What are a Director’s Duties in Insolvency?

Reviewed by

Christopher Andersen

Reviewed by Christopher Andersen

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.

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22nd April 2024

Responsibilities for Directors of Insolvent Companies

Directors of insolvent companies have the following responsibilities:

1. Prioritise creditors over shareholders: When a company becomes insolvent, the directors’ priorities shift from serving the interests of shareholders to protecting the interests of the company’s creditors.
2. Asset protection: Directors must take steps to protect any remaining assets the company has.
3. Equal treatment of creditors: Directors must treat all creditors equally and cannot prioritise or favour one creditor over another.
4. Prevent further financial deterioration: Directors must ensure that the company’s actions do not worsen the financial position or cause further detriment to the creditors.
5. Appoint an insolvency practitioner: Directors should consult with or consider appointing an insolvency practitioner to manage the company’s financial situation and carry out any insolvency proceedings.

Prioritise Creditors Over Shareholders

When a company becomes insolvent, the directors’ responsibilities shift fundamentally. Instead of focusing on maximising value for shareholders, the directors must reorient their duties towards protecting the interests of the company’s creditors. This shift is necessary because, during insolvency, the company’s assets legally become the primary resource for satisfying creditor claims rather than distributing profits to shareholders. Directors need to ensure that any decisions made do not harm the rights of creditors to recoup their investments.

Directors must act cautiously to ensure their actions uphold the statutory priority of creditors’ claims and avoid wrongful trading under Section 214 of the Insolvency Act.

Asset Protection

Directors must protect the company’s assets to maximise returns to creditors. This duty is critical to avoid accusations of wrongful or fraudulent trading as outlined in Sections 213 and 214 of the Insolvency Act 1986. Protecting assets involves careful monitoring of the company’s financial activities, securing physical and intellectual properties, and ensuring no further depletion of the asset base that might jeopardise creditor repayments.

Equal Treatment of Creditors

The Insolvency Act 1986 mandates that directors must treat all creditors equally. This means avoiding preferential payments or transactions which might favour one creditor over another, as stated in Section 239 of the Act. Such actions can be challenged in court and potentially reversed. This equal treatment is crucial for maintaining fairness and transparency in the insolvency process, helping to manage repayments systematically and equitably.

Prevent Further Financial Deterioration

Directors are required to prevent any worsening of the company’s financial position to protect creditors’ interests. This includes avoiding risky decisions that could increase liabilities or diminish asset value. Directors must demonstrate prudence and compliance with the duty to minimise losses to creditors, thereby adhering to their fiduciary responsibilities under the Insolvency Act and the Companies Act 2006, which outline the standards for directors’ conduct during insolvency.

Appoint an Insolvency Practitioner

Directors should appoint an insolvency practitioner to manage the insolvency process. This specialist, regulated under the Insolvency Practitioners Regulations 2005 and licensed by a recognised professional body (e.g., the Insolvency Practitioners Association), plays a critical role in advising on and administering insolvency procedures such as administration, liquidation, or voluntary arrangements. Their expertise is vital in ensuring that the process complies with legal requirements and in navigating the complexities of insolvency law to achieve the best possible outcomes for creditors.

Directors’ Responsibility for Mismanagement

Directors of insolvent companies have a heightened duty to exercise care and diligence in managing the company’s affairs. Failure to fulfil this duty can result in personal liability for mismanagement, which may include wrongful trading, fraudulent trading, and misfeasance.

• Wrongful Trading If a director knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation, and they failed to take appropriate steps to minimise potential losses to creditors, they may be held personally liable for wrongful trading. This liability can extend to paying compensation to the company’s creditors.
• Fraudulent Trading If a director carried on the business of the company with the intent to defraud creditors or for any other fraudulent purpose, they may be guilty of fraudulent trading. Fraudulent trading is a criminal offence, and directors found guilty may face fines, disqualification, or imprisonment.
• Misfeasance Misfeasance refers to a breach of duty or misconduct by a director in managing the company’s affairs. If a director’s actions have caused financial loss to the company or its creditors, they may be held personally liable for misfeasance. This liability can involve repaying or accounting for the misapplied money or property, contributing to the company’s assets, or compensating the creditors.

Directors must exercise reasonable care, skill, and diligence in managing the company’s affairs, particularly when facing insolvency. Failure to do so can result in personal liability for mismanagement, including wrongful trading, fraudulent trading, and misfeasance charges. These potential consequences underscore the importance of directors fulfilling their legal duties and acting in the best interests of the company and its creditors.

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