What are a director’s legal duties and responsibilities while insolvent?

When does a director’s duty to creditors arise?

As a company director, you have certain legal duties and responsibilities. They include promoting the company’s success, exercising reasonable care and skill, and avoiding conflicts of interest. However, when your company cannot pay its debts (it’s insolvent), your legal duties and responsibilities as a company director change.    

Here we discuss what those duties and responsibilities are, the steps you can take to meet them and the potential consequences if you don’t. 

Director’s duties when your company is insolvent

Your company is insolvent when it cannot pay its debts when they fall due or its liabilities exceed its assets. If you find yourself in this financial situation, your duties as a director change. If you do not meet those duties and responsibilities, you could be accused of wrongful trading and potentially become liable for its debts. You could also be disqualified from acting as a director for up to 15 years. 

If you think your company is insolvent, seek professional assistance immediately. A licensed Insolvency Practitioner will be able to assess your situation, confirm your financial position and advise you on your next steps. 

When your company is insolvent, rather than running it in the best interests of the directors and shareholders, you must put your creditors’ interests first. In practical terms, that means ceasing trading, safeguarding company assets and taking steps to minimise the money the company owes. Operating responsibly and in line with your director’s duties is key to reducing the risks for you personally.

What steps should you take?

Cease trading

Cease trading as soon as your company becomes insolvent to ensure you do not accrue further debts it cannot repay. This is the point from which your conduct as a director is likely to be examined if you subsequently enter a formal insolvency procedure such as Administration or Liquidation. 

Contact an Insolvency Practitioner

Speaking to an Insolvency Practitioner (IP) will demonstrate your commitment to acting in the right way and help you form a defence against claims of wrongful trading. They will be able to provide an objective view of the company’s financial position and give you practical advice and assistance around the various company turnaround and business recovery options available. If the company cannot be saved, the IP can also guide you through the liquidation process. 

Safeguard company assets

Once the company is insolvent, you must not sell or transfer any assets away from the company. Instead, do everything you can to preserve the assets by securing property and machinery and collecting payments debtors owe the business. 

Act in the best interests of your creditors

Throughout the insolvency, you must act in a way that maximises the interests of your creditor group as a whole. There are various ways you can do that. Ceasing trading helps to ensure you do not accrue further debts you cannot repay. You must treat all your creditors equally and avoid making ‘preference payments’, where you pay certain creditors ahead of others. You are also obliged to inform your creditors of the situation at an early stage and keep them updated throughout.

Hold a shareholders’ meeting

Once you’ve considered your options, call a shareholders’ meeting to discuss your next steps. The shareholders may decide to appoint an administrator or vote in favour of a winding up resolution to put the company into Liquidation. You can then appoint an Insolvency Practitioner to take control of the business and administer the procedure. 

What are a director’s legal duties during Liquidation?

Even if you decide to liquidate the company, you still have legal duties and responsibilities you must meet. You must hand over timely and accurate business records and paperwork to the liquidator so the liquidation can proceed efficiently. That includes up-to-date asset registers and financial records.

You must also attend an interview with the liquidator if they request it and answer their questions fully. They will request an interview if they have concerns about how the business was run in the time leading up to or during the insolvency.        

If you owe money to the company in the form of an overdrawn director’s loan account, the liquidator will request you repay it to increase the funds available to your creditors. You will also be liable for any personal guarantees you have given for debts the company cannot pay in full.

What happens if you don’t adhere to your director’s duties while insolvent?

If your company is insolvent and subsequently enters Administration or Liquidation, the Insolvency Practitioner administering the procedure will investigate your conduct during and leading up to the insolvency. If they uncover examples of misconduct, wrongful trading or fraudulent activity, they will send a report to the Insolvency Service, which is part of the Department for Business and Trade. It will decide whether to pursue the matter and what action to take.

The Insolvency Service can impose a range of penalties, including fines, making one or more directors personally liable for company debts and director disqualifications of up to 15 years. In the most serious cases of fraudulent trading, you could receive a custodial sentence of up to two years.

Who has legal duties when a company is insolvent?

It’s not only the registered directors who have legal duties when a company is insolvent. Anyone who has control over the company and its affairs is responsible for protecting the interests of its creditors. That includes those who may not be registered as directors at Companies House but instruct the directors or contribute to high-level decision-making.

How can we help?

Adhering to your legal duties as a director of an insolvent company is not always easy, particularly when you’re desperate to turn the situation around. At Begbies Traynor, our licensed Insolvency Practitioners provide professional advice and guidance to keep you within the legal parameters while exploring the most appropriate way to save or close your business. Get in touch for a free, same-day consultation or arrange a meeting at one of our 100+ offices throughout the UK.