UK: Powers, Duties And Responsibilities Of Directors Of An English Private Company Limited By Shares

Part A – Source of Powers

1. Source of powers

1.1 An English company has the powers given to it by law and by its Memorandum of association (the 'Memorandum of Association'), which sets out the objects of the company.¹

1.2 A company's Articles of Association (the 'Articles') sets out how the powers of the company are allocated between the officers of the company and the members (i.e the shareholders). The Articles form a contract between the company and all its members, dealing with membership rights such as the entitlement to vote. In the case of most English companies, the Articles are supplemented by and are to be read in conjunction with alongside what is known as Table A of the Companies (Tables A to F) Regulations 1985 (as amended) ('Table A'). Table A applies save in so far as it has been excluded or varied by the Articles. Table A is a standard specimen set of articles which set out in detail the regulations by which the company will be managed and how powers are to be delegated.

1.3 The extent of a director's power therefore largely depends upon the Articles and directors should always make it their responsibility to examine the contents of the Articles accordingly.

1.4 Generally under English law, the directors of the company are mandated to manage the business of the company and to exercise all the powers of the company in so doing. This is subject to the provisions of the Companies Acts 1985, 1989 and 2006, the Memorandum of Association, the Articles and any resolution of the company.

1.5 A third party dealing with the company is entitled to assume that the directors have all powers to act on behalf of and bind the company. If, however, a director acts beyond his authority, he may be personally liable to indemnify the company for any loss that the company has suffered as a result. However, the company in general meeting may ratify any act of the directors that is ultra vires and relieve the directors from personal liability (see further below).

Part B – Powers, duties and responsibilities of directors

2. Director's duties

The duties and responsibilities of directors derive from a number of different sources, including:

2.1 Statutory duties, including those under the Companies Acts 1985, 1989 and 2006;

2.2 the common law rules and equitable principles that already exist and will continue to apply in interpreting the 2006 Act duties; and

2.3 obligations arising under the Articles.

3. Duties under the 2006 Act

3.1 The 2006 Act contains seven general duties. These codified general duties are owed to the company and not to the shareholders. The codified duties are set out below. Please note that in many, if not most, situations more than one duty will be relevant. Please also note that the duties are the personal responsibility of each director, not of the board or the company.

(a) To act within the director's powers A director must act in accordance with the company's constitution and must only exercise his powers for the purposes that the articles grant them. It is important for directors to appreciate that the liability for not complying with the company's constitution is strict, being that liability does not depend on whether the breach was intended or not. Directors should therefore make sure they are familiar with the Articles and the powers they are given by this document.

(b) To promote the success of the company The 2006 Act has placed a new responsibility on a director to act in a way in which he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members, taken as a whole and without regard to particular individuals or groups. Success, therefore, should be guided by more than the mere 'long-term increase in value' of the company. Maximising profits and increasing the value of the company will remain important, if not the only, considerations of directors. This broader conceptualisation of success has been labelled 'enlightened shareholder value'. When discharging this duty a director should have regard to the following:

(1) the likely consequences of any decision in the long term;

(2) the interests of the company's employees;

(3) the need to foster the company's business relationships with suppliers, customers and others;

(4) the impact of the company's operations on the community and the environment;

(5) the desirability of the company maintaining a reputation for high standards of business conduct; and

(6) the need to act fairly as between the members of the company.

Many companies will find themselves having to change very little about their current executive and board procedures, as these factors were designed to reflect considerations that would be relevant where a company follows best practice. In the decision making process there is generally no absolute wrong or right approach; the directors must make a judgement in good faith for the success of the company having regard to all the information and having taken advice when appropriate.

Please note that these factors are not exhaustive. A director's duty to promote the success of the company will require him to consider what the relevant factors are in each instance.

(c) To exercise independent judgment

A director must exercise independent judgement and ensure that he does not allow personal interests, for example in a particular contract, to affect his or her independent judgement in the interest of the company. He must not, therefore, blindly follow the other directors on the board and a director must always come to his own decisions and conduct his own evaluation of the evidence.

This duty does not prevent a director from exercising his or her power to delegate nor his ability to seek advice but he or she must still exercise his own judgement in deciding whether to follow the action suggested by that person.

(d) Duty to exercise reasonable care, skill and diligence

A director owes a duty to the company to exercise the same standard of care, skill and diligence that would be exercised by a reasonably diligent person with:

(1) the general knowledge, skill and diligence that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company (an objective test); and

(2) the general knowledge, skill and experience that that director has (a subjective test).

The use of both tests means that each director must exercise his duty to a minimum standard, as suggested by the objective test, and then the standard is raised under the subjective test if that director has specific skills or expertise. So if, for example, a director had an accounting qualification, he would be expected to exercise more active scrutiny of the accounts, for instance as to the appropriateness of accounting policies, than a director without such a qualification.

(e) Duty not to accept benefits from third parties

A director must not accept a benefit that has only been conferred by virtue of his position as a director, save in the case where such acceptance of the benefit could not reasonably be said to create a conflict of interest. However, the directors must also consider his duty discussed at paragraph 3.1(f) below to ensure that there are no other circumstances which could give rise to a conflict of interest. In all cases, where a director has a suspicion that the receipt of the gift would cause a reasonable person to doubt the impartiality of the director he should not accept the gift.

Benefits do not include benefits given by the company or pursuant to a service contract.² Any receipt of benefits by a director can only be authorised by the members of the company, and not by the board.

In practice, the company should review policies on the giving and receipt of corporate hospitality and ensuring that directors are briefed on what is and is not permissible in relation to benefits received from third parties.

(f) To avoid situations which could give rise to conflicts of interest

A director is subject to a duty to avoid situations in which he has or may have a direct or indirect interest or duty to a third party that conflicts with or may conflict with the company's interests. The 2006 Act specifically provides that the duty applies in particular to the exploitation of property, information or opportunity, irrespective of whether the company could take advantage thereof or not. A director of the company who finds himself in a situation where a conflict of interest might occur ought to declare the nature of his interest at a meeting of the directors of the company so that the conflict can be authorised, provided that a quorum is met without counting the conflicted director. Furthermore, the resolution authorising the conflict must be passed without the vote of the director whose interest is in question. Board authorisation is only permissible if the members have passed a resolution authorising it or if it is allowed under the Articles. If board authorisation is not possible, the transaction or agreement is liable to be set aside unless the prior approval of the members is obtained or if it is ratified by the members.

In practice, boards are likely to require directors to review their potential conflicts on a regular basis so that they can be considered and, if thought appropriate, approved by the board.

Non-conflicted directors should always be mindful of their own duties as directors, in particular the newly formulated fiduciary duty to promote the success of the company, and should not authorise a conflict if they consider that, overall, the approval of the situation would disadvantage the company.

Moreover, the board should consider what limits, if any, to place on any authorisation and what procedures should be put in place to deal with confidential information and actual conflicts should they arise. The company should consider how conflict authorisations are to be managed practically and put in place a formal process detailing how directors should record and review authorisations and report on them to shareholders.

Although the duty is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest, the extent of this exclusion is uncertain. It is likely that this will only cover a small number of trivial matters which could not reasonably have any effect on the decision making of a director.

However, despite this exclusion a director must always be aware of the broad scope of this duty. There are a variety of situations in which a director may be in a position of conflict with the company. For instance, if a director is a director of another company, which becomes a competitor of or a major supplier to the company, where he represents a major shareholder or has a position with one of the company's advisers. Other examples might include where a director personally or a company of which he is a director:

(1) is a potential customer or supplier to the company;

(2) owns property adjacent to the company's property;

(3) has an advisory relationship (for example financial or legal) with the company or a competitor; or

(4) wants to take advantage of an opportunity that has been offered to but declined by the company.

Please note that actual transactions or arrangements, for example entering into a supply contract, may evolve from being a potential conflict situation for which board approval would be required, to being a transaction in respect of which a director would need to declare their interest (see also paragraph 3.1(g) below).

We would recommend that any procedures a company sets up to deal with conflicts of interests would include:

(1) a questionnaire being sent to each director to identify their own potential conflicts;

(2) this questionnaire should require the consideration of indirect conflicts, such as where a director's spouse or family work for an adviser to the company;

(3) regular board meetings (at least annually) to declare, consider and, if though appropriate, authorise conflicts of interest;

(4) a record of authorised conflicts ought to be kept, reviewed and the directors regularly asked to update it;

(5) provisions should be put in place to allow for authorisation of a conflict of interest on short notice;

(6) incoming directors should receive a briefing on the company's conflicts policy and their first board meeting should require a declaration and authorisation of conflict situations; and

(7) where a director proposes to take up a new post in another company or institution a board meeting should be convened specifically to consider any potential conflicts of interest which might arise from this proposal.

(g) Duty to declare interests in existing and proposed transactions or arrangements with the company

There are two distinct obligations to disclose direct or indirect interests in relation to: (i) proposed transactions or arrangements with the company; and (ii) existing transactions or arrangements with the company. The duty covers both the nature and the extent of the interest.

As regards proposed transactions or arrangements, a director must disclose his interest to the other directors before the company enters into the transaction or arrangement. As with conflicts above, unless the director's interest is declared, the transaction or arrangement is liable to be set aside. Failure to declare an interest is also a civil offence.

As regards existing transactions or arrangements, the director must declare the interest as soon as reasonably practicable. Failure to do so is a criminal offence. Therefore, a director must do everything he can to acquaint himself with the business and arrangements of the company in order to avoid a failure to disclose an interest.

In each case, an interest of a person other than the director himself would require the director to make a disclosure, if that person's interest amounts to a direct or indirect interest on the part of the director. A further declaration of interest must be made if the original declaration proves to be, or becomes, inaccurate or incomplete. The declaration may be made at a meeting of the directors, by notice in writing to his co-directors or by general notice to the directors (either at a board meeting or by the director using reasonable steps to ensure that the notice is brought up and read at the meeting after it has been given).

Disclosure is only required where the director is aware or should reasonably have been aware of the transaction or the conflicting interest. Furthermore, no disclosure is required where the interest cannot reasonably be regarded as likely to give rise to a conflict of interest or if other directors are already or ought reasonably to be aware of the director's interest or if it concerns his service contract that has been or will be considered by the board or a committee thereof.

Shadow directors must declare any interest by notice in writing.

3.2 Directors also have many other duties under the 2006 Act and under a wide variety of other laws and regulations, such as insolvency, health and safety, employment and tax legislation. For example, the Health and Safety at Work Act 1974 (the 'Health and Safety Act') puts liability on any director where the company has been found guilty of such an offence and that offence was committed with the consent or connivance of, or was attributable to any neglect on the part of, the director. Such an offence can be punishable by imprisonment for a term not exceeding two years or a maximum fine of £20,000 (see further paragraph 8 below). Companies may also provide for more onerous duties in the Articles.

3.3 Directors' duties are, therefore, owed to the company by each director individually and thus it is the Company which must enforce those duties rather than shareholders (unless they are able to bring a derivative action). One director's breach of a duty will not, in and of itself, create a liability on any other director.

3.4 Whilst the company (as a legal entity acting through its board) is generally responsible for the acts of its directors towards third parties, there are circumstances where the board can require an individual director to indemnify the company for any loss if suffers as a direct result of the directors' actions.

3.5 The 2006 Act contains over 200 offences punishable by fine, imprisonment or both. Directors can be personally liable in relation to many of them as principal offenders, or jointly with the company, even as parties to the company's offences.

4. Other statutory duties and liabilities under the 2006 Act

4.1 Substantial property transactions

The company is prohibited from entering into a substantial property transaction with a director or any connected person. A substantial property transaction is one where the asset being traded between the director and the company is worth more than £100,000 (or if worth between £5,000 and £100,000 is equivalent to more than 10% of the company's net assets).

This prohibition does not apply if the transaction is approved by the shareholders in advance.

Payments under directors' service contracts and payments for loss of office are excluded from the definition of 'substantial non-cash asset' as are transactions with a company that is being compulsorily wound up or in administration.

Contravention of the provisions on substantial property transactions makes the arrangement and any transaction entered into in pursuance of the arrangement voidable and the relevant director may be liable to account to the company for any gain made as a result of the transaction and to indemnify it for any loss suffered.

4.2 Loans, quasi loans and credit transactions

(a) Subject to certain limited exceptions, the company must not:

(1) make a loan or quasi loan to its directors (or any person connected with him). Note that the company will make a quasi loan if it assumes a liability of a director on terms that the director will reimburse it;

(2) guarantee or provide any security in connection with a loan or quasi loan made by a director or any other person to him; or

(3) enter into a credit transaction as creditor for the benefit of its director (or any person connected with him), or guarantee or provide any security in connection with a credit transaction for a director (or any person connected with him). Note that credit transactions include lease and hire purchase agreements.

(b) The following transactions do not require shareholders' approval and are exceptions to the above rule:

(1) loans of small amounts (£10,000 or less) or short term quasi loans not exceeding £10,000 in aggregate;

(2) inter-company loans within the company's group;

(3) minor credit transactions (an aggregate amount of £15,000 or less) or credit transactions in the ordinary course of the company's business;

(4) the loan is granted for the purpose of expending on the company's business and the value does not exceed £50,000. For this exception, expenditure on company business includes funds provided to directors of the company's holding company and connected persons;

(5) the loan is required to defend criminal or civil proceedings in connection with any alleged negligence, default, breach of duty or breach of trust by the director in relation to the company or an associated company; and

(6) the loan is granted in connection with defending a director in an investigation by a regulatory authority, or against action proposed to be taken by a regulatory authority, in connection with any alleged negligence, default, breach of duty or breach of trust by him in relation to the company or an associated company.

(c) Where a transaction is entered into in contravention of the 2006 Act, although there are no criminal penalties, there are civil consequences in that the transaction or arrangement is voidable and the relevant director may be personally required to account to the company for any gain made as a result of the transaction.

4.3 Political donations

The 2006 Act controls the amount of and method for making political donations without the prior approval of members in general meeting. Recipient political bodies have been extended to include registered parties, independent election candidates and EU political organisations. Donations can include gifts, sponsorship, subscriptions, membership fees, money spent paying expenses of any political party, loans other than on commercial terms and the provision of any property, services or facilities other than on commercial terms.

Directors of the company will be jointly and severally liable to pay the company the amount of any unauthorised donation or expenditure with interest and to compensate the company for any loss or damage suffered as a result.

5. Protection against personal liability

Directors act on the company's behalf. They should make sure that this role, as agent of the company, is made clear to any third party. To avoid personal liability, the directors of the company should:

5.1 ensure that the company's complete name, together with the word 'ltd' appears on any letter, notice, invoice, receipt, bill of exchange, cheque, or promissory note. Where the name is incorrectly set out, or the word 'ltd' is omitted from any of the above documents, the directors will be personally liable;

5.2 sign documents 'for' or 'on behalf of' the company, rather than in their own capacity; and

5.3 ensure that the chain of authority down to the person actually issuing the correspondence and purporting to bind the company is established clearly in writing.

6. Directors liabilities, indemnity and insurance

6.1 Indemnity

Generally, the company cannot exempt a director from liability for breach of one or more of their duties to the company or limit the director's liability for such a breach or exempt a director from any liability for negligence, default or breach of trust in relation to the company.

However, the company may (but is not obliged to):

(a) indemnify a director in respect of proceedings brought by third parties (covering both legal costs and the financial costs of any adverse judgment, except for the legal costs of unsuccessful defence of criminal proceedings, fines imposed in criminal proceedings and penalties imposed by regulatory bodies such as the Financial Services Authority). The company may therefore indemnify a director against such third party actions as class actions or actions following mergers and acquisitions or share issues;

(b) pay directors defence costs as they are incurred, even if the action is brought by the company itself (although an assessment must still be made as to whether this is likely to promote the success of the company). A director would still in many cases be liable to pay any damages awarded to the company and to repay directors defence costs to the company if their defence were unsuccessful; and

(c) indemnify a director if the company becomes a trustee of an occupational pension scheme against liability incurred in connection with acting as trustee of that scheme. If the company agrees to indemnify a director in this way it must disclose this fact in its annual report and accounts. Shareholders have the right to inspect and request a copy of any indemnification agreement between a director and the company.

6.2 Indemnifying directors

Many articles of association provide for an indemnity to a director against any liability which he may incur in defending any proceedings in which he is acquitted, or in which judgment is given in his favour in relation to the affairs of the company, or costs incurred in an application for relief, provided that the director repays the costs if he is unsuccessful. This indemnity only extends so far as is allowed by the 2006 Act.

It is also common for companies to obtain Directors and Officers Insurance (D&O Insurance), which is an insurance policy taken out by a company on behalf on its directors and officers to cover liabilities arising as a result of their negligence, default, breach of duty and breach of trust. This type of insurance usually pays for the director's legal costs, expenses and civil damages awarded against him.

7. Connected persons Where provisions relating to directors apply also to persons connected to directors, note that children and step-children (of any age, not just those under 18 as at present), parents and same sex partners are, amongst others, included in the definition under the 2006 Act. 8. Health and safety at work

8.1 All companies and their directors are under a common law obligation to take reasonable steps to ensure the health, safety and welfare of their employees.

8.2 In addition many statutes, including the Health and Safety Act, place duties upon companies to provide safe systems and places of work. Prosecutions may be brought against the company and individual directors for a breach of any such duty.

8.3 Although the health and safety legislation affects all 'employers', individuals who are not employers may also be prosecuted for some offences. Where either a company (or other trading entity) or an individual may be prosecuted, the Health and Safety Executive ('HSE') or other prosecuting authority generally brings proceedings against the company.

8.4 The HSE adopts strict guidelines in its approach to prosecuting health and safety offences and will consider a prosecution to be in the public interest where:

(a) Death results from a breach of the legislation; or

(b) There has been reckless disregard of health and safety requirements; or

(c) There have been repeated breaches giving rise to significant risk, or persistent and significant poor compliance; or

(d) False information has been supplied wilfully, or there has been intent to deceive in relation to a matter giving rise to significant risk.

9. Environmental legislation

Directors should be alert to their duties under environmental legislation. Recent environmental legislation has expanded the range of offences for which a director may be liable if it is proved that an offence has been committed with the director's 'consent, connivance or neglect'. The legislation covers almost all types of pollution including discharges to air, land and water and the depositing, keeping or treating of waste without proper authorisation. Civil and criminal sanctions (by way of fines or, in the most extreme circumstances, imprisonment) may be imposed.

10. Product liability Under the General Product Safety Regulations 2005 (the 'Regulations'), manufacturers, importers, distributors and retailers who produce or supply goods to consumers must ensure the goods are safe and they impose obligations of notification, record keeping and recall in the event of an unsafe product. The Regulations apply not only to companies but also to their directors and other officers (and persons holding themselves out as such). A breach of the Regulations may result in imprisonment or a fine.

Part C – Compliance and corporate governance issues

11. Compliance and corporate governance issues

Some of the main ongoing compliance requirements for directors and the company are summarised below.

11.1 Board meetings

Directors should hold regular board meetings, attended by all directors, and ensure that detailed minutes of decisions are taken and circulated. If it is not the company's practice to circulate detailed information and documentation prior to a proposal being put to the vote, it would be prudent for the company to prepare detailed board minutes which can serve to document the decisions being taken.

However, guidance emphasises that this is not a mere 'checklist' exercise and a company will not be required to 'tick each box' every time. It has also been suggested that companies should seek to promote awareness of this 'enlightened shareholder' philosophy amongst those carrying out its executive and decision making functions. This will help ensure that when proposals and documents are put before the board they will have been created by people who are aware of these considerations.

For example, directors should consider any potential conflicts of interest they may have and, if any exist, ratify them at board level. If potential conflicts are not ratified, the director in question will be potentially in breach of duty and may be held liable to account to the company for any profits arising from the conflicting relationship.

11.2 Annual general meetings

Under the 2006 Act, private companies are not required to hold Annual General Meetings ('AGMs'). However, the shareholders may still demand that the directors hold a general meeting. To be able to compel the directors to call a meeting the relevant members must hold at least 10% of the share capital or voting rights (or 5% if a general meeting has not been held in the last twelve (12) months).

Unless a company is a single member company, as good practice it should still hold a general meeting at least once every year and the minutes of all proceedings in general meetings must be recorded and minute books kept at the registered office for inspection. These records must be kept for a period of ten (10) years.

11.3 Annual accounts

The directors of the company must prepare a directors' report for each financial year. Failure by the directors to produce the report may result in a fine or imprisonment.

For each financial year, a company must also produce a balance sheet and a profit and loss account. Also, a parent company must produce group accounts showing a consolidated balance sheet and profit and loss account. They must be accompanied by notes to accounts, and be approved and signed off by the board.

Since the 2006 Act has removed the requirement on private companies to hold AGMs, the requirement on companies to present its accounts before shareholders in general meeting has also been removed. However, the 2006 Act requires companies to circulate the accounts to the shareholders no later than the earlier of the date of actual delivery to the registrar or the deadline for delivery. The period for filing accounts is nine (9) months from the end of the relevant accounting reference period for accounting periods beginning on or after 6 April 2008.

Companies House fines defaulting companies automatically when accounts are filed late and has increased its penalties significantly as part of its drive to tighten its control on late filing of documents.

11.4 Appointment of auditors

With regard to the appointment of auditors for financial years beginning on or after 1 October 2007, shareholders are required to make an appointment for each financial year within 28 days of the accounts for the last financial year being circulated to it. If no other auditor has been appointed by the end of this period, the auditors are deemed to have been automatically re-appointed.

11.5 Accounting records

Accounting records must be kept which are sufficient to show the company's transactions and financial position. The records are to be kept at the registered office or such other place as the directors think fit, for a period of three (3) years from the date on which they are made, and should be open to inspection by the company's officers.

11.6 Annual return

The company must complete an annual return every year, made up to no later than the company's 'return date', usually the anniversary of incorporation and every 12-month period thereafter. The annual return must be delivered to Companies House within 28 days after the date to which it is made up either in paper format or electronically together with the prescribed fee.

11.7 Register of Members

The company must keep a register of its members showing their names and addresses, together with the date they became, and if applicable, ceased to be, a member. The register should be kept at the company's registered office or a place within England and Wales notified to Companies House and be available for inspection to company members and other persons. A person seeking inspection of the register must first make a request to the company to do so. The company must comply with this request within five (5) working days of receipt or apply to the court that the request is not sought for a proper purpose.

11.8 Company Identification

The company's name should appear, in a legible form, outside every office or place of business of the company.

The company's notepaper should mention:

(a) the company registered name;

(b) the place and number of registration; and

(c) the fact that it is a limited company.

11.9 Company Secretary

Subject to the Articles, companies now have the option whether or not it has a formally appointed company secretary. If the company decides that it will no longer have a company secretary, it will need to inform Companies House.

The company should be aware that regardless of whether it choose to have a company secretary or not, the administrative functions of a company secretary will remain and still need to be carried out. Before making a decision, it is worth bearing in mind that the administration under the 2006 Act has increased by around one third from the requirements under the previous act.

Temple Secretarial Limited, Withers' nominee company secretary, currently acts as company secretary for many of the firm's clients.

Part D – Insolvency considerations

12. Insolvency considerations

12.1 The directors of a company in financial difficulty face additional duties and liabilities and may, in certain cases, be personally liable for debts of that company. In addition to considering the interests of the company and its shareholders, they are expected to take steps to safeguard the interests of its creditors. Whilst directors are required to bear creditors foremost in mind, the directors will have particular concerns about their own personal position and potential liability for their actions (and possible disqualification) as they take the company forward.

12.2 English law does not generally prohibit directors from continuing to trade whilst a company is insolvent, which would effectively prevent any possibility of rescue or recovery. What is required is responsible decision making in times of financial difficulty.

12.3 To minimise the risk of a director's liability under any of the above provisions, the director should keep himself fully informed as to the company's cash and trading position, and take a realistic view of the company's future prospects.

12.4 Set out below is a brief outline of some of the main insolvency provisions.

13. Wrongful trading

A director may be guilty of wrongful trading if:

13.1 at some point before the commencement of the winding up of the company, he/she knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding an insolvent liquidation.

When considering whether there is a reasonable prospect of the company avoiding an insolvent liquidation, a director needs to consider both whether there is a foreseeable point in time when the financial difficulty which the company is in will end, and whether it has the resources to get to that point - that is, the director must not only see the light at the end of the tunnel, he/she must be confident that the company has the momentum to get there; and

13.2 he/she failed to take every step he/she ought to have taken to minimise the loss to creditors: (a) The facts which a director of the company ought to know or ascertain, the conclusions which he/she ought to reach and the steps which he/she ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both:

(1) the general knowledge, skill and experience reasonably expected of a person carrying out the same functions as the director; and

(2) the general knowledge, skill and experience which that director actually has.

The test is therefore an objective minimum standard, supplemented a subjective standard based on the actual expertise level of the director in question.

(b) This provision was designed to deter directors from continuing to trade where there is no reasonable prospect of the company avoiding insolvent liquidation. A director found guilty of wrongful trading may be ordered to contribute to the company's assets for the benefit of its creditors as the Court thinks is proper. A Court may also disqualify a director from being in any way connected with a company.

(c) Liability can only be avoided if the director can satisfy the Court that he/she took every step he/she ought to have taken to minimise the loss to creditors. Note the following:

(1) a director must take positive action to mitigate the loss to creditors - merely claiming that he/she had done nothing to cause loss will not be a good defence;

(2) the action must be taken at the right time (that is, when he/she knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding an insolvent liquidation). Liability will not be avoided if the director acted too late;

(3) a director cannot avoid liability by resigning when he/she realises that the company is facing financial difficulty. Resignation is unlikely to be a means of minimising the loss to creditors;

(4) the director should remain on the board to ensure that his/her warnings are recorded, both for his/her own protection, and so that at least one voice will be heard representing the interests of creditors if his/her co directors refuse to act; and

(5) the onus is on the director to prove this defence.

Only after following such steps should resignation be considered.

14. Fraudulent trading

If any business of a company is carried on:

14.1 with the intention of defrauding creditors of the company or of any other person; or

14.2 for any other fraudulent purpose,

any director who is shown to have been knowingly party to the carrying on of the business in that manner is liable:

14.3 to imprisonment and/or a fine; and

14.4 (on the winding up of the company) to contribute to the company's assets for the benefit of its creditors.

By way of example, the courts have held that the offence of fraudulent trading is committed when directors continue to incur credit on the company's behalf without any reasonable expectation of funds being available to repay the debt when, or shortly after, it falls due.

15. Transactions at an undervalue and preferences

In addition to the offences of wrongful and fraudulent trading, certain transactions may be overturned where they have the effect of disadvantaging a company's creditors.

15.1 Transaction at an undervalue

An administrator or liquidator may apply to the court for an order setting aside a transaction at an undervalue.

A transaction at an undervalue is one for which either a company receives no consideration, or the consideration it receives is significantly less than it provides.

It can be set aside if it was entered into:

(a) in the two years prior to whichever is the earlier of the date on which (i) an administration application is made; (ii) notice of intention to appoint an administrator is filed with the court; (iii) the appointment of an administrator takes effect; or (iv) the winding up commences; or

(b) at a time between (i) the making of an application to court for an administration order and the making of such an order on that application; or (ii) the filing with the court of a notice of intention to appoint an administrator and the appointment of an administrator,

provided that, at that time, the company was insolvent, or became insolvent because of the transaction. In the case of a transaction with a director, however, there is a presumption that the company was insolvent at the relevant time; the onus is therefore on the director to prove otherwise.

The court will not, however, set aside a transaction at an undervalue if it is satisfied that it was entered into in good faith for the purpose of carrying on the company's business and, at the time, there were reasonable grounds for believing that the transaction would benefit the company.

15.2 Preferences

An administrator or liquidator may apply to the court for an order setting aside a preference which a company has given to a person.

Broadly, a preference is a transaction entered into by a company that puts a creditor into a better position on insolvent liquidation than he/she would otherwise have been.

It can be set aside if it was entered into:

(a) in the six months prior to whichever is the earlier of the date on which (i) an administration application is made; (ii) notice of intention to appoint an administrator is filed with the court; (iii) the appointment of an administrator takes effect; or (iv) the winding up commences. (This period is extended where the preference is in favour of a director to two years); or

(b) at a time between (i) the making of an application to court for an administration order and the making of such an order on that application; or (ii) the filing with the court of a notice of intention to appoint an administrator and the appointment of an administrator, provided that, at that time, the company was insolvent, or became insolvent because of the preference.

The court will not, however, set aside a preference unless the company was influenced in deciding to give it by a desire to put the creditor into a better position. In the case of a preference in favour of a director, however, there is a presumption that the company was so influenced; the onus is on the director to prove otherwise.

Footnotes

1 With effect from 1 October 2009, the memorandum of association will be abolished and the objects clause will be deemed to be a restriction in the company's articles.

2 Please note that service contracts for the employment of directors for a period of more than two years require shareholder approval.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.