going

concern basis. Where it would be reasonable to continue to trade,

for example in an effort to complete a contract and generate

further revenue; such directors will not be on the hook for

reckless trading because they chose to continue trading rather than

close down and liquidate. In Re: Hefferon Kearns Limited (No.

2)2, the court commented that

"it would not be in the interests of the community that

whenever there might be significant danger that a company was going

to become insolvent, the directors should immediately cease trading

and close down. Many businesses which might have well survived by

continuing to trade coupled with remedial measures could be lost to

the community".

It is important however to contrast this scenario of cautiously

continuing with business in spite of economic difficulties with the

situation in which an insolvent company is not being wound up and

the principal reason it is not being wound up is the insufficiency

of its assets, i.e.; that the company's assets would not be

sufficient to cover the costs of a winding up. Section 251 of the

Companies Act 1990 is intended to address cases such as this and

identifies a number of remedies which a liquidator or creditor or

contributory may seek in such a situation which include:

The power of court to impose criminal and civil liability on

directors for failure to keep proper books of account;

The power to apply to court for return of assets of the company

improperly transferred;

The imposition of liability for fraudulent and reckless

trading; and

The restriction of the directors.

Matters which may give rise to personal liability for debts of

the company

When considering the circumstances in which the directors'

duties are owed to the creditors of the company, it is useful to

recall those situations in which some personal liability or other

sanction will be imposed. Within the general framework of Irish

companies legislation, the situations in which personal

responsibility will be imposed on the directors of a company

remain, however, the exception rather than the rule.

Fraudulent trading

If in the course of a winding up of a company, or where an

insolvent company is not being wound up, or in the course of an

examinership; any person found by a Court to be knowingly a party

to the carrying on of the business of a company with intent to

defraud creditors of the company or creditors of any other person;

or for any fraudulent purpose, may be guilty of fraudulent

trading.

Section 297 of the Companies Act 1963 (as amended) provides for

a maximum penalty of imprisonment for a term not exceeding 7 years

or a fine not exceeding €63,487.90 or both. In addition,

under Section 297A, any person may be held personally responsible,

without limitation of liability, for all or any of the debts or

other liabilities of the company as the Court may direct. Diverting

monies payable to the company to a director or shareholder,

incurring credit at a time when to the knowledge of the director

there is no prospect of that credit being repayable, non-payment of

monies to employees or to pension funds would all constitute

fraudulent trading.

It is important to note that any person, not just a director,

who is knowingly a party to fraudulent trading can be held liable.

In addition, one instance of fraudulent behaviour will suffice to

make a finding of fraudulent trading. In Re Hunting Lodge

Limited3 on the sale of the only remaining company

asset, there was a secret arrangement to divert half of the

proceeds to a building society account with fictitious names. The

company was insolvent at the time. It was held that this single

transaction was enough to constitute fraudulent trading by the

directors.

However, in order to impose liability, fraudulent intent must be

proven, which can be difficult and a person cannot be held to be

knowingly a party to carrying on business with intent to defraud

unless he is a party to the actual impugned event.

Reckless trading

Because of the difficulty in demonstrating fraudulent intent,

the concept of reckless trading was introduced into Irish company

law. If in the course of the winding up of a company or in the

course of examinership proceedings or where an insolvent company is

not being wound up, it appears that any person...