Directors Face Personal Liability When They Fail to Disclose That Their Company Is in Financial Distress

Unfortunately, a lot of sectors are facing dire straits in these tough economic times. Instances of companies entering business rescue or liquidation are on the rise. What we have noticed in a number of these instances is that directors are woefully unaware of their responsibilities to stakeholders once a company becomes financially distressed. Ignoring these responsibilities may well result in a director facing criminal sanction or being found to be personally liable for the debts of a company.

Written By of Cowan-Harper-Madikizela Attorneys

A Reminder to Debtors and Creditors Both – Directors Face Personal Liability When They Fail to Disclose That Their Company Is in Financial Distress

The Companies Act, 71 of 2008 places certain reporting and accountability provisions on directors where a company is financially distressed or trading in insolvent circumstances. As a general rule of thumb, directors of a company should strongly consider placing the company into business rescue where it is financially distressed. The term financially distressed has little to do with the levels of angst of directors. Where it appears to the directors that a company will be reasonably unlikely to be able to pay all of its debts when they become due, or it appears reasonably likely that a  company will become insolvent within the immediately ensuing 6 months – the company is financially distressed.

While the Companies Act does allow directors the discretion as to whether to place a company in business rescue where it is financially distressed, it also places a duty on the directors to disclose to its creditors that it is financially distressed if the directors decide not to proceed with business rescue.

Likewise, if a company is trading in insolvent circumstances, directors of a company should strongly consider placing the company into liquidation. It is assumed that directors will firstly become aware of a company being in financial distress prior to a company commencing to trade under insolvent circumstances.

The Companies Act views directors who knowingly ignore these circumstances in a poor light. Allowing a company to trade knowing it is in financial distress or in insolvent circumstances without notifying creditors could easily be viewed as reckless or negligent or even as an intention to defraud creditors.

Reckless trading or conducting business with the intention of defrauding creditors results in liability of a company’s directors for the loss sustained by a company. This is bad news for directors of debtors and good news for creditors. Creditors can insist that an inquiry be held into the conduct of the directors of a debtor company with a view to recouping debt direct from the debtor company directors where a debtor company is placed in liquidation.

And then, additional angst for directors of debtor companies, unrelated to financial (dis)stress, is that allowing a company to trade recklessly or negligently with the intent to defraud creditors attracts criminal liability.

If you believe that a company on whose board you sit is nearing the point of being financially distressed, carefully consider your obligations and keep it in mind that laxity on your part, or willingly ignoring your obligations, could come home to roost at your front door.

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