Can Directors Pay Themselves Before Liquidation?

Yes, but only within strict legal limits. When a company is insolvent or approaching insolvency, payments to directors receive close scrutiny. Salary, dividends, loan repayments and expense reimbursements are all treated differently under UK law. If a payment improperly reduces the assets available to creditors, a future liquidator may seek to recover it.

Picture the situation: the bank balance barely covers next week’s wages, suppliers are threatening court action, and you still need to cover personal bills. Knowing which payments may still be legitimate, and which are likely to be challenged later, is critical before moving any money from the company.

The quick answer: who gets priority once insolvency looms

When a company is insolvent, directors must take creditors’ interests into account when making decisions about the company. Payments to directors are not automatically prohibited, but transactions that disadvantage creditors may later be challenged by a liquidator under the Insolvency Act 1986.

At a glance:

Safe-ish when conditions are met

• Regular salary already agreed in an employment contract and paid through PAYE
• Reimbursement of genuine business expenses with proper records
• Employee claims such as redundancy or unpaid wages claimed through the Redundancy Payments Service

Higher risk or commonly challenged

• Dividends paid when the company has no distributable profits
• Repayment of director loans shortly before insolvency
• Sudden increases in salary or bonuses when the company is unable to meet its debts
• Certain payments made after a winding-up petition in compulsory liquidation

In practice, any transaction that significantly reduces the funds available to creditors may later be reviewed and potentially reversed.

Why the ‘twilight zone’ changes how directors must act

Directors normally owe duties to promote the success of the company for the benefit of its members under Section 172 of the Companies Act 2006.

However, when a company becomes insolvent or insolvency is probable, directors must also consider the interests of creditors. The UK Supreme Court confirmed this principle in BTI 2014 LLC v Sequana SA (2022).

This shift does not mean directors suddenly lose control of the company, but it does mean decisions must be made with creditor interests in mind. Transactions that improperly benefit directors or connected parties may later be challenged.

Two common indicators that a company may be insolvent are:

Cash-flow test

• The company cannot pay debts as they fall due.

Balance-sheet test

• The company’s liabilities exceed the value of its assets.

When these warning signs appear, directors should exercise caution before authorising payments to themselves.

Timeline of director responsibilities

Solvent trading
– Directors focus primarily on shareholder interests.

Insolvency probable

• Directors must consider creditor interests when making decisions.

Formal insolvency procedure

• Once administrators or liquidators are appointed, directors no longer control company assets.

Early warning: clawbacks and director liability risks

A future liquidator can examine transactions made before insolvency and challenge certain payments under the Insolvency Act 1986.

Key powers include:

• Section 239 IA 1986 – preference – Allows a court to reverse payments that put one creditor in a better position than others if the company was influenced by a desire to prefer that creditor.
• Section 238 IA 1986 – transaction at an undervalue – Allows recovery of assets transferred for less than market value.
• Section 212 IA 1986 – misfeasance – Allows claims against directors who have misapplied company money or breached their duties.
• Section 214 IA 1986 – wrongful trading – Allows the court to order directors to contribute to company losses if they continued trading when they knew the company could not avoid insolvent liquidation.

Director disqualification – Under the Company Directors Disqualification Act 1986, directors can be banned for up to 15 years for unfit conduct.

Red flags that may trigger investigation

• Sudden increases in director remuneration during financial distress
• Repayment of director loans while other creditors remain unpaid
• Dividends paid when the company has no distributable profits
• Asset transfers to connected parties at undervalue
• Missing accounting records

Understanding how different payment types are treated is essential.

What actually counts as ‘paying yourself’?

Payments to directors before liquidation generally fall into several categories.

Payment type	Legal basis	Position in insolvency	Risk level
Salary	Employment contract and PAYE rules	Preferential claim limits may apply	Low-Medium
Dividends	Companies Act 2006 distribution rules	Shareholders rank last	High
Director loan repayment	Insolvency Act preference rules	Unsecured creditor position	High
Expense reimbursement	Genuine business expense	Depends on evidence	Medium
Employee claims	Employment Rights Act 1996	Paid via statutory scheme	Low

Each category is treated differently under the law.

Salary: when director pay may still be legitimate

A director who is also an employee may continue to receive salary if it reflects genuine work carried out and is paid in the usual way.

Important factors include:

• Contractual basis – A written or implied employment contract helps demonstrate legitimacy.
• Normal remuneration – Sudden or excessive increases in salary shortly before insolvency may attract scrutiny.
• Payroll compliance – Salary should normally be processed through PAYE with the correct deductions.

If payments appear excessive or unjustified, a liquidator may investigate them as potential misfeasance.

Practical salary checks

• Existing employment arrangement
• Payment consistent with previous levels
• Genuine work performed
• Proper payroll records

Dividends: only lawful if profits exist

Dividends can only be paid from profits available for distribution under Section 830 of the Companies Act 2006.

Profits available for distribution means accumulated realised profits less accumulated realised losses.

Key checks before declaring a dividend:

• Relevant accounts showing distributable profits
• Board approval documented in minutes
• Dividend vouchers issued to shareholders

If a dividend is paid unlawfully, Section 847 Companies Act 2006 provides that a shareholder who knew, or had reasonable grounds to believe, the distribution was unlawful may be required to repay it.

Repaying a director’s loan

If a company repays money it owes a director shortly before insolvency, the transaction may be examined as a preference under Section 239 of the Insolvency Act 1986.

For the court to reverse the payment, it must generally show:

• the payment put the director in a better position than other creditors
• the company was influenced by a desire to prefer that creditor

For connected persons, the law presumes that desire to prefer unless proven otherwise.

The typical look-back period for connected parties is two years before the onset of insolvency.

Expense reimbursements: documenting genuine costs

Reimbursement of legitimate business expenses is usually acceptable provided proper evidence exists.

Examples include:

• travel costs for business meetings
• software subscriptions
• accommodation for work-related travel

Best practice is to maintain:

• receipts and invoices
• expense reports
  
• bank records
• clear business justification

If expenses cannot be justified, they may be treated as drawings or added to a director’s loan account.

Director redundancy and other employee claims

A director may claim statutory redundancy and other employee payments if they also qualify as an employee of the company.

The Insolvency Service typically examines factors such as:

• existence of a contract of employment
• regular PAYE salary
• evidence of work performed
• length of service

Eligible claims are paid through the Redundancy Payments Service from the National Insurance Fund, subject to statutory limits.

Common claims include:

Claim	What it covers
Redundancy pay	Based on age, weekly pay cap and years of service
Arrears of pay	Unpaid wages (subject to limits)
Holiday pay	Untaken or unpaid statutory holiday
Notice pay	Statutory notice entitlement

Timing checkpoints: when payments become riskier

Timing often determines whether a payment will be challenged.

Before a winding-up petition

Transactions within certain periods before insolvency can be reviewed.

Typical look-back periods include:

• two years for connected party preferences or undervalue transactions
• six months for other preference claims

After a winding-up petition (compulsory liquidation)

Under Section 127 of the Insolvency Act 1986, dispositions of company property after the commencement of winding-up by the court are void unless the court orders otherwise.

After liquidator appointment

Control of company assets transfers to the liquidator. Directors cannot authorise payments.

What a liquidator will review

Liquidators routinely review transactions before insolvency.

Common documents requested include:

• company accounts
• bank statements
• tax filings
• payroll records
• director loan account ledgers
• dividend paperwork

If a transaction appears improper, the liquidator may seek repayment or apply to court.

Common myths

Salary is always safe – Salary can still be examined if excessive or unjustified.

Small dividends do not matter – An unlawful dividend of any size can be recoverable.

Repaying a director loan is harmless – Loan repayments may be challenged as preferences.

Resigning removes liability – Former directors can still be investigated for decisions made while in office.

Quick checklist before paying yourself

Before authorising payment, directors should ask:

1. Can the company still pay its debts after this payment?
2. Is the payment contractually justified or properly documented?
3. Are there distributable profits for any dividend?
4. Could the payment disadvantage creditors?
5. Have professional advisers reviewed the decision?

If there is uncertainty, professional advice should be sought.

FAQs