Against a backdrop of economic uncertainty and a looming global recession, many senior executives are facing the prospect of leading businesses experiencing financial distress or insolvency.
For many senior executives, being involved in a business that has failed will have long-lasting ramifications. Aside from the reputational harm that may be caused to an individual’s career, they will also be subject to investigations by the relevant office-holder (depending on the type of insolvency process that the business enters into) and this may lead to personal liabilities.
In this article, we set out some tips for senior executives who find themselves working in a business in financial distress.
Consider your role within the business
As a starting point, senior executives should consider whether they are a director of the business in question.
Once a business enters into an insolvency process, the insolvency office-holder appointed in respect of the business will be tasked with investigating the affairs of the company. This includes an investigation of the events which led to the business failing. Office-holders have wide powers under the Insolvency Act 1986 to scrutinise directors of businesses.
It is important to note that “directors" in this context includes:
- De jure directors: those directors who are formally appointed and registered as such at Companies House,
- De facto directors: those directors who are not formally appointed as such but are held out as such by the business, and
- Shadow directors: individuals who are not held out as directors but with whose directors / instructions the directors of the company are supposed to act.
It is also important to note that there is no distinction made between executive and non-executive directors.
Senior executives should carefully consider whether they fall within the scope of the one of the categories above in assessing whether have any personal exposure to the company’s insolvency.
When a business faces financial distress, senior executives may be tempted to resign to avoid dealing with the fallout of a business that has failed.
In reality, resignation will not prevent a director from being scrutinised by an office-holder in the event of an insolvency. When a company enters into an insolvency process, an office-holder has a duty to report on the conduct of individuals. If, in the opinion of the office holder, the director in question failed to comply with statutory and common law directors’ duties, then the office-holder may recommend that the Secretary of State commences disqualification proceedings against the director in question.
Furthermore, for senior executives sitting on the board of companies in financial distress, they face the risk of incurring personal liability for wrongful trading pursuant to s.214 of the Insolvency Act 1986 by continuing to trade the company when they knew, or ought to have known, that there was no reasonable prospect of the company going into insolvent liquidation. Section 214 of the Insolvency Act 1986 contains a defence for directors in respect of any liability for wrongful trading where the director took every step with a view to minimising the potential loss to the company’s creditors.
It follows that taking a proactive approach, by addressing the issues facing the business and seeking to resolve them through carefully considered steps (having taken advice from third party professionals where necessary) is often a better alternative to simply resigning.
Accurately document all decision-making
For companies with robust corporate governance in place, comprehensive board minutes documenting decisions made by the board are the norm.
When a company is facing financial distress, there is a heightened need to accurately record all decisions (and the reasons behind them), particularly where such decisions affect the financial health of the company.
If the company does enter into an insolvency process, having comprehensive board minutes setting out reasoned decision-making (ideally backed by financial information) will assist a director in any investigations that follow, and may also insulate the director against any potential litigation risk.
Consider the extent of directors’ and officers’ insurance
Many businesses will have directors’ and officers’ insurance in place, which is designed to protect officers of the company against any legal claims.
For directors of companies facing financial distress, it is worth checking the extent of any directors’ and officers’ insurance to understand the extent of their protection in the event that the business enters into an insolvency process. Directors should consider:
- Whether they are specifically named on the policy,
- The scope of the policy, as many policies specifically carve out cover in respect of claims such as wrongful trading or misfeasance (as well as any offences involving fraud) and
- The duration of the policy and the extent of any run-off cover, as many claims against directors are not brought until a number of years after the business has entered an insolvency process (at which point, run-off cover may have expired).
Seek advice as appropriate from third parties
For those responsible for managing a business, facing insolvency is likely to be an incredibly stressful time. Seeking advice at the earliest signs of financial distress from suitably qualified turnaround professionals, be it lawyers, insolvency practitioners and / or accountants, will ease the burden on the director in question and may assist the business in avoiding insolvency.
Seeking objective advice from legal and financial experts is also evidence that the director has taken a prudent and reasonable approach in dealing with the prospect of insolvency, and may protect the director from future litigation.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, April 2023