Transactions entered into by a company during the twilight period could render directors personally liable.
What is the Twilight Zone?
The Twilight Zone is the time period that begins when a company becomes insolvent and ends when the company enters a formal insolvency process (e.g. administration or liquidation). A liquidator/administrator will look closely at the company’s dealings and what they find could mean that the limited liability that directors thought that they enjoyed is breeched.
Directors, and shadow directors (persons "in accordance with whose directions or instructions the directors of a company are accustomed to act") could incur personal liability for certain transactions and could end up in a costly legal battle with the liquidator or administrator, trying to defend themselves against charges, for example, that they failed to act in the best interests of the company.
Directors ask a number of questions:
- How will a director know that a company has become insolvent?
- What is then the duty of directors?
- What sorts of transactions could the liquidator/administrator challenge?
- What can directors do to protect themselves?
When does a company become insolvent?
When the company became insolvent is a fact and is important because, for some claims that might be made against directors, the liquidator/administrator will have to show that the company was insolvent at the time the transaction was entered into by the company or that the company became insolvent as a result of the transaction.
Two tests are used to determine if a company is insolvent:
- The cash flow test – the company cannot pay its debts as and when they fall due,
- The balance sheet test – the company’s liabilities exceed its assets.
A company enters into a formal insolvency process when, for example, a winding up petition (for a compulsory liquidation) is presented to the court, a notice is filed in the court for an intention to appoint, or a resolution is passed by the company to wind up.
Once it has been shown that the company is insolvent, what then should a reasonable board of directors actually do?
What sorts of transactions could the liquidator/administrator challenge?
There are at least five types of challenges that a liquidator/administrator could make:
1. A claim that a transaction was entered into by the company in order to prefer a creditor.
Time limit: six months before the company enters a formal insolvency process.
The time limit will be 2 years if the person who is preferred is connected to the company.
2. A claim that a transaction was carried out at an undervalue.
Time limit: 2 years before company enters a formal insolvency process.
3. Extortionate credit transaction.
Time limit: 3 years before company enters a formal insolvency process.
4. A transaction that defrauds creditors.
Time limit: there is no time limit.
5. A disposition of an asset after a winding up petition has been presented to the court.
Time limit: from the date of the petition to the date that the company enters a formal insolvency process
In addition, when a director knows, or he should have known, that insolvent liquidation is the only outcome for the company he is personally at risk of wrongful trading unless he does everything he can do to minimise the loss to the creditors. A director who causes the company to incur further credit potentially risks providing additional support for a claim that he allowed wrongful trading.
How can we help?
Gore and Company is able to advise directors facing insolvency on the risks to directors associated with transactions entered into while the company is in the twilight zone. Where possible we will advise on how the company might be saved, through, for example, an arrangement with creditors or a CVA. Where that opportunity has passed we will advise the directors on the insolvency procedures available to them such as administration or liquidation. Early and prompt action is usualy best to protect directors interests.