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Directors' liability

16 January 2004 by

The problem

You are the director or manager of a restaurant business that faces closure but still carries debts. As such, don't automatically assume you cannot be held personally liable for these debts - even if it is a limited company.

From a directors' perspective, the most important provision under the Insolvency Act 1986 is that of wrongful trading. Wrongful trading is where the directors permit the company to trade even after they ought to have realised that the business was ultimately bound to fail. At that stage they are under an obligation to ensure that all steps are taken to minimise the loss to creditors.

If the liquidator believes that the directors did not do enough to minimise the creditors' losses or were trading whilst insolvent, he may apply to the court for an order that they be required to contribute to the company's assets from their personal funds. This is tantamount to making them personally liable for the company's debts.

In addition to wrongful trading, the liquidator will have the power to apply to the court for a similar order in respect of any director who has acted in breach of any duty in connection with the company. Bearing in mind that a director is under an obligation to act in the best interests of the company at all times, that is a pretty wide obligation.

These issues really become important if the company is insolvent. Insolvent in this context means either that it cannot pay its debts as they fall due or that the company's assets are less than its liabilities. In the case of a restaurant, which is a cash business, it would be difficult ever to show that it satisfied the latter criterion of solvency.

The law states that the term "director" includes any person occupying the position of director. Therefore, in certain circumstances, personal liability for the restaurant debts could extend to anyone in charge - the restaurant manager or even the executive chef.

Expert Advice

There are a number of golden rules if there is any question as to the insolvency of the restaurant. These are:

No credit should be taken other than in the ordinary course of business. It is always risky to seek additional capital in order to trade through a difficult period. If you do choose to do so, always seek specialist advice.

The directors should make sure that the company's housekeeping is properly maintained and that its statutory accounts and filing are all up to date.

Regular management accounts should be prepared and these should be made available to all directors. A director of any company is under an obligation to have up-to-the-minute financial information, and this becomes even more important if the company is struggling financially.

The decision to keep trading and not to close the restaurant should not be taken lightly and should be reviewed regularly. Board meetings should be held frequently to review the management accounts and to reconsider the decision to keep trading. These meetings should be properly minuted and those minutes maintained in the company records.

It must be stressed that there is no obligation on the directors to close down a business as soon as there is a downturn in its turnover. However, a person running any business through the medium of a limited liability company must recognise that the courts regard the limitation of liability as a privilege, not as a right. The directors must have regard to the creditors of the company and all others who might suffer loss by their actions, and act in an informed and responsible manner. Those who do can be confident that they will not incur any personal liability as a result of the demise of the business.

Beware!

Directors who abrogate responsibility and fail to face up to the financial realities of their business, or a business which they manage, will not be dealt with mercifully by the law. Ignorance is no defence, and the law does not make allowance for ostriches who keep their heads in the sand.

Contact

Alistair Bacon at Matthew Arnold & Baldwin, Tel: 01923 690020, E-mail: alistair.bacon@amblaw.co.uk

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