Directors Liability and Reckless Trading

It is important for directors to know when their actions will leave them personally liable for company debts.

While business involves taking risks, there comes a point when risk taking becomes reckless trading. While this may not involve dishonesty, it does require more than just negligence.

Section 135 of the Companies Act (the section on reckless trading) says a director must not:

  • Agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss to the company's creditors; or

  • Cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company's creditors.

The Companies Act 1993 sets out a specific list of the duties of directors. These include duties:

* To act in good faith and in the best interests of the company.

* To use the care, diligence and skills that a reasonable director would exercise in the same circumstances.

* Not to agree to the business being carried on in way likely to cause a substantial risk of serious loss to the company's creditors.

* Not to agree to the company incurring an obligation unless the director believes at that time on reasonable grounds that the company will be able to perform the obligation when it is required to do so.

Section 136 of the Act (insolvent trading)

A director of a company must not agree to the company incurring an obligation unless the director believes at the time on reasonable grounds that the company will be able to perform the obligation when it is required to do so. This provision only applies to directors who agree to the obligation being incurred.   You should note that this applies to persons who are formally designated as the directors and also can apply to the actual person who is running the company.

A company need not cease trading as soon as it becomes insolvent (in a balance sheet sense) but the time that directors can continue trading insolvently is usually limited to a matter of months before a business risk is considered illegitimate.

Directors of a company facing insolvency should critically address the issues causing the company's financial difficulties, and only incur debts when they can forseeably be paid. We strongly recommend going to an accountant and working through the issues.  If the company remains insolvent after several more months you should seriously consider ceasing trading.

Protect Your Assets

Consider protecting your personal assets through a Family Trust.  You need to do this well in advance.  If you are bankrupted within two years of setting up a trust, the Trust is null and void - there is no protection.

Recommended Reading
Two books which have saved us a lot of money are the books "Slash Your Taxes" and "Slash Your Compliance Costs" by Peter Sibbald.  These are available from our bookstore, click here.

Contact a LYFORDS adviser and we can put together a plan to protect your personal assets, put in place a succession plan and the right insurances.