Insolvency: A practical guide for all Directors

If you are a company director, you should be aware of the legal duties that come with the role. However, are you aware that there is a marked change in your duties when it comes to an insolvency situation? You should understand when this change happens and what to consider.

This guide has been written to be relevant to all company directors to help identify what to look out for in the early stages of financial difficulty and some important steps to take before liquidation or administration happens.

Spotting the early signs of insolvency

As a director, you are ultimately responsible for the financial health of the business on an ongoing basis and should be one of the first to know if the company can no longer meet its obligations. However, practically speaking there are a few tell-tale signals that can help identify issues early on:

Cash Flow SignalsBalance Sheet Signals
  • Reduction or complete removal of payment terms
  • Inability to meet financial obligations as they fall due
  • Falling into arrears with HMRC
  • Liabilities become greater than assets
  • Late filing of accounts

Any future investigation will look for the point at which the director knew or ought to have known that there was no reasonable prospect the company would have avoided going into insolvent liquidation or administration. The criteria to judge this point in time will be what could be expected of a reasonably diligent person plus your own specific general knowledge, skill and experience.

What to do if there is a risk of Insolvency?

Once you have established insolvency is a possible outcome, your duties as a director change, you must put the best interests of creditors ahead of shareholders. In all cases, you will need to ensure you have acted honestly and reasonably. Here are some important considerations and practical steps:

  • Do not ignore the early signals – these are evidence that the company is in trouble. As soon as you become aware you should raise the issue with the rest of the board.
  • Get help – identifying the exact point where insolvency is inevitable is difficult in practice and fear of being accused of wrongful trading may lead to taking steps prematurely that ultimately negatively affect creditors. Seek professional help.
  • Creditors first – Take every step to minimise potential losses to the company’s creditors. Failure to do so may be considered wrongful trading. Amongst other things, directors should pay particular attention to the following contentious areas:
    • Incurring any additional liabilities
    • Payments to shareholders
    • Granting security to a previously unsecured supplier
    • Changes to supplier terms
    • Payment of only some unsecured creditors or non-critical suppliers
    • Making of severance payments to senior employees
    • Repaying any debt guaranteed by a director
  • Regular board meetings – ensure all directors are present and aware of the company’s financial position. Directors should reach their decision independently based on the information available. Our governance specialists are perfectly placed to attend board meetings, provide advice and circulate professional minutes.
  • Keep personal records – in addition to the above, you should keep your own records. This may be particularly relevant if you have voiced concerns. By law, the onus falls on the director to prove they took the necessary steps. Simply resigning is rarely looked upon favourably unless the director can prove they have taken reasonable steps but not been supported by the rest of the business.
  • Conflicts of interest – be aware of any conflicts of interest you may have. For example, if you are a director of the group company and the subsidiary.
  • Listed company compliance – directors of listed companies will likely have additional responsibilities when it comes to market updates and disclosures.

Insolvency and personal liability for Directors

From a personal perspective, you should consider the different ways you may be personally liable for the company’s financial position. This could take the following forms:

  • You have been guilty of wrongful trading by not prioritising the interests of creditors. An Insolvency Practitioner will investigate the cause of the insolvency and as mentioned it is your responsibility to demonstrate the steps you took. If found guilty this could lead to disqualification and/or orders to contribute personally to the assets of the company.
  • You owe money to the company e.g. an overdrawn directors’ loan. This money now belongs to the company and you must not be seen to have preferential treatment.
  • You provided a personal guarantee for a bank loan.

Where the director is personally liable for company debts if they are unable to meet these then this may result in personal bankruptcy.

What protection can be put in place?

Whereas for certain liabilities a director may be covered by an indemnity in the company’s articles of association or a separate deed, this is not possible for issues that arise during insolvency. In the event of an insolvency the company can no longer be relied on to have the funds at its disposal to indemnify the director. Instead, directors should look to insurance.

Directors and Offices (D&O) insurance can offer protection against the losses and legal costs associated with claims due to their actions as a director of the company.

When put in place ahead of time it can cover the costs of defence against creditors and insolvency practitioners. This is becoming increasingly important to defend against deep pocketed of claims companies. However, in our experience D&O insurance is also becoming increasingly expensive.

As a director even if you already have a policy in place you should ensure that it is up to date, review any renewals and ensure that all payments are made.

How Elemental can help?

Elemental is an integrated corporate services firm. We have a team of company secretaries, solicitors, governance experts and accountants who can provide clients with guidance on the financial health of the business and directors’ duties.

This article is not intended to constitute formal legal advice and should not be treated as such. Each individual circumstance is unique and formal advice should be taken in respect of specific scenarios.

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