2.7.7 Company insolvency matters

When a company becomes insolvent, obviously non-executive directors risk damage claims against them to contribute to the assets of the company. This is more a theoretical than a practical worry. Ordinarily the board controls litigation decisions and will rarely sue its own members. The few derivative suits, so far, against directors, are described above and have not been successful to date. However, once a company enters a reorganization process onder UK insolvency legislation known as "administration", the administrator is authorised to sue in the name of the company. The liquidator who is appointed instead upon insolvency of the company has the same power. Also section 212 of the Insolvency Act 1986 authorises the liquidator to apply to the court for an order requiring the directors to make a contribution to the company's assets if they have breached a duty owed to the company. There is, however, no reported decision in which an administrator or liquidator has exercised his right to bring an action against a director, whether an executive or an outside director. Liquidators have brought some cases to court, but none involving a public company.1

There is another cause of action. A liquidator may petition the court to tule that the directors have engaged in "wrongful trading". This is the case if the company is insolvent and the director knew or ought to have concluded that there was no reasonable prospect that it could avoid this fate and he failed to take every step a reasonable director could have taken to minimise the creditors' potential loss. These cases, too, are rare. Essentially because, though the Insolvency Act requires evidence of "failed to take every step that a reasonable director would have taken", it gives no guidance as to what those steps might be. The amount of the contribution to be paid and "the relationship between cause and effect", i.e. "causation" can also be difficult. Liquidators, usually accountants, are hesitant to start complicated litigation which they might lose.

Finally, D&O insurance policies typically cover this type of liability in bankruptcy cases. There is doubt about the validity of the insurance, because some view this "wrongful trading liability" as penal, i.e. having a reference to criminal law, rather than compensatory, i.e. belonging to civil law. If it is penal, it would make the insurance invalid.2