A director’s liability in the face of corporate insolvency: what you need to know

No one could have predicted the impact of the COVID-19 pandemic on businesses and economies worldwide. It has crippled companies all over the world with household names such a Macy’s in the US filing for bankruptcy and closer to home, the collapse of commodities trading giant Hin Leong Trading. Unfortunately, analysts speculate the worst is yet to come.

Economies around the world will inevitably enter a period of recession, leading to more and more companies facing the prospect of insolvency. It may not be possible prevent this insolvency tsunami but it is important for a director whose company is on the brink of insolvency to understand the extent of their duties to the company in order to avoid exposing themselves to personal liability.

Below, we provide a guide on what a director’s duties are when a company is on the brink of insolvency as well as how this has changed in light of legislation introduced in Singapore as a response to the ongoing pandemic.

A director’s duty in the face of corporate insolvency

Generally, a director owes both a statutory and fiduciary duty to act in the company’s best interests. As a company is owned by its shareholders, this duty is owed primarily to the company’s shareholders.

However, when a company is insolvent or even when it is on the verge of insolvency, the director’s duty shifts from a duty to its shareholders to a duty to its creditors. This duty requires a director to take into account the interests of the company’s creditors when making decisions for the company.

The rationale for this is that when a company is wound up, the assets of the company are to be divided amongst its creditors. Hence, when a company is on the verge of insolvency the directors then owe a duty to the company’s creditors to ensure, as far as possible, that there are assets to recover when the company goes under. In certain instances, a director’s breach

of this duty can carry, not only civil liability, but also criminal liability. When a company becomes insolvent and a liquidator is appointed, the liquidator has the power to review the affairs of the company prior to the liquidation to uncover any wrongdoing by the company’s directors.

Specific offences a director may be liable for in the event the company is wound up

There are a number of offences that a director may potentially be liable for in the event the company is wound up. We set below the key offences:

Failure to disclose or deliver company property: concealing the state of affairs of the company

Any director (both past and present) must disclose all the property of the company, as well as disclose details (e.g. cost, recipient, timeline, purpose etc.) of how any of the company assets were disposed of prior to the company’s liquidation. The director must also deliver to the liquidator all property, books and papers belonging to the company that are in the director’s custody and control. Failing to do any of the above, or concealing the state of affairs of the company in any other way, is a criminal offence; if convicted, the director will be liable to a fine up to $10,000 or to imprisonment for up to 2 years.

Destruction or falsification of company books

It is a criminal offence for a director to destroy or falsify any books or documents, or to have knowledge of another person making false entries in the company books with the intention to deceive or commit fraud. Upon conviction the director will be liable to a fine up to $10,000 or to imprisonment for up to 2 years.

Failure to keep proper books of account

A director may be criminally liable if it is found that the company failed to keep proper books of account for the two years preceding the winding up, unless he can prove that he acted honestly and reasonably and that the failure to keep the proper books was excusable given the conditions under which the company operated. The books must be kept in a manner which allows the company’s financial position and the transactions of the business to be conveniently and properly audited, or in a manner which exhibits and explains the financial position and transactions of the company. If convicted, the director will be liable to a fine up to $5,000 or to imprisonment up to 12 months.

Insolvent trading

If a director causes the company to incur debt (while trading) when the director knew or should have concluded that there was no reasonable prospect of avoiding liquidation, then the director may be guilty of insolvent trading. If convicted, he will be liable for a fine up to $2,000 or to imprisonment up to 3 months. In addition, the director may be held personally liable for the whole or any part of that debt.

Fraudulent trading

If it appears that the company’s business was being carried out with the intent to defraud the company’s creditors, other persons, or any other fraudulent purpose, the directors who were knowingly carrying out this fraudulent business (or were party to it) may be personally liable for all of the company’s debts. Furthermore, upon conviction, the director will be liable for a fine up to $15,000, imprisonment for up to 7 years or both.

The impact of Singapore’s COVID-19 legislation

In response to the crippling impact of COVID-19 on Singapore’s economy, the Singapore Government introduced the COVID-19 Temporary Measures Act 2020 (the “COVID Act”) in April 2020 to provide temporary relief to businesses in respect of contractual obligations which may be affected by the pandemic.

The Act is intended to alleviate, as far as possible, the impact of the pandemic on businesses and key economic sectors by providing a ‘grace period’ for certain contractual obligations as well as a suspension of some statutory provisions.

Significantly, the COVID Act temporarily suspends the liabilities of directors in respect of insolvent trading for the duration of the COVID Act. Hence, directors will be relieved of their obligations to stop trading while insolvent if the debts are accrued in the ordinary course of business. However, the COVID Act does not impact any of the other specific offence under the Companies Act mentioned above.

The provision is intended to act as an additional “safety net” for businesses, so that directors will not be liable for debts accrued in the ordinary course of business for as long as this provision in the COVID Act is in force.

Currently, this provision will be in force for six months from the date of its commencement, i.e. 20 April 2020. However, it may be extended for a further six months at the discretion of Parliament.

Conclusion

As a company approaches insolvency, it is important for directors to remember that the creditors are key stakeholders of the company. The directors must handle the delicate balance of trying to bring the company out of its financial difficulties, and preserving sufficient assets to satisfy the creditors. The COVID Act is certainly a welcome relief in these uncertain times, but directors must continue to act carefully.

If you require assistance with any director’s duty issues or any insolvency issues, please do not hesitate to get in touch with Partner Lionel Chan by email ([email protected]) or telephone (+65 6239 5874); or Senior Associate Tanya Thomas Vadaketh by email ([email protected]) or telephone (+65 6239 5870).