Uncertainty and directors personal risk

Recent revelation that the UK entered a recession in the last quarter of 2023 has sharpened concerns about economic uncertainties in this troubled world both nationally and internationally.

Many businesses are experiencing difficult trading conditions. How are directors supposed to fulfil their statutory duties and avoid potential personal risks given all these risks?

We are often approached by businesses which, although not under immediate threat, are seeing a marked downturn in demand. If it continues for much longer, this could lead to critical cashflow issues.

The legal position

There are two legal principles which directors must bear in mind:

1. Where there is the prospect of insolvency the focus of directors duties moves from maximising shareholder value to acting in the interests of the company’s creditors
2. The main personal risk faced by directors is the offence of wrongful trading: allowing a company to continue trading (and incurring losses) after the point at which they ought to have concluded that there was no reasonable prospect of avoiding formal insolvency.

Wrongful trading is a particularly difficult area. In practice it is a hindsight judgement made by an insolvency practitioner who will review the conduct of all directors, seek to find a point in which at which the directors ought to have ceased trading and then look to recover the losses after that.

Practical considerations

The backdrop to the board’s thinking must be the fact that putting a company into liquidation is an abrupt and terminal process which is deeply damaging to asset values and therefore to the prospects for creditors.

Whilst sometimes the liquidation decision in unavoidable, it should be very much a last resort. Directors should always consider other alternatives – and key to this is acting early. If things are left until the company is unable to meet its payroll at the end of the week then options are rather limited!

Protective Measures

Case law suggests that directors are entitled to take commercial risks but there are also a number of basic steps which directors can take to minimise personal risks:

• Be aware of the company’s financial position and prospects. Good management information – not just a profit and loss account, but a current balance sheet and projections as well are an essential ingredient for directors to make sensible decisions
• Meet regularly to review the company’s position and keep a minute of these meetings, recording the information which was available to the directors, the key assumptions they made, and noting that their decisions were made in recognition of the risk of insolvency and the duty to creditors
• Take advice (and follow it)

Don’t leave it too late!

The key point made above is the necessity to take action early.

There will often be a range of options available ahead of total financial meltdown, ranging from cost restructure and raising additional finance to an accelerated disposal process aimed at maximising asset value by achieving a going concern sale of at least part of the company’s operations.

If you see financial turbulence coming get in touch with our business recovery team.