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Home / ... / Insolvency - Section 150 Restriction Applications

The most significant impact of the 2001 Company Law Enforcement Act on insolvency practitioners has been the removal of their discretion as to whether a restriction application should be brought against an errant director. A liquidator of an insolvent company is now required to report to the Office of the Director of Corporate Enforcement (ODCE) on the affairs of the company within 6 months of his appointment. This Section 56 report sets out, among other things, the liquidator’s view as to whether the directors acted honestly and responsibly. The liquidator will be obliged to bring a restriction application against the directors unless relieved of the obligation of doing so by the ODCE. Section 150 of the Companies Act, 1990 obliges the court to restrict a director of a company that goes in to insolvent liquidation unless the director proves that he acted honestly and responsibly in relation to the conduct of the affairs of the company and that there is no other reason why it would be just and equitable to restrict him. Restricted individuals cannot act as a director or secretary of another company for a period of 5 years unless that company has a paid up share capital of €63,487 in the case of private companies or €317,435 in the case of public companies. It is an offence for a restricted director to subsequently act as a director of a company which does not meet these minimum capital requirements. Such a director may be made personally liable for the debts of the company if it goes into insolvent liquidation. A company which meets these capital requirements and seeks to appoint a restricted person to its board, will itself be subject to the following restrictions:

a) The company cannot avail of the Section 60 whitewash procedure for the provision of financial assistance for the purchase of its own shares;

b) The company cannot avail of the exemptions under the Companies Acts to the prohibition on a company making loans, quasi-loans and entering into credit transactions in favour of directors and persons connected with the directors.

c) The restrictions that preclude public limited companies from allotting shares for non cash consideration unless certain conditions are satisfied will apply to a private limited company which appoints a restricted director to its board. In determining whether to make a restriction order, the court considers any incompetence or lack of probity on the part of the director and examines the director's responsibility for the insolvency of the company. In addition, the court reviews the extent to which the director has complied with his obligations under the Companies Acts. A number of recent High Court decisions have examined the type of conduct that will warrant a restriction order and the following trends are emerging:

• Failure to keep proper books of account: In a significant number of cases, the High Court has imposed a restriction order when faced with inadequate company financial books and records that do not comply with the basic standards required under the Companies Acts. • Failure to take account of the company’s insolvency: Once the directors become aware of the financial difficulties faced by the company and the company enters the “zone” of insolvency, steps must be taken by the board of directors to address the situation. Board meetings should be held regularly; management accounts should be kept up to date and the integrity of the financial information being presented to the board should be tested; advice should be taken from an independent accountant preferably with insolvency expertise and if appropriate, a restructuring plan considered. All of these actions should be well documented in detailed board minutes.

• Trading while insolvent: In some circumstances it may be reasonable for the directors to take the view that the company can trade out of its financial difficulty. The courts have consistently held that the conduct of the directors should not be assessed with the benefit of hindsight. However, the awaited cash injection - whether from sales, borrowings or equity funding - cannot be a mere possibility but must be a reasonable expectation supported by independent evidence. Equally, where directors have used money owed to the Revenue Commissioners to fund trading or allowed the company to incur large amounts of credit without any real prospect of repayment, the courts are likely to make the restriction order.

• Fraudulent preference of creditors: There are a number of cases where directors have used incoming receivables to reduce a bank overdraft facility where such facility was secured by a director's personal guarantee. Without exception, this conduct has resulted in the court making a restriction order.

• Irresponsible drawings: Large director salaries and liberal use of expense accounts while a company is in the zone of insolvency and subsequently goes under, will not be considered the actions of a responsible director. Conversely, the courts tend to look favourably on directors who decline to draw a salary or invest personal resources in the company while it is in difficulty.

• Failure to assist the liquidator: The courts are quick to sanction directors who do not assist the liquidator when asked.

In a recent case, Mrs. Justice Finlay Geoghegan held that in addition to the duties under the Companies Acts, each director must comply with his common law duties of skill, care and diligence in relation to the exercise of his functions. This was interpreted as a minimum obligation on each director, including non-executive directors, to keep himself informed about the affairs of the company and to join with his fellow directors in supervising and controlling the affairs of the company. The court acknowledged that non-executive directors should be allowed a certain measure of delegation as they were not involved in the day to day running of the company. Nonetheless the court was clear that it was not acceptable for any director to remain ignorant of the affairs of the company or fail to exercise adequate supervision. This reaffirms the attitude adopted by the court in another recent judgement where a non-executive director who kept himself informed of the company’s affairs and exercised a monitory role towards the company's financial situation avoided a restriction order. This jurisprudence emerging from Section 150 actions shows the High Court is actively promoting the high standard of corporate governance envisaged by the 2001 Act. The courts will expect compliance from directors with their obligations under the Companies Acts and their common law duties as directors will also be scrutinised.

Accountancy Ireland, Vol 36, No 6, December 2004.

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