Good Intention is no defence

A Trustee of a charity should be cognisant that they could face the same potential risks, both reputational and/or in respect of personal liability, as that of a director of a failed insolvent company.      

It would appear from recent articles in the press, that there is a likelihood that the Insolvency Service may bring proceedings against any one or more of the Trustees/directors of Keeping Kids Company (“Kids Company”) with a view to disqualifying them from being involved in the management of another company for a defined period.

The purpose of this article is broadly to summarise, (1) the basis upon which the Insolvency Service may bring disqualification proceedings against one, or more, or all of the Trustees/directors of Kids Company and (2) more generally, the potential risks of claims being brought by the office holders (liquidator/administrator) of a failed and insolvent charity/company against its trustees/directors, where considered responsible and culpable for its failure, making them personally liable to make a contribution to the charity/company’s assets, mitigating its deficit to its creditors.

A winding-up order was made in the High Court of Justice against Kids Company on 20 August 2015, upon the petition of its directors. We do not know the precise grounds and circumstances on which the petition was brought and the winding-up order was made. The Official Receiver (the Insolvency Service) was automatically appointed as the liquidator of the company. This is what is commonly termed as a ‘compulsory liquidation’.

The primary duty of a liquidator is to realise the company’s assets for the benefit of its creditors. Furthermore, the liquidator (the Official Receiver in case of a compulsory liquidation) has a statutory duty to investigate the company’s affairs and in conjunction, submit a report to the Department for Business, Energy and Industrial Strategy (BEIS), in reality the Disqualification Unit of the Insolvency Service, on the conduct of the director(s) of the company pursuant to the Company Directors Disqualification Act 1986.

It is the Secretary of State/the Disqualification Unit that decides whether a director’s conduct is so poor and, as such, it is in the public interest to make an application to Court for an order for the disqualification of the director on the grounds that he/she is unfit to be concerned in the management (and promotion and formation) of a company. Various matters of conduct are considered in determining whether a director is unfit. Typically they include (amongst other things):

Continuing to trade at the risk to creditors (broadly speaking, trading whilst insolvent);
Misapplying company assets or breach of any duty owed by the director to the company including in particular any breach by the director of a duty under of the Companies Act 2006 (general duties of directors);
The extent of the director’s responsibility for the causes of the company becoming insolvent; and
Misleading creditors as to the company’s financial position.

The minimum period of disqualification is 2 years, with a maximum period of 15 years. The Disqualification Unit has three years within which to commence proceedings against a director. However, the Disqualification Unit can seek to obtain the consensual agreement of the director to an undertaking from him/her to be subject to the same prohibitions as an Order may otherwise provide.

Clearly, if an individual is disqualified either by an Order or by an undertaking, there is not only the consequential lasting reputational damage to the individual concerned, but also the prohibitions placed upon him/her from acting in any capacity in relation to any other business with the potential consequential loss of livelihood.     

Quite separately (and additionally), once the company has been wound up (or placed into administration) claims may be brought by the company’s insolvency office holder (an administrator or liquidator) against the company’s trustees/directors for a court order making them personally liable to make a contribution to the company’s assets or to repay assets (or their value) improperly paid away.  By definition, a limited liability company protects the directors and owners of the business from incurring any personal liabilities in the event that the company fails and defaults on its debt obligations. As the name implies, a limited company limits the liabilities of directors, but it does not completely eliminate the possibility of the “veil of incorporation being lifted” and one or more of the directors being held personally liable.

Whilst there are a variety of claims that may be brought by an administrator or liquidator under the Insolvency Act 1986 or (at the office holder’s instigation) by the company itself against its directors, typically these may include claims:

• That company assets have been misapplied or not been paid for a proper purpose in the interests of the company;
• For wrongful trading – the director knew or ought to have known that the company had no reasonable prospect of avoiding insolvent administration or liquidation. In such cases the director may be held personally liable to contribute for the increase in losses suffered by creditors from the time when the director ought to have appreciated that there was no such prospect;
• In more serious cases for fraudulent trading.

Directors who can show that they have taken reasonable and objective business decisions based on accurate financial information and appropriate professional advice will be unlikely to be penalised if their decisions or assumptions subsequently turn out to be wrong, so long as it was reasonable at the time to believe that insolvency could be avoided. There are of course a number of practical steps a trustee/director should take to seek to avoid personal liability generally and, more specifically, where there is even an acute risk of potential failure, including for example:

• Explore all options;
• Take care when entering into potentially vulnerable transactions;
• Monitor financial performance and forecasts more regularly;
• Ensure frequent Board Meetings and keep Minutes;
• Voice any concerns and ensure these are recorded;
• Take prompt independent professional advice (legal and accounting);
• If all else fails and it is untenable to continue, consider whether to resign, and providing written reasons with legal advice; and
• Maintain a Directors’ & Officers’ policy and consider, where necessary, making a precautionary notification.