Directors and Statutory Duty

‘A director is... a person appointed to act as one of a board, with power to bind the company when acting as a board, but having otherwise no power to bind them’ [1] . The appointed directors for Cheesy Chips Ltd are Adam Adamant (managing director), Peter O’Till (Chief Financial Officer), Penelope, Owen and Hugh Adamant. As directors of the company they are expected to act within their powers. In doing so they must act in ‘accordance with the company’ [procedures] by applying their powers correctly [2] . These duties are implied to ensure that directors have the authority to apply all their powers when dealing with company affairs. In this paper, I will firstly examine whether the directors are in breach of their duty, and if so, whether the breach has affected their fiduciary obligations within the company. Secondly, it also identify whether they have been trading fraudulently and or wrongfully, by allowing the company to experience financial difficulties which led to insolvent liquidation. Finally, this paper analyse whether the court may grant a disqualification order against the directors for the breach committed.

Director’s duties and breach:

As director of a company, there are certain fiduciary obligations that must be followed. A fiduciary is a person who acts on behalf of another, taking into consideration this person’s best interest and therefore building a relationship of ‘trust and confidence’. As established in Bristol and West Building Society v Mothew [3] . It may be stipulated that, as directors of Cheesy Chips Adam and Owen disposed the company assets in breach of their fiduciary duty and were therefore reluctant to act in the company's best interest [4] . The cross-guarantee transfers may be classified as improper, considering they (Adam & Owen) handed over the company’s assets without considering the effect it may have on Cheesy Chips. In addition, they did not seek any legal advice nor did they inform fellow directors of their actions. See Bishopsgate Investment Management Ltd v Maxwell No 2 [5] .

Directors are expected to act with reasonable care, skill and diligence when performing his/ her duty [6] . Where it is established that the directors fail to act with reasonable care, skill & diligence whilst performing their duties, it is likely that their act will be regarded as jeopardising Cheesy Chips future [7] . S.174 imposes a ‘twofold subjective and objective test’, requiring a director to obtain and apply care and knowledge when performing their duties [8] . This was explained by Justice Jonathan Parker in Re Baring plc (No 5), where he illustrated that ‘directors have, both a collective and [individual]... duty to acquire and maintain a sufficient knowledge and understanding of the company’s business, enabling them [to discharged their duties properly]’ [9] . From the facts it is stated that, Penelope, Owen and Hugh has delegated their duties to Adam. The fact that the latter parties were reluctant to perform their duties indicates that, it is unlikely that they have been maintaining a collective duty. Therefore, discharging their duties incorrectly where they are required to acquire sufficient knowledge and understanding of the company [10] . Although the directors are expected to acquire sufficient knowledge of the company affairs, they are not required to have any ‘special qualifications’ in order to perform his/ her duties within the company as established in Re Brazilian Rubber Plantations and Estates Ltd [11] . However, where a director obtain ‘special qualifications’ a higher duty of care is required on his/ her part [12] . Therefore, where the sales figures Peter had produced were incorrect, it may be argued that the other directors should not be held liable for his breach [13] . The court may consider their inability, in relation to the incorrect figures produced by Peter, considering he is a professional and is therefore trusted to perform his duties [14] .

The principle of equity requires a director in breach of his fiduciary duty to disclose such breach of misconduct to the company [15] . The director must consider whether he is acting in the best interest of the company, where he disclosed his breach of duty [16] . The fact that Adam and Owen had signed cross-guarantees to the bank for two other companies without informing the other directors indicates that, they are likely to be in breach of their fiduciary duty. The court may in this case apply the principle laid down in Simply Loans Direct Ltd v Wood, by illustrating that they could not have thought they were acting in the interest of the company [17] . However, if Adam and Owen can prove that in signing the cross-guarantees they were doing so for the benefit of the company, they may be relieved from any liabilities. Nonetheless, the fact that the two other companies seem to have no connection with Cheesy Chips, Adam and Owen may be liable for misapplying company funds, as this was an act of misfeasance. This was established in Facia Footwear Ltd (In Administration) v Hinchcliffe [18] . Although Owen did not act intentionally when he assist his father by signing the cross-guarantees, he may be held liable for dishonest dealings. The liquidators may argue that, he should have read the documents before signing and therefore should have known that his actions may have been fictitious. This was applied in Lexi Holding plc v Luqman, where the directors whom acted fictitiously were held liable for breach of their director’s duty [19] .

From the facts, it is stated that the position of Cheesy Chips has ‘deteriorated appreciably' and that, the directors were well aware of the likelihood that the company may face insolvent liquidation. Directors are not only acting in the interest of the company and should therefore consider the interest of creditors, when making decisions in cases of insolvency [20] . Director’s must make the interest of creditors their priority, in cases where the company is at risk of becoming insolvent see Colin Gwyer and Associates Ltd v London Wharf (Limehouse) Ltd [21] . In Winkworth v Edward Baron Development Co Ltd Lord Templeman illustrated that, ‘a company owe a duty to its creditors’, and therefore may be held liable for breach of this duty [22] . In his ongoing judgment, he explained that where there is doubt of insolvency, directors must make it their priority to repay company's debts. In doing so, it should ensure that the company’s administrations are properly looked after and that company’s affairs are not exploited, for their own benefits rather than that of the creditors [23] . With regards to this statement, the court may find the directors liable for breach of their duty, where they declare dividend to the shareholders, without taking the creditors interest into consideration [24] .

Fraudulently/ Wrongful Trading:

When a company faces financial difficulty, it is up to the director to decide whether to close the company down, go into insolvent liquidation or continue trading in the hope of improving the company’s financial status [25] . The court in this case will therefore analyse whether the company has been trading fraudulently or unlawful and identify whether the directors will be held liable under the Insolvency Act as explained below.

Peter O’Till, the Chief financial Officer of Cheesy Chips has been producing accounts which are based on incorrect figures, much higher than they should be. S.213 of the Insolvency Act illustrates that, where a company is in the process of ‘winding-up’ and it appears that there have been cases where this company has been trading ‘with the intent to defraud its creditors’, the court during liquidation, may declare that any person knowingly continue to trade under this circumstance will be held ‘liable to make such contributions to the company’s assets’ [26] . However, in order to be liable under the latter provision it must be proven that the directors had the intention to defraud. This was explained in R v Grantham [27] . If in any case Cheesy Chips reach the stage of winding-up the company, Peter may be held liable under s. 213 of 1986 Act.

Upon experiencing financial difficulties, Adam persuaded the other directors of Cheesy Chips Ltd to continuing trading, in the hope of the company’s financial position improving. The general principle here is that, where the directors can prove, they had ‘reasonable prospect’ to believe that the company were not going into insolvent liquidation’, no liability for wrongful trading [28] will arise. This argument was posed in the case of Secretary of State for Trade and Industry v Taylor, where Chadwick J states that the Company Act does not impose a duty on directors ensuring that, they seize trading during insolvency [29] . In his judgment, he illustrates a strong belief that where directors have no doubt that they will be acting in the interest of the company, they should try to trade through insolvency liquidation [30] . Contrary to his previous statement, Justice Chadwick also stipulates that, trading with a possibility of future loss should be anticipated by directors and indicated that this may impose a ‘personal liability’ on their part [31] . In regards to this, the directors of Cheesy Chips may be relief from liabilities for wrongful trading, by indicating that they were merely trading out the difficulties of the company [32] . On the other hand, the level of sales in Cheesy Chips had fallen over the years and their main customer withdrew their account, which caused the company more loss making it difficult to continue trading. The liquidators may argue that, the directors were aware that the liquidation of the company was inevitable and by continuing to trade they have instigated wrongful trading and is therefore personally liable. As applied in Re Produce Marketing Consortium Ltd [33] .

It becomes illegal to trade during insolvent liquidation, where the directors have realised that there is a ‘reasonable prospect’ that the company may be going into insolvent liquidation [34] . After six months of trading, Adam decided that the company should start taking all necessary steps to place Cheesy Chips into insolvent liquidation. In order to pursue a claim under s.214 of the Insolvency Act 1986, the company must be in liquidation [35] . Directors may incur ‘personal liability’ where the company faces insolvent liquidation, therefore obliged to ‘repayment of corporate debts’, where they allow the continuance of trading, with the knowledge that there is no reasonable prospect of avoiding insolvency [36] . Initially, the directors of Cheesy Chips could have taken reasonable steps to avoid insolvent liquidation, when their main customer withdrew their account but were reluctant to and may therefore be held liable for trading wrongfully [37] . Additionally, in identifying whether the directors are liable for losses caused through wrongful trading, the court may consider whether or not they took all reasonable steps to ‘minimise the potential loss to the company’s creditors’ before liquidation occurs [38] . In addition, where the directors allow trading to continue during insolvency phase, their judgement during that period must be assessed in relation to the company’s circumstances at that point. See Re Sherbourne Associates Ltd [39] .

Disqualification:

Cheesy Chips is being placed into liquidation, this occurs where the assets of the company have depreciated and where it becomes futile for any company to repay debts or manage any other expenses of the ‘winding up’ [40] .

As indicated above where the directors of Cheesy Chips Ltd (namely Peter and Adam) acted fraudulently and wrongfully under s.213 and s.214 of the Insolvency Act, they may be held liable for an offence contrary to this provision [41] . In accordance, the directors may have to ‘contribute to the companies assets’, where the court has granted a disqualification order [42] . In cases where a disqualification order is granted against a person, a restriction is imposed on this person preventing him/ her from acting as a director of the company ‘whether directly or indirectly’ [43] . Under s.6 of the Company Directors Disqualification Act (CDDA), the Security of State may apply for a disqualification order against the directors of a company in insolvent liquidation by proposing that the directors are unfit in performing their duties as managers of the company [44] . However, although the directors of Cheesy Chips may be held liable in breach of their fiduciary duties, the court may not disqualify them for trading with the knowledge of imposing risk to the creditors of the company. This was argued in Secretary of State Trade and Industry v Gash where it was held that, the directors failure to cease trading ‘did not necessarily make him unfit to be concerned in the management of the company’ [45] .

A director cannot be disqualified, unless it is proven that their conduct either jointly or severally, has made them unfit to perform their duties in the management of that company [46] . A disqualification order is an offence triable under s.13 CDDA 1986, where a person in breach of a disqualification order, may be held ‘personally liable’ for any liabilities and losses incurred by the company [47] . The directors of a company may be held jointly and severally liable, with the company for any debts incurred by this company [48] . The fact that Adam, Owen and Peter are likely to be in breach of their duty illustrates that, the remaining directors may be held jointly and severally liable for any debts the company has sustained due to their wrongful act [49] .

Adam has proposed that the directors all declare ‘generous dividends’ to the shareholders, in which case a large sum was paid to Adam as he is the main shareholder. In establishing that the directors have benefit from his breach, the court will assess whether the breach is ‘serious enough’ to ‘warrant disqualification’ [50] . S.6 CDDA 1986 imposes a minimum period of ‘two years’ for disqualification, where the defendant’s misconduct has caused a breach. Therefore, it is essential that the misconduct is serious enough to the merit of the two year disqualification order, imposed under the latter statutory provision [51] .

Furthermore, where the company is in the process of winding up, the court may grant a disqualification order against an individual, where it is established that he/ she may be guilty for an unlawful offence whilst trading or for any fraud committed whilst performing his/ her duty [52] . Consequently, the court may also assess the degree of seriousness committed by Adam and Owen, in regards to the cross-guarantees. In addition, if it is found that a director has caused the company provisions to be in default persistently, the court may decide to order disqualification [53] . In regards to this, the court may consider the depreciation of Cheesy Chips Sales figures and whether this was caused by defaults on Peter part. Therefore, accessing whether these defaults have been consistent up to three times within a five year period, in which case a disqualification order may be granted against him [54] .

To conclude, it is likely that all four directors may have breach their statutory duty to act within their powers as directors of Cheesy Chips Ltd. In breaching their duty, they have failed to act with reasonable care, skills and knowledge which have resulted to fraudulent and wrongful trading. However, where it is found that the directors may have been trading wrongfully it may not lead to their disqualification, if they can prove that they reasonably believed that continuance could lead to improving the company’s position. On the other hand, where it is identified that they were aware of the risk that trading would lead to insolvent liquidation, the court will assess their fitness to act as directors and if they are considered unfit they may be disqualified. Nonetheless, this may not give rise to disqualification as it requires a high level of seriousness. It is therefore unlikely that, the court will disqualify Penelope and Hugh considering their contributed breach is barely regarded as serious. However, it is uncertain whether Adams, Owen and Peter will escape a warrant of disqualification, taking into account the fact that they may have intended to defraud the company. Nonetheless, it is up to the court to decide and access the level of seriousness, where it may be proven that the latter intended to defraud the company, in which case a disqualification order may be imposed for a period not exceeding 12 years [55] .