A recent example of a firm going bust shows the risks company directors take if they neglect their duty to creditors and are ’wilfully blind’ to problems their business may face

In the recent case of Roberts vs Frohlich, Mr Justice Norris considered whether the directors of a property development company, Onslow Ditchling Limited (ODL) had acted improperly prior to ODL’s liquidation.

His judgment and comments are a timely reminder to directors of the need to constantly consider their duties and position on an ongoing basis and to take action and not be “wilfully blind” to issues. This is especially so for directors of property development companies, who should continually monitor the company’s position as opposed to deciding not to “enquire or consider lest an unpalatable truth be exposed.” The directors of ODL will be liable for a fine and could potentially be the subject of disqualification proceedings.

ODL was liquidised in order to acquire a single site with existing planning permission, the building and ultimate sale of 30 industrial units. Both directors were experienced professionals (an accountant and an engineer) and both had extensive experience in property development companies.

Directors should not put personal or other interests before those of the company

Mr Justice Norris acknowledged that the development was “speculative in the sense that there were risks attached”, but that this was an inherent risk of economic activity. He commented on the “wilfully blind optimism” of the directors that “something might turn up” and held that once the circumstances reached a certain stage, both directors were guilty of a breach of directors duties (which was owed to the creditors of ODL) as they failed to act in what they honestly believed was in ODL’s best interests by:

  • Instructing the contractor to undertake works in the knowledge that they had insufficient funding and that the funder was strictly adhering to terms that ODL could never meet.
  • Failing to obtain pre-sales which was not only a funding requirement, but essential for the viability of the development.
  • Failing to obtain supplementary funding rendering them to unable to meet payment to trade creditors who were pressing for payment.

They were also guilty of:

  • Misfeasance as they failed to exercise reasonable skill and care; in the circumstances no reasonable director would have continued with the development in light of the issues
  • Wrongful trading in breach of section 214 of the Insolvency Act 1986 in that they knew, or ought to have concluded, that there was no reasonable prospect that ODL would avoid going into liquidation at the stage that ODL were both balance sheet and cash flow insolvent.

Mr Justice Norris was critical of the directors’ “reckless belief that […] something might turn up” which he saw as being “groundless and folorn”.
Company directors should regularly and carefully evaluate and assess the financial position and viability of the future trading of the company. In order to assess the company’s position they should consider taking formal advice from lawyers and accountants and should:

  • Focus on doing what is in the best interests of creditors.
  • Identify “pinch points” such as payments which the company cannot make and which may set the timetable for future events.
  • Investigate a viable strategy for returning the company to solvency - one which has a reasonable prospect of succeeding - and document it.
  • Hold regular board meetings and document them.
  • Consider the need to keep major creditors informed.

The list of what company directors should not do includes:

  • Accept credit where there is no reasonable expectation of the creditor being paid.
  • Allow the company to make significant payments or grant security without first taking advice and canvassing the view of other members of the board.
  • Put personal or other interests before those of the company when dealing with matters relating to the company.
  • Continue to trade on the basis of an overly optimistic view of future prospects, for example in the “reckless belief that […] something might turn up”, which, as Mr Justice Norris stated is, “on any objective view, groundless and folorn”.

This article was originally published under the headline ’The eye test’.

Alison Cull is a senior associate at Pinsent Masons