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Duties and liabilities of directors when a company is facing insolvency

  • Ireland
  • Corporate

12-10-2020

Many businesses are facing testing and unprecedented challenges due to the impact of Covid-19. It is important during these times of financial uncertainty that directors of companies are aware of their duties, particularly when a company is facing insolvency.

1. Directors’ duties

Each director has a duty to ensure that the provisions of the Companies Act 2014 (the “Act”) are complied with. The Act also codifies the principal fiduciary duties of directors, which are:

(i) to act in good faith in what the director believes to be the interests of the company;

(ii) to act honestly and responsibly in relation to the conduct of the affairs of the company;

(iii) to act in accordance with the company’s constitution and exercise his or her powers only for the purposes allowed by law;

(iv) not to use the company’s property, information or opportunities for his or her own or anyone else’s benefit;

(v) not to agree to restrict the director’s power to exercise an independent judgment;

(vi) to avoid any conflict between the director’s duties to the company and the director’s other (including personal) interests;

(vii) to exercise care, skill and diligence; and

(viii) to have regard to the interests of the company’s employees in general as well as the interests of its members.

In a solvent company, the general rule is that these duties are owed by the directors to the company alone. However, the Act provides that the directors must have regard to the interests of shareholders and employees when exercising these duties.

Where a director is proven to be in breach of his or her relevant duties, a director may be required to:

(i) account to the company for any gain which he or she makes directly or indirectly from the breach of duty; and/or

(ii) indemnify the company for any loss or damage resulting from the breach.

2. Directors’ duties when a company is insolvent

There will only be a modification to the general rule that directors have no duties to creditors where the company is insolvent and the directors are aware of the insolvency.

The Irish tests for insolvency are:

(i) the cash flow test which examines the ability of the company to pay its debts (which include, current, contingent and prospective debts) as they fall due; and

(ii) the balance sheet test which examines whether the company’s assets are greater than its liabilities (which includes current, contingent and prospective).

In circumstances where the company is insolvent and the directors are aware that it is insolvent, the directors continue to owe their duties to the company but there is authority that the directors:

(i) must have regard to the interests of creditors;

(ii) may have a duty to put the company into voluntary liquidation;

(iii) have a duty to preserve the company’s assets so they can be applied in discharge of its liabilities; and

(iv) have a duty not to make payments directly or indirectly to themselves to the detriment of general and independent creditors.

However, it should be remembered that a creditor has no direct right of action against a director for breach of director duties and so, the above duties are owed to the company and are enforceable by the company, most likely acting through its liquidator.

3. Potential consequences of an insolvent liquidation for Directors

In addition to potential liability for a breach of their fiduciary duties, directors of an insolvent company should be aware of the risks that can arise on a company’s insolvency and subsequent liquidation. Some of the main risks for directors are detailed below. 

Reckless Trading

A director of an insolvent company can face personal liability where it appears that the director was, when an officer of the company, knowingly a party to the carrying on of any business of the company in a reckless manner. Even if a director is not, in fact, found to have been knowingly a party to the carrying on of business in a reckless manner, the director can be deemed in law to have been reckless in either of the below circumstances:

(i) where the director was a party to the carrying on of the business and having regard to the general knowledge, skill, and experience that may reasonably be expected of a person in his or her position, the director ought to have known that his or her actions or those of the company would cause loss to the creditors of the company or any of them; or

(ii) the director was a party to the contracting of a debt by the company and did not honestly believe on reasonable grounds that the company would be able to pay the debt when it fell due for payment, as well as all its other debts (taking into account the contingent and prospective liabilities).

Fraudulent Trading

In addition to potential criminal liability, a director of a company who is 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 made personally liable for all or any part of the debts or other liabilities of the company.

Unlike a breach of fiduciary duties, an application for a declaration of reckless or fraudulent trading can be made by a liquidator, examiner, receiver or any creditor or contributory.

Restriction

A director of an insolvent company may be restricted from acting as a director or secretary or being concerned or taking part in the promotion or formation of another company for a period of five years. This restriction does not apply to a company that has the capital requirements that are prescribed by the Act in place.

The liquidator of an insolvent company is required to bring an application for a restriction order unless the liquidator is relieved of this obligation by the Director of Corporate Enforcement. If an application is made, the court is required to make the restriction order unless it is satisfied that the director has acted honestly and responsibly, co-operated with the liquidator and there is no other reason why it would be just and equitable that the director should be subject to the restriction order.

An alternative to a restriction order is a restriction undertaking. Instead of being brought to court and made the subject of a court restriction order, a respondent director can voluntarily agree, or undertake to act as though such an order had been made. The power to initiate a restriction undertaking rests with the Director of Corporate Enforcement. A respondent director may not initiate the process but instead has the option to accept the restriction undertaking.

The Office of the Director of Corporate Enforcement (the “ODCE”) published guidance in June 2020 in relation to restriction orders in light of the Covid-19 pandemic. The ODCE have published a non-exhaustive list of key considerations that are relevant to the ODCE’s determination as to whether directors of companies who are unable to pay company debts as they fall due as a consequence of the Covid-19 pandemic have acted honestly and responsibly, and if not, whether they should be offered restriction undertakings or otherwise face restriction applications. The considerations include:

(i) the adequacy of the directors’ processes and procedures for monitoring the company’s financial position on an ongoing basis;

(ii) whether the directors sought appropriate professional advice;

(iii) the basis upon which the company’s directors formed the view that the company would trade out of its difficulties within a reasonable timeframe (which might include, for example, the potential impact of access to Government grants, loans and other supports);

(iv) the length of time that trading continued after it had become apparent, or should have been apparent that the company was insolvent;

(v) the extent to which the company’s financial position continued to deteriorate, as well as the nature of any additional liabilities that accrued, during the period during which the directors knew, or ought to have known, that the company was insolvent;

(vi) if there are material tax liabilities involved, the extent to which such liabilities arose prior to, or during the pandemic and where they arose during the pandemic period, the extent to which the company availed of, and complied with, the Revenue Commissioners’ requirements for deferred payment and warehousing of liabilities; and

(vii) the steps taken to reduce costs and/or restructure the business.

While the ODCE must have regard to the facts and circumstances of each individual case, the ODCE guidance states that it is unlikely that the ODCE will consider that the company directors should be restricted in circumstances where the directors’ decisions and judgments were:

(i) made on the basis of objectively verifiable evidence;

(ii) based on assessments and assumptions that were reasonable in the context of the circumstances pertaining at the relevant times; and

(iii) made in good faith and the directors otherwise have acted honestly and responsibly.

Disqualification

A director of an insolvent company may be disqualified from being appointed or acting as a director or other officer, statutory auditor, receiver, liquidator or examiner or being in any way concerned or taking part in the promotion, formation or management of a company. The Act provides for the automatic disqualification on conviction of the director of certain indictable offences. The Act also provides that the court may make a disqualification order for such period as it sees fit if any of the grounds for disqualification prescribed by the Act apply to that director.

For more information, please contact

Gerard Ryan, Partner and Head of our Corporate department - gerardryan@eversheds-sutherland.ie

Gary Madden, Solictor in our Corporate department - garymadden@eversheds-sutherland.ie