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13 September 2016 | By Raymond Silverstein Community

A director's obligations

When a company is in financial difficulties, a director's duties change. Are you prepared, asks Browne Jacobson's Raymond Silverstein

Recent public and combative questions of Sir Philip Green by members of parliament is a salutary lesson for directors who might be unaware that their duties change if a company is in financial difficulties.

Most directors are familiar with their general statutory, common law and fiduciary duties, including the duty to exercise independent judgment, and will be confident applying these in their typical day-to-day operations. But how many directors understand the extent to which they can be held accountable when things go wrong?

What changes?

As a general rule of thumb, the interests of creditors increase in importance as a company’s financial position worsens. If matters do not improve and the company is insolvent, the interests of creditors will displace the interests of the company – and when making decisions the directors must consider the impact of those decisions on the creditors as a whole rather than focussing on any individual creditor or class of creditor.

The main questions for directors of an insolvent (or near insolvent) company are: (1) what can they do to keep the company in business without running the risk of committing an offence or damaging the creditors’ position, which could ultimately result in the directors incurring personal liability? and (2) when should they call it a day?

These are not easy questions to grapple with and the sooner directors seek advice, the better. The task will then be to look at (and keep under consideration) whether there is a reasonable prospect of avoiding insolvency and ensuring that any step the directors take is not going to worsen the overall position of creditors. If this cannot be achieved, directors may become liable for the losses suffered to creditors if they continue trading. Thorough record keeping is essential and highly recommended to evidence the rationale for the directors’ decisions and any professional advice taken to support those decisions.

Directors can take some comfort that if their actions are ever questioned, a court will not approach these same matters with the benefit of 20:20 hindsight. Provided that advice has been taken and followed, and there is a rational basis to justify the directors’ conduct, it will be recognised that they have operated in imperfect and challenging circumstances.

Likewise, the input and advice of the non-executive directors should be sought and recorded. We have seen too many examples over the years of non-executive directors not challenging the executive directors, not asking difficult questions and being truly independent. An effective board will have at least one NED who acts as true “challenge partner” and their advice during times of financial difficulty will be invaluable.

The future?

Following BHS’ collapse, the chief executive of the Pension Protection Fund has suggested that certain takeovers should require clearance from the Pensions Regulator before they proceed.

If executive directors are unwilling or unable to understand and meet the challenges when their business is in financial difficulty, and NEDs fail to act as truly independent challenge board members, then further regulation seems inevitable.