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Responsibilities of a director in times of uncertainty: A practical overview, 6th September 2012

As the uncertainty facing the market continues, Scottish businesses face the potential for financial difficulty.

As the uncertainty facing the market continues, Scottish businesses face the potential for financial difficulty. It is important that a director is aware of his or her legal duties in order to avoid personal liability should the business fail to recover. While doing one’s best to keep the business afloat it is easy to fall foul of the law in this area. To assist we have highlighted some of the main issues to be aware of in order to mitigate the risk of problems arising.

- Up to date information
A director has a duty to ensure that he or she is provided with comprehensive, accurate and up to date trading and financial information at all times if the company is in financial difficulty (and even if it is not). Without such information to hand it is impossible to make a correct and educated decision on behalf of the company. If you are in any doubt from your own company records, contacting an accountancy firm for advice would be advisable.

- Legal Solvency Tests
There are two tests in law which are applied to a company in financial difficulty to determine their solvency:

The Balance Sheet Test - Can the company pay it debts as they fall due? The first is fairly straight forward. If the company’s gross assets exceeds its gross liabilities it will not be considered “Balance Sheet Insolvent”.

The second is also fairly easy to determine. It is not uncommon for a company to have debt and incur sometimes significant credit in the normal course of business. The legal test does not relate to the simple non payment of an invoice within the 30 day period but rather the expiry of a charge for payment (14 days) or statutory demand (ordinarily 21 days). Both of these require a legal process in which a timescale set out in law has expired after service of charge or demand on the company at its registered office by Sheriff Officers. At the expiry of the timescale set out if the debt remains unpaid, the company will be considered to have “failed to pay it’s debts as they have fallen due”.

The risks of failing one of the above tests are far reaching. From a director’s point of view, if the company continues to trade, incur further debt, etc at this point, the director can potentially lose his or her separate legal personality from the company and in incur personal liability.

- Ongoing Monitoring
Given the fluid nature of business it is vital to remain armed with the most up to date financial information on an ongoing basis. A common issue is that of cash flow and whilst on one day matters appear bleak, the next day the situation can recover to a significant extent. In order to ensure you are able to make the correct decisions the situation must be monitored on a regular basis.

- Take Advice
A company will ordinarily have some form of professional advisor who should be able to at least point a director in the right direction. It is imperative though that the correct advice is taken. Corporate recovery specialists (either insolvency practitioners or lawyers) should be engaged if there is any concern amongst the directors that a corporate insolvency event may take place.

- Reasonable Prospect of Recovery
It is the job of a director to satisfy themselves, based upon accurate and up to date information referred to above, that there is a “reasonable prospect” of surviving the present issues without becoming insolvent. If there comes a point where this conclusion cannot reasonably be reached and, after having taken correct advice, it is the director’s duty to minimise potential losses to creditors. If this step is not taken and creditors are prejudiced by such decisions the director can be liable for wrongful trading which will "pierce the veil of incorporation" and invite personal liability for the debts of the company.

- Records
In any situation where there is a concern regarding the solvency of recoverability of a company the information referred to above should be carefully kept, together with any advice notes from professional advisors and minutes of board meetings, etc. This is essential in order that a director can establish that he or she adhered to their duties at the material times.

The above forms only a brief overview of some of the main issues which we come across on a regular basis when advising clients (before, during and after the insolvency event) as to their position.

If you have any concerns regarding or would like some guidance in this area please contact Alan McKee - or by telephone on 0141 248 4957.

Last updated: 9.17am, Friday 7th September 2012

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