Director Duties and Responsibilities When Insolvent

Director duties and responsibilities when insolvent

As a company director, if you continue trading after your business has knowingly become insolvent, you are running the risk of breaching your legal duties and responsibilities as a company director.

If your company is unable to meet its financial obligations as and when they fall due, and/or its liabilities exceed its assets, it may be classed as balance sheet or cash flow insolvent.

As the director of an insolvent company, your duties and responsibilities change once the business has run out of cash and has become insolvent. If you fail to uphold these responsibilities you could be accused of wrongful trading and held personally liable for the repayment of certain company debts.

Once a company becomes insolvent, its directors owe a legal duty to creditors to minimise their losses. In many cases this means ceasing trading immediately, however, this is not always the case. If your company becomes insolvent, you should make it a priority to seek the services of a licensed insolvency practitioner who will be able to assess the situation and provide advice as to your next steps.

Who is considered a director during insolvency?

You do not have to be a registered director in order to be held responsible for acting in the best interest of creditors. If you actively participate in controlling the direction of company affairs, or you give instruction to directors (commonly known as “shadow directing”) you are legally responsible for ensuring that the company takes the steps necessary to repay outstanding debts.

For example, if you control the direction of the company and you take part in most of the important decision-making, you would be considered a director from the perspective of the court even if you are not registered as such with Companies House.

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What are directors not allowed to do while insolvent?

A director who controls the affairs of an insolvent company may be held personally liable for company debts if they engage in any of the following practices:

Taking on borrowing with no intention of repaying

If you continue to enter into new contracts, take customer deposits, or obtain finance or funding with no intention of repaying or fulfilling the orders, you may be found guilty of fraudulent trading. This is a serious crime that could result in a penalty of up to 7 years in prison, as well as incurring personal liability for creditor losses. 

Continuing to trade while knowingly insolvent

Continuing to trade when you know your company is insolvent and is unlikely to be able to turn its fortunes around, is known as wrongful trading. By continuing to trade, you run the risk of worsening the position of your creditors and causing them further financial losses. Once you know your company is insolvent, or is likely to become insolvent, you must seek the services of a licensed insolvency practitioner for advice as to your next steps. 

Partaking in Transactions at Undervalue

If you sell any assets of the company at a price considerably below market value - or gift them to another party for no payment whatsoever - the court has the power to reverse these transactions to put the company back into the position it was in prior to these transactions being made. By depleting the company's assets, you are reducing the money available to all creditors, something which goes against your legal responsibilities and duty to creditors.

Making preference payments

The directors of a company  is obliged to act in the best interests of its creditors as a whole once the company becomes insolvent. This means that you’re not allowed to repay certain debts in favour of others. For example, if you choose to repay a personally guaranteed debt or a debt owed to a friend or family member, but make no effort to make payments on other debts, you could be accused of treating certain creditors with preference. If the court finds you guilty of this they may reverse the repayments by ordering the repaid creditor to refund the payment to the insolvent company.

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Director duties during company liquidation

Adhering to your responsibilities as the director of an insolvent company is vitally important, particularly if the company subsequently enters a formal insolvency process such as liquidation, whether this is done voluntarily by way of a CVL or is forcibly wound up by the court in a compulsory liquidation.

When a company is liquidated, the appointed insolvency practitioner is obligated to conduct an investigation into the affairs of the insolvent company in order to determine the reason behind the company's insolvency and whether the actions of its directors contributed to this. They will consider the actions you took when you ought to have known the company was insolvent, particularly when it comes to the transactions you entered into at this point and how long you continued to trade on before seeking advice from a professional.

By contacting an insolvency practitioner at the earliest signs of insolvency, you are demonstrating your desire to protect the interests of creditors and therefore adhere to your legal duties as the director of an insolvent company.

Failing to take action and instead waiting for your company to be forced into compulsory liquidation by order of the courts will not reflect well on you and your fellow directors during the liquidation investigation.

How Real Business Rescue can help

If your company is insolvent and you are worried about whether you are adhering to your legal duties and obligations during this time, our licensed insolvency practitioners can provide the help and advice you need. With 100 offices across the UK, you’re never far away from expert and confidential advice.