Directors' responsibilities in trying times

The commonly-known duties and responsibilities of a director

An individual who is appointed as statutory director of any company owes fiduciary duties and responsibilities to the company. These fiduciary duties and responsibilities include:

• Acting honestly
• Exercising duties with skill, care and diligence
• Exercising powers in good faith for the company’s interests
• Avoiding situations which may give rise to conflict of interest
• Not using the position to gain personal advantage or cause detriment to the company
• Disclosing interests in any transactions involving the company
• Keeping proper accounts as well as books and records
• Complying with prevailing laws and regulations

But what happens when the company is insolvent or heading towards insolvency?

In addition to the above mentioned fiduciary duties and responsibilities, directors should also be aware that they owe the Creditor Duty to the company especially when the company is insolvent or heading towards insolvency.

In a recent case, the Singapore High Court and Court of Appeal have given guidance that directors are obliged to consider the interests of creditors as part of his duty to act in the best interest of company. This is known as the Creditor Duty.

This Creditor Duty must be considered not only when the company in insolvent, but when the company is in a financially parlous situation. As a guidance, financially parlous is a situation that is less severe than being on the verge of insolvency.

When the company is financially parlous or heading towards insolvency, the creditors of the company become the main stakeholder. The creditors’ interest carries more weight than the interest of the shareholders as the company is effectively using creditors’ monies to continue trading. For this reason, directors must consider the Creditor Duty when the company is approaching insolvency.

Potential offences under Creditor Duty

‍As a director, it is important to understand and be aware of the potential offences under the Creditor Duty. When a company is financially distressed, directors and management are likely to be devoting their energy and effort in dealing with operational issues and challenges on a daily basis. Very often, they may overlook certain actions which may be legally offensive without realising the impact of their actions and decisions.

Some of these offences include:

• Trading when the company is insolvent
• Cause the company to incur debt with no prospect of repayment
• Example: Continue trading and order goods from suppliers when the company is unlikely to have the means to pay for the goods

‍

‍

• Carrying on business with the intention to defraud creditors or any other persons
• Example: Devise a scheme to borrow money with no intention to repay. The loan subsequently goes into default and the company is placed in liquidation, therefore avoiding repayment for the loan

‍

‍

‍

• Giving preference to selected creditors with the intention to put them in a better position than other creditors
• Takes place when the company is insolvent or become insolvent as a result
• Example: Choosing to pay down a shareholder's loan instead of the company's suppliers when the company is facing cashflow constraint

‍

‍

• Transferring the company's asset at no consideration (gift) or significantly less than the value
• Takes place when the company is insolvent or become insolvent as a result
• Example: Transferring the ownership of company car to another director/shareholder with no consideration or based on large discount to the market value when the company is in financial distress

‍

‍

Directors who cause the company to carry out transactions relating to the above may face legal actions that may result in them being made personally liable for the losses suffered by the company and/or face jail terms if convicted.

When is a company considered to be insolvent?

Insolvency refers to the inability of a company to pay its debts.

In a 2021 case, the Singapore Court of Appeal provided clarification that the cashflow test should be the only test to determine if the company is insolvent, i.e if it is able or unable to pay its debts.

In the cash flow test, a company is only considered to be insolvent if it is unable to pay its debts as they fell due, as opposed to the balance sheet test where the company is considered to be insolvent if it has more liabilities than assets.

Debts which are outstanding but have not fallen due are not taken into account in the cashflow test.

Going by this principle, in a situation where the company is still able to pay for debts which have fallen due, it is still considered to be solvent even if its liabilities exceeded its assets.

If you know of anyone who may have queries on the aforesaid Directors’ responsibilities or facing similar situations and need further advices, please feel free to reach out to our Advisory team via contact@finova.com.sg