If you are a director of an Insolvent Company that is either insolvent or in danger of becoming insolvent then serious consideration should be given to possible prospective ramifications. A director of an insolvent company entering liquidation bears the risk that their behaviour in the period leading up to the commencement of the company’s winding up will be the subject of review and a report to the Director of Corporate Enforcement (DOCE) by the liquidator. Pursuant to that report and the decision made by the DOCE a liquidator may bring proceedings to restrict or, in cases of a more serious nature, disqualify a director.
In the event of a director being restricted by the Courts then he or she is precluded from acting as a director (whether directly or indirectly) or as a company secretary or of being concerned with or taking part in the promotion or formation of any company (subject to some minor exceptions) for a period of five years.
Section 150 of the Companies Act, 1990, (as amended) sets out the grounds for restriction. Court proceedings under Section 150 are slightly different to normal civil matters. One of the major differences is that the burden of proving innocence rests upon the director.
Under Section 56 of the Company Law Enforcement Act, 2001, a liquidator is required to furnish a report to the DOCE within six months of his appointment. On the basis of this report the DOCE will decide whether restriction proceedings are necessary in the circumstances and will instruct the liquidator accordingly.
The DOCE can direct the liquidator to take such restriction proceedings (or indeed disqualification proceedings under Section 160 of the Companies Act, 1990 if the matter is deemed serious enough) on a variety of grounds. In order for a director to successfully defend the liquidator’s application for restriction, the director must prove that he acted honestly and reasonably in relation to the conduct of the affairs of the company and that there is no reason why it would be just or equitable that he should be subject to restrictions imposed (Section 150 Companies Act, 1990, Sub Section 2(a)).
The test is very factually specific and provides a broad discretion to the High Court to decide whether or not the individual director acted honestly or reasonably or whether or not there are other factual elements of the case which should be taken into account. Although it may seem that the legal terrain is unfavourable to a targeted director, the Court has proved itself to be practical and realistic while, at the same time, seeking a minimum standard of acceptable behaviour on the part of directors of insolvent companies. Recently the High Court declined to restrict insolvent directors of a Cork based interior design company. In that case it was acknowledged that they should have stopped trading in 2009 when the company had debts in excess of €400,000. The liquidator in that case acknowledged that the company was hopelessly insolvent and was only trading on a hand to mouth basis. Further the liquidator said that the directors’ decision to continue trading was “irresponsible self delusion”. The judge in this case however said that the directors’ decision was “not taking an unacceptable risk and was not so imprudent as to amount to wilful and irresponsible self delusion”. Accordingly the judge refused the liquidator’s application and declined to restrict the directors. The judge outlined that the purpose of the legislation was not to punish directors of a company for commercial misjudgement or error nor to engage in a witch hunt because a particular business had failed.
Despite the foregoing case the test on what amounts to reasonable and prudent behaviour on behalf of a director is factually specific and places the director under scrutiny as to whether he properly attended to his duties. The purpose of the process is to act as an “ex post facto” (i.e. retrospective) protection of the interests of the public as there are no eligibility criteria in Ireland for becoming a company director. It is notable that there is no age restriction either, with a minority of companies in Ireland showing directors of less than 8 years of age.
Section 150 restrictions can also apply to non-executive directors (e.g. directors in name only or who have limited involvement in the operation of the relevant company). In particular, we are seeing a spate of cases coming through the courts whereby spouses of company directors are being subjected to restriction proceedings. There is no exemption provided for such directors and the courts have held over the years that a director acting in a limited capacity (such as a spouse) could not be excused merely because they had little involvement. If that person agrees to act as a director then they are subject to the same rigours as every other director and under the same duties and responsibilities to the company.
If you are a Director of an Insolvent Company, what action should you take to protect yourself against a potential restriction application?
Firstly, it is important to act honestly and reasonably with regard to the dealings of the company. This would involve keeping clear and accurate books of account and records for the company. It is also advisable that all decisions relating to the company are minuted and that a book of minutes is kept available for the liquidator so as to show all reasonable efforts made and the reasons for any decisions taken. It is extremely important for a director of an insolvent company to seek advice from an insolvency professional; perhaps the company accountant in the first instance and thereafter a solicitor who specialises in corporate insolvency. Directors should be aware of the serious personal and financial implications that might follow actions taken by their company in the period leading up to a liquidation. Directors need to make decisions in this period with a full appreciation of the risks involved. For example, it is not permissible to prefer one creditor over another. This preference might be reversed and the relevant directors can be held personally liable to the company in the amount of the preference. Restrictions and disqualifications are almost a certainty if such offences occur.
It is possible for a restricted director under Section 150 of the Companies Act, 1990, to apply for reinstatement. A director may apply under Section 152 of the Act within twelve months of the perfection of the restriction order. This application is made to the High Court. The Court may grant any order it sees fit against the entirety of the restriction or just part of it. There are certain formalities which an individual applying for such relief must deal with including giving 14 days’ notice to the liquidator. Individuals should seek specialist advice in this regard.
Given that the decision to initiate proceedings to restrict and/or disqualify a director of a company in liquidation rests with the DOCE (albeit based upon the report issued by the liquidator) it is important for any director of an insolvent company to be aware of their duties and obligations to the company, particularly during the insolvent period, so as to avoid the rigours of such a restriction. It is also interesting to note that the costs of the restriction application will generally be made against the insolvent director in the event that they are so restricted. This is a ‘double whammy’ form of punishment because most directors of insolvent companies have just lost their job and, as a consequence, their income. On top of this they cannot become a director again for a specified period.
Beware of Technical Insolvency
A company becomes technically insolvent when it does not have the ability to pay its debts as they fall due. A large amount of companies will fall into technical insolvency but then trade their way out of this in due course. Others, however, may not be so successful and may end up in liquidation. It is therefore essential for directors to understand the concept of “insolvency” and particularly the fundamental change in a director’s duty in this situation.
Generally, a director owes his primary duty to the shareholders of a company. The primary duty however shifts once the company becomes insolvent (technically or otherwise) whereby the director will then owe a primary duty towards the creditors of the company. Once the primary duty shifts to the creditors then a whole range of other consequential duties arise. It is through this period that a director’s conduct will be most subject to scrutiny in the Section 56 report to the DOCE and will of course be a major factor in the decision as to whether or not the DOCE issues a direction to the liquidator to initiate proceedings for a restriction or disqualification.
We can help you
Clarke Jeffers are specialists in corporate insolvency and would be happy to meet with you to discuss any application for restriction against you or fellow directors or indeed provide advice to the directors of insolvent companies on what steps should be taken.