Directors Guilty of Misfeasance in Insolvency Proceedings

Some directors will always sadly be tempted to denude troubled businesses of their assets before they formally become insolvent. However, companies are not personal piggy-banks and, as one High Court case showed, the consequences of such conduct can be severe indeed.

The case concerned an insolvent company that was run by a husband and wife and which owed HM Revenue and Customs (HMRC) alone more than £2.5 million when it was wound up. In the preceding year, it had made undocumented payments of almost £175,000 to the husband and more than £38,000 to the wife.

It had also paid more than £125,000 to a non-trading second company, of which the couple were also directors, and more than £68,000 to a bank in respect of legal costs relating to an alleged fraud of which the couple had been accused. The liquidators of the insolvent company launched proceedings to recover all of those sums.

In upholding the claim in its entirety, the Court found that the couple were de facto directors of an insolvent company and it was not in a position to pay its debts when the payments were made. It had underpaid Income Tax and National Insurance Contributions and had used HMRC as a source of working capital.

In the circumstances, they had no business making the payments to themselves: these were effectively gifts. The remittances to the dormant company, which were almost immediately transferred on to the husband, were not made for genuine commercial reasons. The payment to the bank was a consequence of the couple's own wrongdoing. Both husband and wife were found guilty of misfeasance and breaching the fiduciary duties that they owed to the insolvent company as directors.

Company law prohibits the payment of any 'distribution' if the company does not have sufficient retained reserves to make the payment. As a company is, in law, a separate person from the directors, it also prohibits the use of company funds for the personal purposes of the directors. Lastly, it is unlawful for directors to allow a company to continue to trade if they know it to be insolvent and there is no reasonable prospect that it will be able to meet its debts.

Among the remedies available to the liquidators or administrators is to sue the directors for sums improperly withdrawn. Where circumstances are sufficiently grave, the directors can be made personally liable for a company's debts.

Lastly, it is usual that in severe cases, the Insolvency Service will seek an order to ban a director from holding office as a company director for a period of time.