FLK1 · Multiple-choice practice

FLK1 Business Law — Question 14

Question

Xylo Ltd, a company specializing in IT services, is facing financial difficulties and may be unable to pay its debts. The company’s directors decide to continue trading, hoping to turn the business around. However, they fail to inform the company’s creditors about the company’s financial situation. Which of the following statements is correct regarding the directors’ actions?

The directors are personally liable for the company’s debts because they continued trading while insolvent.
The directors are protected from personal liability because they were acting in the best interests of the company.
The directors can avoid personal liability if they can demonstrate that they had a reasonable belief the company could overcome its financial difficulties.
The directors are automatically disqualified from acting as directors due to the company’s insolvency.
The directors’ personal liability depends on whether they have personally guaranteed any of the company’s debts.

Answer and explanation

Correct answer: C. The directors can avoid personal liability if they can demonstrate that they had a reasonable belief the company could overcome its financial difficulties.

Directors have a duty to avoid wrongful trading, which includes continuing to trade when the company is insolvent and there is no reasonable prospect of avoiding further losses to creditors. By failing to inform the company’s creditors about the financial situation, the directors are in breach of their duty and may be held personally liable for the company’s debts incurred during the period of wrongful trading.

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