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Directors’ duties; a timely reminder

In a recent High Court case, the Court found that the directors of a company were guilty of:

1. Misfeasance and breach of duty as directors; and
2. Wrongful trading under Section 214 of the Insolvency Act 1986

where they had failed to halt the company’s activities when it was clear them that the company was insolvent.

In this case, the Defendants were directors and shareholders of Onslow Ditchling Limited  (‘the Company’) which was a company set up for the purposes of developing industrial and trading units. The company’s activities were mostly funded through arrangements with a Bank. Following a dispute with a main contractor the Company went into liquidation in September 2005 where there was a deficiency as regards unsecured creditors of at least £900,000.00. The Liquidators brought an action against the directors under two headings:

1. That the directors were guilty of misfeasance and breach of duty as directors by permitting the company to commence the development or indeed to continue the development in circumstances where they knew or ought to have known that it was speculative, inadequately funded and bound to fail; and
2. That they were guilty of Wrongful trading and breach of Section 214 of the Insolvency Act 1986.

The decision in this case, in short, is that the Court agreed with the Liquidator!

To be fair to the directors, Court were satisfied that up to July 2004 the directors honestly believed they were acting in the best interests of the Company. By September 2004 however, the situation was entirely different: the directors knew that the Bank funding conditions could not be met and their other funding options had petered out. As a result, the directors’ failure to call a halt to the work, to disclose the funding status of the project to the main contractors and a failure to disclose the contractual status of the project to the Bank, put them in breach of directors’ duties owed to the Company and its creditors.

The Judge also held that the directors had not exercised the degree of skill and care required of them from September 2004 set out in Section 214(4) of the Act. The judge drew a distinction between their ‘misjudgement’ in July 2004 and their negligence two months later.  The Judge took into account not only what the directors respectively knew, but what they ought to have known or ascertained as reasonably diligent people discharging their respective functions and having the general knowledge, skill and experience which each had. The Judge held that from 14th September 2004 the Company was trading wrongfully.

In common with most wrongful trading cases, this case is very fact specific but serves as a usual reminder of the widening scope of the duties of directors when a Company experiences financial difficulties and is in the vicinity of insolvency. In this case the Judge had no difficulty in identifying a point of no return when the directors became guilty of breaching their fiduciary duties and of wrongful trading.

This case serves as a timely reminder to directors of their duties when a Company is in financial difficulty. Directors need to be aware that where a company is insolvent or of doubtful solvency, it is really the creditor’s money which is at risk and consequently the interests of the creditors become paramount and should be taken into account when directors exercise any discretion.

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