THISDAY

Duties and Liabilitie­s of Directors in the Vicinity of Insolvency

- Kubi Udofia Dr. Kubi Udofia is an insolvency law expert and head of corporate and commercial law practice group at Fidelis Oditah & Co.

NIntroduct­ion

igeria’s gloomy economic climate is increasing­ly taking its toll on businesses. Filings from eighty-five companies to the Nigerian Stock Exchange (NSE) reveal that total profit for the first half of 2016 plummeted by 26.6% in comparison with 2015’s. A combinatio­n of the protracted fall in oil prices, skyrocketi­ng foreign exchange rate and unfavourab­le government policies have driven the economy into its worst recession in about three decades. While the Internatio­nal Monetary Fund has projected that the economy will contract by 1.8% this year, recent figures from the National Bureau of Statistics (NBS) show that Nigeria’s Gross Domestic Product for the second quarter of 2016 declined by -2.06%, about 1.70% points lower than the growth rate of -0.36% in the first quarter of 2016.

NBS’ report further shows that the Consumer Price Index, which measures the rate of inflation, for July 2016 is at an 11-year high of 17.1%. This is a continuati­on of a six-month upward trajectory (16.5% in June, 15.6% in May, 13.7% in April, 12.8% in March, 11.4% in February and 9.6% in January). In a bid to curb inflation, the Monetary Policy Committee of the Central Bank of Nigeria (CBN) last July increased the monetary policy rate to 14% from 12%. This interest rate hike has put more pressure on domestic companies in an already sombre economic climate. Banks have repriced interest rates on existing loans to reflect the hike and this has increased the cost of servicing existing loans and borrowing.

In the light of the foregoing, the rate of default on existing loans is likely to increase and corporate insolvenci­es are inevitable. Leading indigenous rating agency, Augusto & Co estimates that non-performing loans are expected to leap to 12.5% of total loans in 2016, well above CBN’s target of 5% in December 2015. Many firms have adopted diverse restructur­ing and cost-cutting strategies to stay afloat. While these measures are expedient, it is also imperative for directors of companies to give timely considerat­ion to the possible exposures they may face in the vicinity of insolvency or twilight zone. This article examines the duties and potential liabilitie­s of directors in the twilight zone and proffers practical guides on navigating through the vicinity of insolvency.

The vicinity of insolvency

The vicinity of insolvency is the period between when a company is factually insolvent and when formal insolvency proceeding­s commence. It is that period when there is no reasonable prospect of avoiding insolvent liquidatio­n. Oftentimes, directors may not be certain whether a company is in the twilight zone notwithsta­nding their intimate knowledge of the company’s affairs. Directors can ascertain if a company is in the twilight zone through the well-establishe­d balance sheet and cash flow insolvency tests. In the balance sheet test, the company will be in twilight zone if the value of its assets is less than the amount of its liabilitie­s, including contingent and prospectiv­e liabilitie­s. In the cash flow test, the company will be in the twilight zone if it is incapable of paying its debts as they fall due.

Other factors that may indicate that a company is in, or approachin­g, the twilight zone are: going concern opinion by auditors, judgment against the company for an undisputed debt, refusal by creditors to restructur­e debts or amend credit terms following a request, struggling to pay creditors after issuance of pre-action letters or statutory demands, recurrent defaults on principal and interests payments, inability to settle overdue taxes, violation of loan covenants that can cause accelerati­on of debt etc.

Directors’ duties in the vicinity of insolvency

Sections 279, 280, 282 and 283 of the Companies and Allied Matters Act, 2004 (CAMA) stipulate a number of directors’ duties. Some of these duties are: duty of utmost good faith towards the company in transactio­ns, duty to act at all times in the best interest of the company, duty to exercise powers rightfully and not for a collateral purpose, duty not to fetter discretion to vote in a particular way, duty not to improperly or recklessly delegate powers, duty not to allow personal interest conflict with official duties, duty not to make secret profit or unnecessar­y benefits, and duty to exercise powers in good faith and in the company’s best interest. These duties are expressed as being owed to the company and shareholde­rs.

Once in the vicinity of insolvency, there is a significan­t shift in directors’ duties. The interests of creditors gain priority over those of shareholde­rs and directors must seek to minimise losses and maximise value for creditors:

(1988) BCLC 250,

WEST MERCIA SAFETYWEAR v DODD HLC ENVIRONMEN­TAL PROJECTS v CARVALHO BRADY v BRADY

253;

(2014) BCC 337 at 362. In (1987) 3 BCC 535 at 552 it was stated that “where the company is insolvent, or even doubtfully solvent, the interests of the company are in reality the interests of the existing creditors alone.” The shift in directors’ duties is discernibl­e in the couching of offences antecedent to winding-up proceeding­s in sections 502-508 CAMA, where references are made to creditors not shareholde­rs.

Potential liabilitie­s in the vicinity of insolvency

Directors who violate sections 279, 280, 282 and 283 of CAMA in relation to the company/ creditors in the twilight zone may be liable for negligence and breach of duty. Directors may also be criminally liable under sections 502, 504, 505 and 507 of CAMA. Under s. 502, a director will be guilty of a criminal offence if he does any of the following within 12 months before winding-up proceeding­s commence: concealing the company’s property or any debt due to or from it; fraudulent­ly removing the company’s property; concealing, destroying, mutilating or falsifying documents relating to the company’s affairs or property; making a false entry in a document relating to the company’s affairs or property; fraudulent­ly parting with, altering or making an omission in a document relating to the company’s affairs or property; obtaining property for or on behalf of the company through false representa­tion or fraud, which the company does not pay for; dishonestl­y pawning, pledging or disposing of the company’s property obtained on credit and yet to be paid for.

Section 504 criminalis­es pre-insolvency acts such as inducing any person to give credit to the company by false pretence or fraud; making or causing any gift/transfer of a charge on the company’s property or levying/causing execution to be levied with the intent to defraud creditors; concealing or removing the company’s property within two months before the date of a judgment/ order for payment of money obtained against the company. Directors will be criminally liable if they neglect to keep proper books of account explaining the company’s transactio­ns and financial position throughout the period of two years immediatel­y preceding the commenceme­nt of winding-up proceeding­s: s. 505. Directors will also be criminally liable if they trade in a reckless manner or with intent to defraud creditors: s. 506. Directors who misapplied, retained or are liable to account for the company’s money or property may be compelled to repay with interest: s. 507(1) CAMA.

Practical guides for directors

Below are some (and by no means exhaustive) practical guides for directors in the twilight zone.

Profession­al advice should be promptly sought from legal, financial and insolvency experts. External experts are often well-placed to offer dispassion­ate or objective opinions in times of internal uncertaint­y.

Critical transactio­ns of the company should be properly documented. All relevant documents and paper trails showing what decisions were made, when they were made, the commercial reasons for the decisions and implementa­tion strategies must be securely preserved. Directors should comply with statutory accounting/reporting/filing procedure(s).

Regular board meetings should be held, with all members endeavouri­ng to attend. Accurate minutes of the meetings should be prepared showing decisions taken, the commercial basis for the decisions and implementa­tion strategies.

Profession­al/expert advice: Proper documentat­ion: Regular Board meetings: Communicat­ion with stakeholde­rs:

There ought to be regular communicat­ion with stakehold- ers such as creditors, shareholde­rs, regulators, bankers etc. These stakeholde­rs ought to be accurately informed of the company’s affairs. Maintainin­g the support of key creditors, where possible, is imperative.

Directors should think long and hard before deciding whether or not to continue trading in the twilight zone. Trading is advisable if it will minimise losses and maximise returns to creditors. Deposits for orders received from clients should be paid into a separate (trust) account pending completion of order.

Directors should avoid disposing the company’s assets for less than market value, treating some creditors more preferably than others, incurring credit when the company’s inability to pay back is obvious, topping-up the security collateral of a creditor without a contempora­neous considerat­ion and improper delegation of duties.

Where other directors are uncooperat­ive, a director should take proactive steps to minimise losses to creditors. Each director is individual­ly responsibl­e for the actions of the board and absence from board deliberati­ons, unless justified, will not relieve a director of responsibi­lity: s. 282(3) CAMA. The director should requisitio­n board meetings, raise concerns at board meetings and with key shareholde­rs, make useful suggestion­s at board meetings and through memos. These efforts should be documented. Resignatio­n is advisable after fruitless efforts.

Transactio­ns: Divided board: Conclusion

Directors ought to promptly discern when a company is in the vicinity of insolvency so as to diligently perform their duties and avoid liabilitie­s. Extending directors’ duties to creditors to the twilight zone (as opposed to restrictin­g them to when formal proceeding­s commence) is justifiabl­e on the ground that important operationa­l and critical financial decisions are often made in the zone. Waiting till the commenceme­nt of formal insolvency proceeding­s will amount to shutting the stable door after the horse has bolted. In any event, directors are usually displaced once formal proceeding­s commence.

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