Directors Beware: Reckless Trading Has Its Consequences…

Recently, the Directors of a large construction company were held liable for $36 million after they allowed the company to trade recklessly.

The company was trading for nine years while it was insolvent, and as a result it owed $110 million to its unsecured creditors. The directors of the construction company have been held personally liable (subject to appeal), and are being required to pay between $6 million and $24 million each, for breaching their duties and allowing the company to engage in reckless trading. 

While this was a large company and big news, the issue and the law also applies to small to medium sized businesses.  Therefore, if you are a Director, you should ensure you understand the meaning of “reckless trading” in the context of your business.

What is reckless trading?

The law against reckless trading prevents companies from trading while they are insolvent.

Before any company, large or small, enters into a transaction, all Directors must be satisfied that the company can pass the “solvency test”.  This test requires the Directors to be sure, prior to entering into a transaction, that after completing the transaction the company has the ability to pay back its creditors, and that its assets will still exceed the value of its liabilities.

If the solvency test is not satisfied and the company still enters into a transaction(s), it is possible that the company could be engaging in reckless trading and the directors could be personally liable.

Your obligations as a Director… even if you’re a “Hands-Off” Director

All Directors need to ensure they always act in the best interests of the company and to ensure they satisfy the solvency test before entering into transactions.   

All Directors, including “silent Directors” (who have no hands-on role in the business), should be aware that if they do not comply with their Director duties then they could be held personally liable… possibly for a significant amount.

Therefore, it is important for Directors to have a good understanding of the risks associated with each transaction. Directors of larger companies should introduce formal procedures to oversee the risks, these could include having audit committees and/or a formal risk register. For smaller companies, Directors need to consider the financial position of the company before making any decision.

The construction company example is an important reminder to Directors that they have a duty not to allow their company to engage in reckless trading. If your company starts to show signs of financial difficulty, it is recommended to seek professional advice before your company enters into any transactions.