Director’s Duties In Times Of Financial Distress

Economic activities slowed down as people around the world heed respective governments’ advice to stay indoors as the Covid-19 pandemic ravages through global economies, distressing businesses across sectors and industries.

Many companies are faced with significant constraints in cashflow and working capital in varying capacities. The pandemic wave capsized a number of businesses, spurring a series of liquidation and bankruptcy actions around the world.

Duties of a Company Director

Directors are answerable to the decisions made by the company, and this is especially so in times of uncertainties. It is crucial for directors to arm themselves with the relevant knowledge in respect of their duties and responsibilities towards the company in order to navigate choppy waters without getting the company, or themselves, into hot soup.

Whilst the title or position as a “director” may sound glamourous, the sheer pressure and the amount of responsibility involved as a company director cannot be undermined.

It is trite that a director has the duty to manage the company, regardless of whether the director is a de facto director, nominee director, substitute director and even a shadow director (section 2 of the Companies Act 2016). The following are some of the primary duties which a director should be aware of: 

• Duty to exercise power for a proper purpose and in good faith in the best interest of the company (section 213(1) of the Companies Act 2016); 
• Duty to exercise reasonable care, skill and diligence in discharging his duties (section 213(2) of the Companies Act 2016); 
• Duty to make business judgment in accordance to the Companies Act 2016 and for a proper purpose and in good faith (section 214(1) of the Companies Act 2016) 
• Duty to declare interest and to avoid any conflicts of interest (section 221(1) of the Companies Act 2016); 
• Duty to keep accounting and other records to sufficiently explain the transactions and financial position of the company (section 245(1) of the Companies Act 2016); 
• Duty to implement system of internal control to ensure assets are properly safeguarded and all transactions are properly recorded. (section 246 of the Companies Act 2016). 

Expectations During Trying Times

In view of the general duties, the next question which should be asked is what should a director do or be expected to do during these trying times? What if the company undergoes insolvency? 

A company is considered insolvent if it is unable to pay its debts as they fall due, or when liabilities of the company exceeds its assets. Under normal circumstances, directors of a solvent company will not be made liable for losses sustained by the company so long as the director has acted in good faith, for proper purposes, and in the best interest of the company.

However, when a director knew or ought to have reasonably known that a company would not avoid insolvent liquidation, he then has a duty to take every step which a reasonably diligent person would take in order to minimize potential losses to the creditors. 

When the Company Goes Under

With that in mind, the next important point which a director should take note of if a company is undergoing insolvency is that “the creditor is king”.

The interests of creditors override those of the shareholders when a company undergoes insolvency, considering that it is the creditors’ assets being held within the company rather than those of the shareholders. As such, the director owes a duty to ensure that whatever steps taken during the course of trading do not prejudice creditors or increase the company’s debts. Failure to do so may put the director at risk for wrongful trading, which carries with it unlimited personal liability.

Simply put, a director’s primary duty is to act in the best interest of the company. But what are the possible breaches which a director can be said to commit during insolvency? Well, a director can be said to have committed a breach of director’s duty if he/she continue trading either: 

• Knowing that the company has little or no prospect to pay its debts when they fall due (section 539(3) of the Companies Act 2016); or 
• With the intention to defraud the creditors of the company (section 540(1) of the Companies Act 2016) 

It is important to note that the intention to defraud creditors of the company may extend to actions before the insolvency (Tang Eng Iron Works Co Ltd v Ting Ling Kiew & Anor [1990] 1 CLJ 1239). Thus, section 540(1) of the Companies Act 2016 can operate both insolvency proceedings and also where there are no insolvency proceedings. If a company carries on the business with the intent to defraud, every person who was knowingly a party commits an offence and upon conviction, shall be liable to imprisonment for a term not exceeding 10 years or fine not exceeding RM1 million or both (section 540(5) of the Companies Act 2016). 

Preferential Payment to Creditors?

The next issue which a director should look at is whether preferring payment for one over another creditor can be done during insolvency. We can refer to section 528 of the Companies Act 2016 for the answer: 

“Any transfer, mortgage, delivery of goods, payment, execution or other act relating to property made or done by or against a company which is unable to pay its debts, as the debts become due, from its own money in favour of any creditor or any person in trust for any creditor shall be deemed to have given such creditor a preference over other creditors in the event of the company being wound up on a winding up petition presented within six months from the date of making or doing the same and every such act shall be deemed fraudulent and void.”

Where payment is preferentially made to one creditor over another when there is insufficient fund in the company will amount to an undue preference in relation to the benefitting creditor. Charges, in turn, will be void against the liquidator. This is mainly to preserve the pari passu principle under which the credits in a winding-up share ratable in the assets that are available for distribution. 

Conclusion

From we can gather from the above, it is clear that the current pandemic definitely has a large impact on all of us. The uncertainty of the financial and operational risk is daunting. As such, it is crucial for the directors to be aware of their duties and obligations in their road to survival and recovery in such times. 

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Written by:
Michelle Chew