Directors’ liability – Duties during insolvency

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In a previous post, we discussed areas of exposure and avenues for recourse for directors of insolvent companies. In this post, we look at how directors’ legally prescribed duties may shift during insolvency.

In some countries, notably the United States, the fiduciary duties of directors are legally transferred from the company to its creditors. In Canada, directors’ fiduciary duties remain with the insolvent company, but a duty of care to all company stakeholders is added to directors’ legal responsibilities. Directors must consider the reasonable expectations of creditors, employees, contractors and business partners, in addition to those of shareholders.

In practice, this generally means that a company should not carry on business if it can’t meet its obligations as they come due. If a company continues normal-course business activities – outside court-ordered creditor protection – it risks a legal action for trading while insolvent. Directors, as the ultimate decision makers, could be personally liable for company actions that increase debt while the business is insolvent, contrary to the interests of creditors.

Conflicting priorities

When a company nears insolvency, directors are frequently caught between conflicting priorities – on one hand, in trying to carry on business and return the company to financial health, while on the other hand, exercising a duty of care to creditors, employees and others who will lose money if the business ultimately fails.

In such situations, directors must be able to show they have given due consideration to the interests of all stakeholders. In many cases this will mean that, if no new funding is available to the company, directors should consider applying to court for insolvency protection in order to either restructure debt or liquidate assets of the business for the benefit of creditors.

Minimizing risk

It’s a difficult balancing act and, where directors get it wrong, they can be open to oppression actions, for failing to meet the reasonable expectations of stakeholders or for claims of negligent misrepresentation if, for instance, creditors unknowingly advance new loans to an insolvent company.

To minimize risks of personal liability in a business insolvency, directors should:

  • Attend all board meetings and make detailed notes of voting, especially dissenting votes
  • Establish strong financial reporting and review processes
  • Establish regular reports by professionals on all statutory obligations, such as pension contributions
  • Regularly review directors’ and officers’ insurance and corporate indemnity protections with an independent advisor; and
  • Consider resigning from the board in the event of insolvency or impending insolvency.
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