Chris is an Insolvency Practitioner regulated by the ICAEW since 2014,.
He is experienced in contentious insolvency with excellent analytical skills and strong knowledge of both general and technical insolvency matters.
When cash is tight and suppliers start chasing, your legal priorities begin to change. As insolvency becomes likely, directors must increasingly consider the interests of creditors and take steps to minimise further losses. Fail to act and you risk personal liability, disqualification or, in serious cases, prosecution.
This guide sets out what UK law expects when insolvency looms, the red lines that trigger penalties and the practical steps that help keep both you and the business on the safest possible footing.
When insolvency becomes likely, directors must place increasing weight on protecting creditors’ interests and avoiding actions that worsen their position.
Safeguard company assets, including cash, stock, equipment and intellectual property, and avoid disposals for less than proper value.
Avoid actions that unfairly favour one creditor over others.
Do not incur new liabilities where there is no reasonable prospect of meeting them.
Keep financial information under close review and respond promptly if solvency deteriorates.
Keep clear board minutes, forecasts and records showing informed decision-making.
This overview is for information only; seek tailored legal advice before acting.
The Legal Roots of These Duties
Directors’ responsibilities towards creditors arise primarily from section 172(3) of the Companies Act 2006 and creditor-protection provisions within the Insolvency Act 1986.
Section 172(3) provides that the duty to promote the success of the company is subject to any rule of law requiring directors to consider or act in the interests of creditors. As financial difficulty increases, courts recognise that creditor interests become increasingly important.
Act
What it requires once insolvency is likely or present
Companies Act 2006 s172(3)
The duty to promote the success of the company is subject to rules requiring directors to consider creditor interests where insolvency is likely or present.
Insolvency Act 1986
Wrongful trading (s214, s246ZB): directors may be ordered to contribute personally if they continue trading when they knew or ought to have concluded there was no reasonable prospect of avoiding insolvent liquidation or administration.Misfeasance (s212): liability for misapplying or retaining company money or property.Avoidance provisions: transactions at an undervalue (s238), preferences (s239), and certain floating charges (s244–245).
Under normal trading conditions, directors focus on promoting the success of the company for shareholders. As insolvency becomes likely, decisions must increasingly consider the impact on creditors and avoid worsening their position.
When Do Creditors Take Priority?
Creditor interests become increasingly significant once insolvency is present or likely. Liability for wrongful trading can arise from the point at which directors knew, or ought to have known, that insolvent liquidation or administration could not reasonably be avoided.
Two statutory yardsticks
UK law recognises two principal indicators of insolvency under section 123 of the Insolvency Act 1986:
Cash-flow test: the company is unable to pay its debts as they fall due.
Balance-sheet test: the value of the company’s assets is less than its liabilities, taking account of contingent and prospective liabilities.
Failing either test may indicate insolvency.
Practical red flags to watch for
Repeatedly missing payment dates on rent, suppliers or wages
HMRC arrears building without a realistic repayment plan
Overdrawn banking facilities with no agreed extension
Management accounts showing deteriorating net asset position
Cash-flow forecasts projecting shortfalls
Creditor threats of statutory demand or court action
These warning signs should prompt an urgent board review and, where appropriate, professional advice.
Mini-scenario: the duty in action
ABC Ltd’s cash-flow forecast shows it will soon be unable to meet debts as they fall due. The directors conclude that insolvency is likely and begin focusing on preserving assets and avoiding actions that worsen creditor returns. Continuing to trade without a credible rescue plan could expose them to personal contribution orders under the Insolvency Act 1986.
Actions Directors Should Take Once Insolvency Looms
When insolvency is likely, directors should be able to demonstrate that their decisions were reasonable and aimed at minimising loss to creditors.
Safeguard assets
Ensure company assets are protected and properly recorded.
Avoid asset disposals unless supported by proper value and commercial justification.
Maintain accurate asset and insurance records.
Avoid unfair preference
Avoid making payments or granting security that unfairly improves one creditor’s position over others if insolvency follows.
Record the commercial reasons behind payments made during financial distress.
Consider whether continued trading is justified
Before taking new orders or incurring new costs, consider whether doing so improves or worsens the position of creditors overall.
If there is no reasonable prospect of avoiding insolvent liquidation or administration, continued trading may give rise to wrongful trading liability.
Seek professional advice early
Professional advice can help directors assess restructuring or formal insolvency options.
Record when advice was sought and what conclusions were reached.
Record decisions and forecasts
Keep board minutes, financial forecasts and written reasoning for decisions.
Good records help demonstrate that directors acted responsibly.
Call-out: a common mistake – Directors sometimes prioritise certain creditors believing this reduces risk. However, payments that place one creditor in a better position than others may later be reviewed and challenged depending on the circumstances.
Deals and Payments That May Breach Creditor Duties
Certain transactions entered into before insolvency may later be challenged by an administrator or liquidator.
Transactions commonly reviewed
Transactions at an undervalue (Insolvency Act 1986, section 238).
Preferences (section 239), where a creditor is put in a better position than others in insolvency.
Certain floating charges granted shortly before insolvency (sections 244–245).
Continuing to trade where there is no reasonable prospect of avoiding insolvent liquidation (wrongful trading, section 214).
Trading carried on with intent to defraud creditors (fraudulent trading).
Wrongful v fraudulent trading
Aspect
Wrongful trading
Fraudulent trading
Nature
Civil remedy
Civil liability and potential criminal offence
Core test
Director knew or should have known there was no reasonable prospect of avoiding insolvent liquidation or administration
Business carried on with intent to defraud creditors or for a fraudulent purpose
Typical consequences
Contribution order and possible disqualification
Contribution order and potential prosecution under Companies Act 2006
Wrongful trading is not itself a criminal offence; it is designed to compensate creditors rather than punish directors.
Penalties for Getting It Wrong
If insolvency follows and directors fail to meet their duties, personal consequences may arise.
Civil action
Contribution orders under wrongful trading provisions.
Misfeasance claims requiring repayment or restoration of company assets.
Director disqualification for between two and 15 years.
Compensation orders linked to disqualification proceedings.
Criminal action
Fraudulent trading or other offences involving dishonesty or fraud may lead to prosecution, fines or imprisonment.
Courts may impose more than one consequence depending on the conduct involved.
How Insolvency Practitioners and the Official Receiver Fit In
When a formal insolvency process begins, control of the company’s affairs passes to an appointed office-holder such as a licensed insolvency practitioner or, in compulsory liquidation, the Official Receiver.
The office-holder realises assets, distributes funds to creditors and submits a report on director conduct to the Insolvency Service. Directors must co-operate, provide records and answer questions truthfully.
Typical information requested includes:
accounting records and bank statements
asset registers and contracts
details of recent payments or transfers
creditor and employee information
a statement of affairs
Seeking advice before a formal appointment may help demonstrate responsible conduct if decisions are later reviewed.
Regional Note: Northern Ireland Differences
The practical duties of directors are similar in Northern Ireland, although the statutory framework differs. Equivalent provisions are found in the Insolvency (Northern Ireland) Order 1989 and related rules, including wrongful trading provisions equivalent to section 214 of the Insolvency Act 1986. The underlying principle remains the same: once insolvency is likely, directors must consider creditor interests and avoid worsening their position.
Crisis Checklist: First 48 Hours
Early action can significantly reduce risk once insolvency is suspected.
Review cash flow against upcoming liabilities.
Pause non-essential spending until financial position is clear.
Secure company assets and records.
Gather current financial information and creditor balances.
Hold a board meeting and record decisions.
Prepare short-term cash-flow forecasts.
Seek professional advice on available options.
Communicate carefully with stakeholders and keep records.
FAQs
1) Do creditor duties apply if the company is still solvent but at risk?
Yes. Section 172(3) of the Companies Act 2006 makes the duty to promote the success of the company subject to rules requiring directors to consider creditor interests where insolvency is likely or approaching. Waiting until formal insolvency may be too late.
2) How do secured creditors fit into these duties?
Directors must avoid unfairly preferring one creditor where insolvency follows. However, insolvency law recognises different categories of creditors, including secured and unsecured creditors, and their rights differ under statute.
3) Is paying staff or HMRC first a breach of duty?
Not automatically. Payments may later be reviewed depending on the circumstances and whether they meet the statutory test for a preference under section 239 of the Insolvency Act 1986.
4) Can I resign to avoid liability?
No. Wrongful trading provisions apply to anyone who is or has been a director. Resigning does not remove responsibility for earlier decisions.
5) Does taking professional advice protect me from wrongful-trading claims?
Advice is not a complete defence, but documented professional advice may help demonstrate that directors acted reasonably.
6) Are small transactions risky when insolvent?
The issue is not size but effect. Directors should consider whether transactions improve or worsen creditors’ overall position.
7) What records should I keep?
Management accounts, forecasts, board minutes, creditor communications and professional advice should all be retained to demonstrate informed decision-making.
8) How long before insolvency can transactions be challenged?
The Insolvency Act 1986 allows certain transactions entered into before insolvency to be reviewed and, in some cases, reversed. The applicable periods depend on the type of transaction and the relationship between the parties.
9) Does the duty change in administration versus liquidation?
No. The obligation to avoid worsening creditor losses applies in both contexts, although administration may focus on rescuing the business as a going concern.
10) Are non-executive directors equally liable?
Yes. Statute does not distinguish between executive and non-executive directors for these purposes.
11) What happens if creditors are overseas?
Directors must still act in accordance with UK insolvency law and avoid unfairly preferring one creditor over others.
12) Does a personal guarantee override these duties?
No. Personal guarantees do not allow directors to favour one creditor at the expense of others.
13) How can I check if my company is insolvent?
Apply the statutory tests: whether the company can pay debts as they fall due and whether liabilities exceed assets taking account of contingent and prospective liabilities.
14) Are any Covid-era suspensions still in force?
Temporary wrongful trading provisions introduced during the Covid period applied only for limited statutory periods. Directors should assume the ordinary wrongful trading rules now apply.
15) Will insurance cover contribution orders or disqualification costs?
Insurance arrangements depend on policy terms. Directors should check their own cover carefully rather than assuming protection.
Your Next Safe Step
If insolvency is a possibility, seeking professional advice early helps clarify whether the business can continue trading safely or whether formal restructuring or insolvency procedures should be considered. Early action improves outcomes for both directors and creditors and reduces the risk of personal liability later.
