When a company is insolvent, the directors’ usual duty to promote the success of the company for the benefit of its members as a whole is displaced by a duty to act in the interests of the company’s creditors. A company is considered to be insolvent if it is unable to pay its debts as they fall due (cash-flow insolvent), or if the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities (balance-sheet insolvent). If a company is in financial difficulty, therefore, it is important that the directors take appropriate professional advice to determine whether insolvency considerations apply.
Directors (including de facto directors – see below) may have to make financial contributions to an insolvent company if they are found to be liable for any of the following:
This applies if a director, or any person who has been concerned or has taken part in the promotion, formation or management of the company, has misapplied or retained, or become accountable for, any money or other property of the company. In such a case, the court may compel the director or manager to repay, restore or account for the money or property, with interest. Further, if the director or manager has been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company, they may have to contribute to the company’s assets by way of compensation such sum as the court thinks just.
If a company is wound up and it appears that any business of the company has been carried on with the intent to defraud creditors or for any fraudulent purpose, any person, including a director, who was knowingly party to the fraudulent trading may be liable to make such contributions to the company’s assets as the court thinks proper.
Even where there has been no intent to defraud, a director of a company may have to contribute to the assets of the company if, before the company went into insolvent liquidation, they knew or ought to have concluded that there was no reasonable prospect that the company would avoid liquidation. A director may incur such a liability for wrongful trading without dishonesty, though it is a defence if the director took every step that they ought to have taken with a view to minimising the potential loss to the company’s creditors.