Whilst there have been previous discussions about the fiduciary duties of directors, an area that is not often discussed is the fiduciary duties of directors to a company following formal insolvency. The purpose of this article is to highlight that whilst directors can start afresh following their previous company going insolvent, they may still be liable to the company if they are able to derive a profit out of an opportunity of their position as director.
What is a fiduciary relationship?
A fiduciary is an individual who holds a legal or ethical relationship of trust with one or more other parties. Being a fiduciary means being responsible for managing assets for another person or group of individuals. It is therefore important that within a fiduciary relationship, there is a duty and obligation to act in the best interests of the other party.
With honesty and trust essential in a fiduciary relationship, the individual acting in a fiduciary role must not obtain a personal benefit at the expense of the other.
What is insolvency?
Insolvency occurs when an individual or company are unable to pay their debts on time. When all other methods of improving the financial situation of the individual or company have failed, an insolvency proceeding will take place.
During the insolvency proceeding, the individual or company must agree to take steps towards a resolution of paying the creditors. With the help of a licensed insolvency practitioner, the individual or company will discuss the options available to them. The most common solution for insolvency is bankruptcy.
Spotlight on directors
An issue that is not always given the prominence it deserves is the ongoing nature of the fiduciary duties of directors to their company after formal insolvency. With the current financial situation in the UK, it seems as though an economic recession is likely. As a result, there will be many directors parting with their existing companies, but what happens after this?
After parting with the company, it is common for directors to set up afresh, trading with the same customers and often with identical contractual relationships. It may seem that following the insolvency process of the company, nothing has changed. The director moves on whilst having the ability to trade with the same customers. However, it is not that simple. If a director has entered into an arrangement to buy the business and assets from an insolvency practitioner, they are free to do with them what they like. But what happens when no arrangement actually exists?
Being the director of a company comes with many responsibilities and duties. Being trusted with the management of the company means a director must always act in the best interests of the company they represent.
When making decisions as a director, it is important to consider:
- The potential long-term consequences for the company
- The interests of your employees
- Maintaining your company’s good business reputation
- The need to promote good relationships with suppliers and customers
- The company’s impact on the environment and local community
- The need to act fairly between members, for example, treating those with few shares in the same manner as institutions with a large shareholding.
Even after a company has gone insolvent, the director still owes an ongoing fiduciary duty to the company. One of the duties of a director, which is not spelled out in the Companies Act, is not to derive a profit from an opportunity arising out their position as a director.
The consequences of doing so means the director is liable to account to the company for any profits they make. Therefore, if a director sets up afresh using the old company’s intellectual property and they are still legally the director of the insolvent company, a recovery may be made for the benefit of the creditors.
In ordinary circumstances a director’s breach of fiduciary duties to a company may be ratified by a shareholder resolution. The reason for this is because in most cases, directors and shareholders are one and the same. But there are judicial decisions which might suggest that such a resolution cannot be passed in circumstances that are not bona fide or likely to cause loss to circumstances or loss to creditors. This would include where a company’s insolvency practitioner loses the opportunity to sell the business goodwill.
A director of a previous company that has gone insolvent still has options to not be held liable to his old company for his actions. Directors can seek relief from the court (under the old S. 727 Companies Act 1985) that he or she should not be held liable to their old company for their actions.
However, it must be questionable as to whether the court would sanction the director for using intellectual property, including customer contracts, from the old company to their advantage. One of the reasons for the sanction may be that instead of using the intellectual property for their advantage to start afresh, this could have been sold to the insolvency practitioner for the creditors’ benefit. Again, the circumstances of the director are incredibly important to whether they will be held liable to their old company for their actions, if there was no agreement in place when they left the company.
Overall, should a director have entered an arrangement to buy the company and assets from the insolvency practitioner, then they are free to do as they wish. If not, then the director must not derive a profit from an opportunity arising out of his or her position as a director. If a director uses the old company’s intellectual property without an arrangement, the consequence may be that they are still liable to account to the company for any profits they make.
For more advice on the fiduciary duties of directors to their company following insolvency, contact Irwin Insolvency. Irwin Insolvency are expert insolvency practitioners based in the West Midland who have over 25 years’ experience dealing with businesses of all sizes in a variety of different industries.
Interesting related article: “What is Bankruptcy?“