What To Do if Your Company is Having Financial Difficulties: Legal Duties & Solutions

If your company is facing financial difficulties, it is essential to act swiftly and decisively. As a director of a UK limited company, you may be under intense pressure from creditors and facing the risk of insolvency. It is important to understand your legal duties to protect both yourself and your business. Ignoring these responsibilities can lead to personal financial exposure or even disqualification.

By taking informed action, such as seeking professional advice and exploring rescue options, you can address these challenges effectively and potentially safeguard your company’s future.

At a Glance

• Financial difficulties trigger heightened legal responsibilities for UK company directors, particularly when insolvency is likely.
• Insolvency is assessed using both the cash-flow test (ability to pay debts as they fall due) and the balance-sheet test (assets versus liabilities, including contingent and prospective liabilities).
• Early warning signs include missed supplier payments, mounting tax arrears, and creditor threats or statutory demands.
• When insolvency becomes probable, directors must act in the interests of the company while giving proper regard to creditors’ interests.
• Continuing to trade without a reasonable prospect of avoiding insolvency can expose directors to wrongful trading claims and court-ordered financial contributions.
• Fraudulent trading involves deliberate dishonesty and can result in civil liability, criminal penalties, and imprisonment.
• Ignoring creditor pressure can lead to winding-up petitions, frozen bank accounts, and loss of control of the business.
• HMRC has strong enforcement powers but may agree to Time to Pay arrangements if approached early with a credible plan.
• Informal negotiations can provide temporary relief, but formal procedures may be required if financial distress persists.
• Formal rescue options include a moratorium, Company Voluntary Arrangement (CVA), and administration, each offering legal protection and structured oversight.
• Where rescue is not viable, liquidation through a CVL or Compulsory Liquidation provides an orderly wind-down of the company.
• Employees are protected through statutory schemes such as the Redundancy Payments Service, subject to legal limits.
• Early professional advice from a licensed insolvency practitioner is critical to minimising risks and identifying the best available outcome.

Recognising the Early Signs of Insolvency

Recognising early signs of insolvency is essential for you as a director to fulfil your legal duties and protect your company. Two key legal tests are used to assess insolvency: the cash-flow test and the balance-sheet test.

The cash-flow test indicates insolvency if your company cannot pay its debts as they fall due. The balance-sheet test assesses whether the value of the company’s assets is less than its liabilities, taking into account contingent and prospective liabilities, not just headline balance sheet figures.

You should be vigilant for warning signs such as:

• Missed supplier payments
• Mounting tax arrears
• Creditor threats or formal demands

These indicators suggest serious financial distress and may lead to statutory demands or escalating HMRC enforcement. Ignoring these signs can trigger heightened legal responsibilities, including the need to place greater emphasis on protecting creditors’ interests.

Statutory demands, for example, typically require payment or resolution within 21 days, after which a creditor may present a winding-up petition as evidence of inability to pay debts. Persistent arrears with HMRC can also result in enforcement action, which may include distraint or court proceedings. Acting promptly is critical, as delay can increase the risk of personal exposure or disqualification. Seeking professional advice early can help you assess your position and identify appropriate solutions.

Director Duties and Legal Responsibilities

When a company is insolvent or insolvency is likely, directors’ duties require careful consideration. Under the Companies Act 2006, directors must act within their powers, promote the success of the company, and exercise reasonable care, skill, and diligence. However, when insolvency becomes probable, the way these duties are exercised changes.

At this stage, directors must act in the interests of the company while having proper regard to the interests of creditors, particularly where decisions could affect their recoveries. You must avoid actions that worsen creditors’ positions, such as taking on additional liabilities without a reasonable prospect of repayment or making unfair payments to selected creditors.

Failure to comply with these obligations can result in serious consequences, including court-ordered financial contributions or disqualification. Wrongful trading arises where directors continue trading when they knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation or administration, and failed to take steps to minimise losses to creditors. Fraudulent trading involves intentional dishonesty and carries far more severe penalties.

Wrongful vs. Fraudulent Trading

Wrongful Trading: This occurs when directors allow a company to continue trading while insolvent, without taking every reasonable step to minimise potential losses to creditors. If proven, a court may order the director to make a financial contribution to the company’s assets.

Fraudulent Trading: This involves deliberate intent to defraud creditors or conduct business for a fraudulent purpose. Examples include knowingly obtaining credit with no intention of repayment or falsifying records. Fraudulent trading can result in civil liability and criminal sanctions, including fines or imprisonment.

Seeking professional advice at an early stage is strongly recommended to help navigate these risks and demonstrate responsible conduct.

Risks of Delay: Personal Liability and Forced Closure

Failing to act when a company is in financial distress can have severe consequences. Ignoring creditor demands or statutory notices can lead to winding-up petitions, which may result in compulsory liquidation. Once a winding-up petition is presented, company bank accounts are typically frozen, severely restricting day-to-day operations and control.

HMRC, as a major creditor, has extensive enforcement powers and may pursue unpaid taxes through court action or other recovery methods if engagement is avoided.

Personal consequences can include being ordered by the court to contribute to company assets where losses to creditors have increased due to wrongful trading. More serious misconduct, such as fraudulent trading, can lead to criminal penalties. Directors may also face disqualification for up to 15 years under the Company Directors Disqualification Act.

Immediate consequences of inaction may include:

• Enforcement action against company assets
• Frozen bank accounts following a winding-up petition
• Reputational damage
• Court-ordered financial contributions
• Potential director disqualification

Early professional advice and timely intervention can significantly reduce these risks and help protect both the company and its directors.

Managing Creditor Pressures and Statutory Demands

When faced with statutory demands or legal threats from creditors, swift and structured action is vital. A statutory demand generally requires payment, security, or agreement within 21 days. Failure to respond can allow a creditor to rely on the demand as evidence of insolvency when seeking a winding-up petition.

HMRC has significant enforcement powers but will often consider Time to Pay arrangements where a company demonstrates genuine financial difficulty and a realistic repayment plan. Early engagement can help prevent escalation to court proceedings.

Effective creditor management includes:

• Acknowledging receipt of demands or notices promptly
• Opening dialogue with creditors to explore payment arrangements
• Keeping detailed records of communications and agreements
• Seeking professional advice if negotiations become difficult

Proactive engagement can often buy valuable time and reduce the likelihood of formal insolvency proceedings.

Informal Negotiations and Early Rescue Approaches

Informal negotiations with creditors can provide critical breathing space for companies experiencing short-term financial pressure. Agreeing revised payment terms or temporary deferrals may allow the business to stabilise without entering formal insolvency.

Time to Pay arrangements with HMRC are a common and effective tool, allowing tax debts to be repaid over an agreed period. Any agreements reached should be documented clearly to avoid misunderstandings.

For example, a company facing cash-flow pressure due to delayed customer payments may successfully negotiate extended supplier terms while agreeing a structured repayment plan with HMRC. This approach can preserve trading relationships and avoid the costs and publicity of formal procedures.

If informal options prove insufficient, professional advice should be sought promptly to assess formal rescue or insolvency routes.

Formal Restructuring Options Explained

Where informal solutions are no longer viable, formal restructuring options can offer legal protection and a structured recovery framework. These processes are overseen by licensed insolvency practitioners and include a moratorium, Company Voluntary Arrangement (CVA), and administration.

Moratorium

A moratorium provides an initial 20 business days of protection from most creditor actions, which can be extended. During this period, legal proceedings are generally stayed, giving directors time to explore rescue options. A licensed insolvency practitioner acts as a monitor to ensure the company meets ongoing obligations.

Company Voluntary Arrangement (CVA)

A CVA is a formal agreement with creditors to repay debts over time. The proposal is approved if at least 75% (by value) of creditors voting support it, provided that more than 50% (by value) of unconnected creditors voting do not oppose it. Once approved, the CVA binds all unsecured creditors, allowing the company to continue trading while meeting agreed terms.

Administration

Administration involves appointing an administrator to manage the company with the objective of rescuing it as a going concern or achieving a better outcome for creditors than liquidation. A statutory moratorium applies, restricting most legal actions unless consent or court permission is obtained.

These procedures provide structured oversight and legal safeguards that informal negotiations cannot.

Liquidation and Closure Routes

Liquidation is appropriate where a company is insolvent and rescue is no longer achievable. The two main routes are Creditors’ Voluntary Liquidation (CVL) and Compulsory Liquidation.

A CVL is initiated by directors and shareholders when insolvency is acknowledged, allowing the appointment of a chosen insolvency practitioner. Compulsory Liquidation occurs when a creditor obtains a court winding-up order, with control passing to the Official Receiver or a court-appointed liquidator.

In both cases, company assets are realised and distributed to creditors according to statutory priority. Once a company is insolvent, voluntary strike-off is no longer available, as insolvency renders the company ineligible for that process.

CVL vs. Compulsory Liquidation

A CVL allows for a more orderly closure and some degree of director involvement. Compulsory Liquidation is adversarial, removes director control immediately, and often leads to closer scrutiny of director conduct.

Protecting Directors and Employees

To reduce personal risk, directors should avoid taking on new liabilities once insolvency is likely, maintain accurate financial records, and ensure personal and company finances remain separate.

Employees are protected through statutory mechanisms when a company becomes insolvent. The Redundancy Payments Service (RPS) enables eligible employees to claim unpaid wages, holiday pay, notice pay, and redundancy entitlements, subject to statutory limits. Certain employee claims, such as limited wage arrears and accrued holiday pay, may rank as preferential debts under insolvency law.

Practical steps for directors include:

• Ceasing new liabilities where insolvency is likely
• Maintaining full records of decisions and transactions
• Separating finances to avoid personal exposure

For employees:

• Prompt communication about the situation and next steps
• Guidance on RPS claims and entitlement processes

These measures support compliance while protecting both directors and staff.

Your Next Steps

To protect both your company and your personal position, consulting a licensed insolvency practitioner is a crucial step. An IP can assess your circumstances, explain your legal obligations, and guide you through rescue or closure options.

Delaying action often worsens outcomes and increases risk. Early advice provides clarity, demonstrates responsible conduct, and maximises the range of available solutions. Acting promptly can make a decisive difference in safeguarding your future.

FAQs