What are Directors Duties in Insolvency?

It’s no surprise that company directors worry about their duties, responsibilities and possible liabilities if their business is insolvent. They are right to do so because directors’ duties do change fundamentally.

From the point of insolvency, the directors have a crucial role to play in minimizing losses to the company’s creditors. But they also owe legal duties to the company and its shareholders, which can come into conflict during times of financial difficulty.

This article will explore the various duties that directors owe and the potential consequences they may face if those duties are breached, particularly in the context of insolvency. We’ll also explain the consequences for directors who fail to uphold their responsibilities.

We would always recommend contacting us for a free, confidential discussion at the earliest opportunity so we can offer some insight into your best course of action.

Directors’ Duties in Insolvency

For directors who have spent many years successfully generating profits for shareholders, it may be difficult to imagine prioritising anyone else.

During solvency, directors have a duty to promote the success of a company.^[1]Trusted Source – Legislation – Directors’ Duties to Promote to the Success of a Company At the point of insolvency, your primary legal responsibilities shift to creditors from shareholders, and your behaviour must be seen to demonstrate this.

Make sure to keep clear records of emails and conversations. Maintain accurate books and records. Understand the rules around trading when insolvent.

And most importantly, take qualified advice from insolvency practitioners such as ourselves at the earliest opportunity.

Duty to Minimize Losses to Creditors during Insolvency

When a company becomes insolvent, meaning that it is unable to pay its debts as they fall due, the directors’ duties shift from promoting the success of the company to minimizing losses to its creditors.

Directors must now focus explicitly on avoiding actions that might increase the company’s debt or worsen the financial position of creditors.

Directors are required to act with due care, skill, and diligence to ensure that they do not cause further harm, act in a timely and decisive manner, and consider the impact of their decisions on the interests of all creditors, not just the ones they have personal relationships with.

This duty requires directors to take a proactive approach to managing the company’s affairs. That means monitoring the company’s financial position closely, making timely decisions about whether to continue trading or to take steps to wind up the company in an orderly fashion.

If the company cannot be saved, the directors must take steps to initiate the insolvency process as soon as possible to minimize losses to creditors.

What does the Insolvency Act 1986 Say About Directors’ Duties?

The key legislation regarding directorial conduct in insolvent situations is the Insolvency Act 1986. Here are the sections of particular relevance.

Section 212: Misfeasance

Misfeasance is essentially misapplying or retaining company property or breaching fiduciary responsibility around money. It applies to both current and ex-officers of the company.

Section 212 makes officers personally accountable to the extent of the loss caused by their actions. It is also taken into consideration by the director’s disqualification unit.

Section 213: Fraudulent Trading

A criminal rather than a civil offence, fraudulent trading is where it can be proven that there was a knowing attempt to defraud creditors.

One example of this would be when a director manages to obtain credit or finance while aware of the company’s inability to pay it back.

A conviction for fraudulent trading requires a definitive proof, which, in practice, is often difficult.

Nevertheless, fraudulent trading is a serious offence carrying financial penalties, potential jail time, and personal liability for corporate debts.

Section 214: Wrongful Trading

An insolvency practitioner involved in liquidating a company must investigate directorial conduct in the time directly preceding the point of insolvency.

In particular, they will be looking for evidence that a director understood the law and did not seek to prioritise any other interests than creditors once they understood their situation.

Wrongful trading^[2]Trusted Source – .UK – Insolvency Act 1986 – Section 214, Wrongful Trading is a civil offence, carrying with it fines, penalties and in the most serious cases jail. Conviction of wrongful trading may also cause directors to be held personally liable for some or all of the corporate debt.

This is where directors who have kept clear records, including recording all key decisions in the minutes of board meetings, stand a better chance of demonstrating their adherence to the law.

The key test of directors conduct is whether :

• they took every possible step to prevent losses to company creditors
• they knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation

Section 238: Transactions at Undervalue

This section covers the risks of directors selling goods or assets at a lower than market value, in the period preceding insolvency. IP’s will be looking at a period of up to two years prior to liquidation.

Where evidence of transactions at undervalue^[3]Trusted Source – .UK – Insolvency Act 1986 – Section 238, Transactions at an Undervalue is discovered, these sales may be ‘set aside’, which means the court can reverse or invalidate the sale.

Section 239 – Preferences

Preferences^[4]Trusted Source – .UK – Insolvency Act 1986 – Section 239, Preferences refers to the possibility of a director or other office holder putting through a transaction which puts one creditor in a preferential position over another after the insolvency.

Again, the insolvency practitioner has the power to set these transactions aside if they have occurred in the period of six months before insolvency. This period is extended to two years where ‘connected’ persons are involved, (such as family members, shareholders or other directions.)

Potential Consequences of Insolvency for Directors

When a company becomes insolvent, and if the directors have failed to uphold their legal duties, they may face potential consequences, including disqualification orders and personal liability for the company’s debts.

Report on Directors Conduct

If a company’s insolvency practitioner suspects that the directors have breached their duties and caused losses to the company’s creditors, they must submit a report on the directors’ conduct to the Secretary of State (in practice, the Insolvency Service) within three months of the company’s insolvency. The Insolvency Service may then investigate the directors’ conduct and take legal action against them if necessary.

Directors Disqualification

One potential consequence of breaching director duties during insolvency is the disqualification order. This order can be issued by a court or by the Insolvency Service and can prohibit a director from acting as a director of any company or being involved in the formation, marketing, or running of a new company for a period of up to 15 years.

A disqualification order can have severe consequences for a director, as it may prevent them from working in their chosen industry or field for an extended period. It can also damage their reputation and make it challenging for them to secure future employment or investment opportunities.

Personal Liability

In addition to disqualification orders, directors who breach their duties during insolvency may be held personally liable for the company’s debts. This can result in legal action against their personal assets, including their home, car, or personal savings.

Summary

Here are some practical tips for directors concerned about potential insolvency:

• Understand your legal obligations to maximise creditor interests
• Keep careful notes of your actions once you suspect the company has crossed the tipping point
• Ensure you don’t pay anyone, including yourself, before taking advice
• Don’t sell any assets without taking advice
• Gather your financial records and recent accounts for a consultation with a licensed insolvency practititioner such as ourselves

FAQs

References

The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.

You can learn more about our standards for producing accurate, unbiased content in our editorial policy here.

1. Trusted Source – Legislation – Directors’ Duties to Promote to the Success of a Company
2. Trusted Source – .UK – Insolvency Act 1986 – Section 214, Wrongful Trading
3. Trusted Source – .UK – Insolvency Act 1986 – Section 238, Transactions at an Undervalue
4. Trusted Source – .UK – Insolvency Act 1986 – Section 239, Preferences