Does the laws concerning directors of insolvent companies strike the right balance of protecting between protecting the public and encouraging entrepreneurship

Section 214 attaches substantial civil liability to a director, and has the capability of having a strong deterrent effect. The civil sanctions include contribution, disqualification, subordination of any debts of the director, and the charging of any debts due to the director by the company. Also the inability of the director to obtain relief under Section 727 Companies Act 1985 adds to the gravity of this liability.

Looking at the issue of whether there is a balance between the creditor protection and the ability of the director to take appropriate business risks, it will be necessary to first examine justification of creditor protection on one hand, and the justification for directors’ limited liability.

Starting with the justification for directors’ limited liability; the current law will discourage people from wanting to take up positions as directors; the directors’ will become more risk averse, and will be more concerned about their position than trying to maximise profits for the company, thereby producing inefficiencies by the directors. Also if creditors can avail themselves of insurance, why push the burden on the director? Furthermore, the current law is likely to cause directors concerned about their personal liability to take their company into liquidation prematurely. In addition to that, is the issue of determining what the ‘proper steps’ the director ought to have taken are to avoid culpability.

On the other hand, the justifications for creditor protection include; deterring irresponsible trading when companies are in financial straits and protecting creditors in certain circumstances, such as the inability for creditors to control directors’ actions; and producing a fair balance between the interests and rights of directors on the one hand and creditors on the other.

I am of the opinion that placing a responsibility on directors in times of a company’s financial strife, would, at least, provide more of a balance between relevant interests. For, if a company is heading for insolvent liquidation, the creditors of the company are effectively the ones who have a residual claim over the company’s assets and so the directors should be taking actions to minimise the losses of the creditors.  The provision covering wrongful trading requires the directors’ allegiance to shift from the shareholders (assuming shareholder primacy) to the creditors.  

On the other hand, the changes made to the administration regime procedure by the Enterprise Act 2002 potentially lighten the burden of directors. Now directors are able to place their company into administration, which has reduced the number of insolvent trading actions.

Moving on to the fraudulent trading provision, Section 214 was introduced because the existing fraudulent trading provision had failed in curbing directors running up losses when their companies were in deep financial difficulties. Section 213 ‘fraudulent trading’ provision however still remains in the current law. It applies when in the course of winding up; any business of the company has been carried on with intent to defraud creditors. It imposes both civil and criminal sanctions.

Section 213 involves an element of actual dishonesty, and before liability can be established it must be shown that the defendant participated in the carrying on of the business in that manner, and doing so with the knowledge that the transaction was intending to defraud creditors. The criminal sanction is a fine and/or imprisonment, while the civil sanction is contributory.

Looking at whether this provision strikes an appropriate balance between relevant interests of the creditors and the directors when a company is nearing insolvency, there appears in my opinion a fair balance being achieved, if not more in the scale tilting in the directors’ favour, this is because the liability carries a subjective element, and the burden of proving that is high as a result of its criminal sanction, thereby in practice, reducing the amount of Section 213 actions. Also the directors’ are able to plead S.727 relief.

A further means by which the current law regulates the conduct of directors of insolvent/near insolvent companies can be seen in Sections 216 and 217 of the Insolvency Act 1986.

Section 216 of the Insolvency Act 1986 defines the circumstances in which criminal liability can be imposed on a director who acts, without the leave of the court, for a company which is known by a prohibited name.

A name will be prohibited where it is the same name that the liquidating company was known as at any time in the 12 months immediately before it went into liquidation, or where it is sufficiently similar as to suggest an association with the liquidating company.

Where there is a company trading under a prohibited name, an individual can be guilty of a criminal offence punishable by imprisonment or fine, or both for acting as a director of the company, and taking part directly or indirectly in the formation, management or promotion of the company.

Section 217 imposes the civil liability for any individual who is in breach of Section 216. Here, the person will be personally responsible for the ‘relevant debts’ of the company. The relevant debts are those debts which were incurred whilst that person was acting in contravention of section 216 or taking instructions from a person he knew to be in contravention of section 216.

In summary, sections 216 and 217 of the Insolvency Act 1986 have potentially severe personal consequences to any individual of acting for a company in contravention of the provisions.

In considering whether there is a balance between the relevant interests under these provisions, on a whole I would say a suitable balance has been achieved, reasons being that in as much as it appears like Sections 216 and 217 bites irrespective of the managerial culpability for the initial failure, the presence of the exceptions outlined in the Insolvency Rules 1986, lighten the burden for persons whose conduct cannot be linked in anyway to the initial insolvency. The courts have shown a sympathetic attitude to granting leave to directors where the facts are such that the director is above reproach.

Nevertheless, I am of the opinion that these sanctions are absolutely necessary to serve as an added deterrent against flouting of the law by irresponsible directors.

In conclusion, it has been explained in the above discussion that the methods used under the current law to regulate the conduct of directors’ are civil and criminal sanctions. These sanctions are implemented by means of their inclusion in statutory guidelines as seen in the Insolvency Act 1986. Since the discussion was primarily relating to the regulation of conduct when the company is insolvent or near insolvency, the necessary provisions examined where sections 213, 214, 216 and 217.

I am of the opinion that with regards to the improper trading provisions under Sections 213 and 214, a fair balance has been struck between discouraging irresponsible conduct and limiting the directors’ personal exposure to financial risk because at that particular point, regards must be had predominantly to the interest of the creditors, who now have proper interest in the proper allocation of the company assets. Also, there appears to be adequate exceptions and defences available to the director in order to be able to limit his personal exposure to financial risk.

In relation to the restriction on re-use of company names provisions under sections 216 and 217, it also seems that a fair balance has been achieved in the sense that although the provisions are stringent, adequate exceptions have been made under the Insolvency Rules 1986, in addition to the sympathetic judicial approach to the granting of leave to directors to re-use names.

I believe that with the current law, any responsible director of a company in/near insolvency will still be able to function without fear of being caught by either the civil or criminal sanctions, so long as there is transparency and accountability on his part.

CORPORATE INSOLVENCY

CHRISTMAS VACATION ASSIGNMENT

COLLEGE: UNIVERSITY COLLEGE LONDON

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