Kevin McLeod
Written By Kevin McLeod
Licensed Insolvency Practitioner
July 24th, 2023

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. However, when a company becomes insolvent, all that changes. 

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. At this point, your duties switch from being to promote the business for the benefit of its shareholders to operating in the interests of the company’s creditors as a whole. 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. 

  1. 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.

  1. The balance sheet test

Are your business’s assets worth less than its liabilities? If they are, your business could be insolvent.

  1. The legal action test 

Does the company have outstanding statutory demands, unanswered court orders or judgements made against it? If it does, that is a clear sign that the company is insolvent. 

What are the Duties and Responsibilities of a Director in Insolvency?

If you think your company is insolvent, your duties and responsibilities immediately switch from the shareholders of the company to its creditors.

Why are directors duties altered in insolvency?

According to provisions contained in the Insolvency Act 1986, you are under a duty to minimise creditor losses. Your behaviour must demonstrate that with clear records of emails and conversations kept and accurate books and records maintained. Fail to do so and you could be held personally liable for company debts and be disqualified from acting as a company director for up to 15 years. 

When a director knows or ought to know their company is insolvent, they must not be involved in any of the following practices or they risk being made personally liable for company debts:

  • Carrying on with no intention of repaying

You must not continue to trade or enter into new contracts with no intention of repaying your creditors. This example of wrongful trading, as covered in Section 214 of the Insolvency Act 1986, 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 could be convicted of fraudulent trading, as set out in Section 213 of the Insolvency Act. This crime carries a potential custodial sentence of up to seven years along with personal liability for the company’s debts. 

  • 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 it is found that those assets were sold at substantially less than market value, the transactions may be reversed and you could be ordered to refund the proceeds. This is covered by Section 238 of the Insolvency Act.

  • 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, it is your duty to act in the best interests of the creditors as a whole. If you put a creditor in a preferential position compared to others up to six months before the insolvency (two years for connected creditors), then according to Section 239 of the Insolvency Act, the transaction can be set aside and that creditor will be ordered to refund the payment to the insolvent company. 

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 are not responsible for acting in the best interests of the creditors.

However, that is not the case. If you give instructions to directors or participate in controlling company affairs, you are legally responsible for ensuring that the outstanding debts of the company are repaid, irrespective of your job title. 

What Practical Steps can Directors Take to Ensure Their Duties are Met During Liquidation?

The practical steps you should take to act in the best 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?

In cases where wrongful or fraudulent trading are discovere, directors may be held personally liable for some or all of the business debt.

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.