The Directors Responsibilities When a Company Becomes Insolvent

For company directors, the onset of insolvency marks a critical juncture where their duties and responsibilities fundamentally change.

No longer is their primary focus solely on promoting the success of the company for the benefit of its shareholders. Instead, the law dictates a significant shift in allegiance: to the creditors.

Understanding this change and acting accordingly is paramount.

Failure to do so can lead to serious consequences for directors, including personal liability for company debts and disqualification from acting as a director in the future.

Directors key responsibilities when insolvent

1. The Paramount Duty to Creditors:

The most significant change is the overriding duty to act in the best interests of the company's creditors as a whole. This means that any decisions made must prioritise minimising potential losses to those the company owes money to.
This duty arises when directors know, or ought to know, that the company is insolvent or is likely to become so.

2. Avoiding Wrongful Trading:

One of the most significant risks directors face in insolvency is wrongful trading. This occurs if a director continues to trade the company and incur further debts when they know, or ought to have concluded, that there was no reasonable prospect of the company avoiding insolvent liquidation or administration. The law doesn't prohibit trading while insolvent outright, but it does penalise directors who worsen the position of creditors by doing so without a reasonable belief that the company can be rescued.
If found guilty of wrongful trading, a director can be held personally liable for the losses incurred by creditors from the point at which they should have ceased trading.

3. Avoiding Fraudulent Trading:

A more serious offence is fraudulent trading, which involves carrying on the business of the company with the intent to defraud creditors or for any fraudulent purpose. This requires proof of dishonesty and can lead to unlimited personal liability and criminal prosecution.

4. Preserving Company Assets:

Directors have a responsibility to preserve and protect the company's assets once insolvency is apparent. This means not disposing of assets at an undervalue or for personal gain, as these actions can be investigated and potentially reversed by an Insolvency Practitioner.
The assets are effectively held for the benefit of the creditors.

5. Treating Creditors Equally (Avoiding Preferences):

Directors must not show preferential treatment to certain creditors over others. Making payments or transferring assets to a particular creditor (especially if they are connected to the director) shortly before the company enters a formal insolvency procedure can be deemed a "preference" and potentially be challenged and reversed by an Insolvency Practitioner.

6. Cooperation with the Insolvency Practitioner:

Once a formal insolvency procedure like liquidation or administration commences, the directors have a legal duty to cooperate fully with the appointed Insolvency Practitioner (the liquidator or administrator). This includes providing all relevant company records, information, and explanations regarding the company's affairs and their conduct. Failure to cooperate is a serious matter.

7. Providing Information (Statement of Affairs):

In most insolvency procedures, directors are required to provide a detailed statement of the company's financial affairs to the Insolvency Practitioner. This document outlines the company's assets and liabilities, providing a clear picture for the IP and the creditors.

8. Seeking Professional Advice:

Crucially, directors of a company facing potential or actual insolvency have a responsibility to seek qualified professional advice without delay. Consulting with a licensed Insolvency Practitioner is vital to understand the company's true financial position, the available options, and the directors' personal responsibilities and potential liabilities. An IP can guide directors through the complexities of insolvency law and help them make informed decisions that are in the best interests of the creditors.

Potential Consequences of Failing Responsibilities

Failing to adhere to these responsibilities can lead to:

• Personal Liability: As mentioned, directors can be held personally liable for certain company debts, particularly in cases of wrongful trading or fraudulent trading.
• Director Disqualification: The Insolvency Service can investigate the conduct of directors of insolvent companies. If they find evidence of unfit conduct, including breaches of their duties, directors can be disqualified from acting as a director of any company for a period of up to 15 years under the Company Directors Disqualification Act 1986.
• Criminal Prosecution: In severe cases, such as fraudulent trading, directors can face criminal charges.

Conclusion

The point of insolvency is a critical turning point for company directors. The focus shifts decisively to protecting the interests of creditors.

By understanding their heightened responsibilities, acting with integrity, and crucially, seeking timely professional advice from a licensed Insolvency Practitioner, directors can navigate the challenging landscape of corporate insolvency and mitigate the potential personal consequences.