The risks of corporate trading and debt

Being a company director is a risky business. The limited liability company was devised as a way to promote trade and industry by freeing its owners from the risk of liabilities. This was open to a great deal of abuse and the legislature has stepped in to remove the protection of limited liability in a number of ways. The most frequently encountered of these come within the insolvency legislation and can cause problems for a director in the course of corporate insolvency due to the risks of trading

Some of the corporate insolvency risks of trading are:

The liquidator has a right to make a claim against the directors of the business based on the wrongful trading. In reality, in case at some point before the winding up process starts if the director had decided that there was no prospective reason as to why corporate insolvency could have been avoided; he is responsible for wrongful trading if he fails to do everything he can to minimize the potential loss to the company’s creditors.

The director’s conduct is judged by what ought to be known and done by a reasonably diligent person having the knowledge, skill, and experience that may be reasonably expected of a director as well as the general knowledge, skill, and experience which the director in question actually has.

If wrongful trading is proved the Court can order a director of an insolvent company to contribute such amount to the company’s assets as it thinks proper. The director, therefore, faces not only the loss of his business and livelihood because of the corporate insolvency – risks of trading but loss of personal wealth by having to put money into the liquidation to put the creditors in the position in which they would have been if he had done more to protect them.

A preference is simply placing one of the company’s creditors or guarantors in a better position than that in which it would otherwise have been and again the liquidator can apply to the Court for an order to restore the position to that it would have been if the company had not given the preference.

Preferences often come up in the context of directors’ guarantees. The company has a bank loan backed by a guarantee. The business fails. However, if the director realizes things are going wrong and keeps on reducing the bank debt to reduce exposure under the guarantee, preferring himself as guarantor and the bank as a creditor.

The Court can order him to put the money back into the company or it can order the beneficiary of the preference to repay the money leaving it in a similar position to the other creditors and leaving the director liable for the full amount which he has guaranteed. Even in a straightforward corporate insolvency, directors should take legal advice. Insolvency advice from an administrator deals with the duties they owe to creditors.

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