When a company is trading normally and business is good, the directors must act in the best interests of the company and to promote the success of the company for its shareholders. When the company becomes insolvent, or insolvency becomes probable, that duty does not disappear. It changes shape: the interests of the creditors as a whole come into it, and they carry more weight the worse the position gets.
In this guide, we’ll discuss the duties of company directors when a business becomes insolvent and explore the practical steps you can take to ensure those duties are met.
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When Does a Company Become Insolvent?
As a company director, you must be able to recognise when your business becomes insolvent. From that point you have to weigh the interests of the creditors as a whole alongside those of the shareholders, and give them more weight as the position deteriorates. No one will tell you when your company is insolvent, so you must be able to spot the telltale signs yourself.
A company is said to be insolvent if it cannot pay its bills as they fall due or its total liabilities exceed the value of its assets. There are a number of common symptoms of an insolvent business that you should look out for:
- You’ve reached your borrowing limit
- You’re regularly making late payment to suppliers
- You have debts building with HMRC
- Your profit margins are falling
- You’re receiving regular threats from creditors
- Staff are leaving due to concerns about job stability
- You’re being contacted by debt collectors
- You have no reliable financial forecasts or information about the performance of the business
If you recognise any of these common symptoms of insolvency in your business, there are certain tests you can do to determine whether your business is actually insolvent.
- The cash-flow test
Can the business make payments when they become due? If you are a frequent late payer or struggle to make regular payments such as staff wages, your business could be insolvent.
- The balance sheet test
Are your business’s assets worth less than its liabilities? If they are, your business could be insolvent.
What legal action does and does not prove
Alongside the cash-flow and balance-sheet tests, section 123 of the Insolvency Act 1986 gives a creditor two shortcuts. A company is deemed unable to pay its debts if a statutory demand for more than £750 then due has gone unpaid, unsecured and uncompounded for three weeks, or if an attempt to enforce a judgment against it comes back unsatisfied in whole or in part.
Those shortcuts have limits. A disputed debt does not become proof of insolvency simply because someone has taken legal action. Where a debt is genuinely disputed on substantial grounds, a winding-up petition founded on it is ordinarily dismissed or restrained, and the creditor is told to sue in the ordinary way. A bare assertion that you do not owe the money is a different matter, and will not protect you.
So treat an unpaid demand or an unsatisfied judgment as a warning to get advice quickly. Once either shortcut applies, a creditor can petition to wind the company up, and the court may make the order even if the company could pass the cash-flow and balance-sheet tests. The order is not automatic. The court has a discretion, and the petition can fail where the debt was paid, secured or compounded to the reasonable satisfaction of the creditor within the three weeks, where the debt is genuinely disputed or met by a genuine cross-claim on substantial grounds, or where the demand itself was defective.
What are the Duties and Responsibilities of a Director in Insolvency?
The usual summary is that your duties switch from the shareholders to the creditors. That is the right direction and the wrong mechanism, and the difference decides real cases.
The Supreme Court settled the point in BTI 2014 LLC v Sequana SA [2022] UKSC 25. Your duty is still owed to the company. What changes is that once you know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable, you must consider the interests of the creditors as a whole. A real but remote risk of insolvency is not enough to engage it. Those interests carry more weight the further the company slides. If an insolvent liquidation or administration becomes inevitable, they become paramount.
So there is no single moment when a switch is thrown, and waiting for one is how directors get into trouble. The duty is engaged earlier than most people expect, and it is judged on what you knew or should have known at the time, not on how things turned out.
Why are directors duties altered in insolvency?
The wrongful trading provisions give this practical shape. Once you know or ought to conclude there is no reasonable prospect of avoiding an insolvent liquidation or insolvent administration, sections 214(3) and 246ZB(3) of the Insolvency Act 1986 (the first for insolvent liquidation, the second for insolvent administration) expect you to take every step you ought to have taken to minimise the potential loss to creditors. Your behaviour must demonstrate that with clear records of emails and conversations kept and accurate books and records maintained. Fail to do so and the court can order you to personally contribute to the company’s assets. Disqualification for up to 15 years can follow too, either ordered by the court that hears the wrongful or fraudulent trading claim or in separate disqualification proceedings, both under the Company Directors Disqualification Act 1986.
When a company is insolvent or close to it, a director involved in any of the following practices risks a court order to contribute personally to the company’s assets or to repay benefits received, and disqualification:
- Continuing to trade with no reasonable prospect of avoiding insolvent liquidation or administration
Under Section 214 of the Insolvency Act 1986 (insolvent liquidation) and Section 246ZB (insolvent administration), wrongful trading is not about your intentions — it is about what you knew or ought to have concluded. If you knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation or administration, and you did not take every step a reasonably diligent person would take to minimise the loss to creditors from that point on, that is wrongful trading. It could see you banned as a company director for up to 15 years.
- Repaying debts through fraudulent means
If you try to raise funds and repay debts by conducting transactions that you cannot fulfil or use inaccurate information to obtain loans, you are at risk on two separate fronts. Section 213 of the Insolvency Act 1986 is civil: on the liquidator’s application the court can order anyone knowingly party to it to contribute to the company’s assets. The criminal offence is separate, under section 993 of the Companies Act 2006, and the maximum on indictment is ten years, a fine, or both.
- Selling assets for less than market value
You may be tempted to sell company assets for a low price to raise quick funds to repay the company’s debts. However, if those assets were sold for significantly less than their value in the two years before the insolvency began, while the company was unable to pay its debts or became unable to as a result, the liquidator or administrator can ask the court to reverse the sale under Section 238 of the Insolvency Act. The buyer can be ordered to return the asset or pay the difference, and a director who benefited, or who breached their duties in agreeing the sale, can be ordered to pay too. The court will not make an order where the sale was made in good faith to carry on the business, with reasonable grounds to believe it would benefit the company.
- Repaying some creditors and not others
When a company is insolvent, the temptation might be to repay creditors that you have a longstanding relationship with or connected creditors, such as businesses run by connected parties, ahead of others. However, you must give proper weight to the interests of the creditors as a whole. Where you put one creditor in a better position than the others, section 239 of the Insolvency Act 1986 lets the court set the payment aside and order it back. The time limits are six months before the onset of insolvency, or two years where the creditor is a connected person.
Two further conditions have to be met, and they are the reason not every early payment is a preference. The company must have been unable to pay its debts at the time, or have become unable to as a result. And the company must have been influenced by a desire to put that creditor in a better position. Paying a supplier because they would otherwise stop delivering is commercial pressure, not desire. Where the creditor is connected to the company (other than only because they are an employee), the desire is presumed and it is for you to show otherwise, which is why payments to family, to fellow directors and to connected companies get looked at hardest. The presumption does not cover insolvency: the liquidator or administrator must still prove the company was unable to pay its debts at the time, or became unable to as a result.
Who is Considered a Company Director in Insolvency?
One area where people can come unstuck is in assuming that because they are not a company director in name, they do not have to consider the interests of the creditors.
That assumption is unsafe, but the correct position is narrower than it is sometimes put. Two categories sit alongside appointed directors. A de facto director is someone who is not appointed but acts as one, taking part in directing the company on an equal footing with the board. A shadow director is defined in section 251 of the Companies Act 2006 as a person in accordance with whose directions or instructions the directors are accustomed to act; advice given in a professional capacity is excluded.
Both are findings of fact that a court makes on the evidence, not labels that attach to anyone with influence. Where one is made, the person is exposed to the same machinery as an appointed director: wrongful trading, which names shadow directors expressly, fraudulent trading, misfeasance, preferences and transactions at undervalue, and disqualification with a compensation order. The general duties in the Companies Act apply to a de facto director as they would to an appointed one, and to a shadow director only so far as they are capable of applying.
What it does not do is make you a guarantor. Being found to be a shadow or de facto director does not oblige you to ensure the company’s debts are paid. Liability still has to be established under one of those routes, on its own test.
What Practical Steps can Directors Take to Ensure Their Duties are Met During Liquidation?
The practical steps you should take to give proper weight to the interests of the company’s creditors will depend on the company’s position. Usually, the directors should try to maintain the company as a going concern. However, if that’s not possible, realising the best possible value from the business and its assets should be the goal.
Importantly, directors would be wise not to resign from an insolvent company until the financial difficulties are resolved or the company enters formal insolvency proceedings such as a creditors’ voluntary liquidation (CVL).
What are the Duties and Liabilities of a director?
Company directors should monitor the company’s financial position closely throughout the process and take the following steps:
- Produce management accounts and financial projections as often as necessary to try and avoid insolvency and rescue the company.
- Seek advice from insolvency practitioners to review your recovery options and keep detailed minutes of meetings.
- Hold regular board meetings and keep minutes.
- Consider the company’s position before incurring further liabilities or repaying loans from directors.
- Enforce effective credit control on the collection of receivables.
- Inform the company’s creditors of the situation at an early stage and keep them updated regularly.
- Follow the legal requirements in the treatment of the company’s employees.
- Take steps to commence insolvency proceedings in a timely fashion if insolvency is unavoidable.
Can a Director of a limited company be personally liable During Insolvency?
Where wrongful or fraudulent trading is established, the court can order a director to contribute to the company’s assets, which in practice means paying for some or all of the loss.
Equally, where the director has signed a personal guarantee document, this also renders the director liable for the amount of security that has been contractually agreed with a finance provider.
Expert and Confidential Advice
Adhering to your duties as the director of an insolvent company is not always easy, but with the right advice and guidance, it is possible to come through the situation unscathed. Get in touch today for confidential, no-obligation assistance from a team of licensed insolvency practitioners.