In Short
- Directors can be personally liable during insolvency if they fail to act in the best interests of creditors.
- Key risks include wrongful trading, fraudulent trading, misfeasance, undervalue transactions, and preferential payments.
- Early action, accurate records, and professional advice can reduce personal liability risks.
Tips for Businesses
Act promptly when facing financial difficulties by seeking professional advice to understand the company’s position. Keep accurate financial records, document key decisions, and hold regular board meetings to review the company’s financial status. Avoid risky transactions and stop trading if the company is no longer solvent.
Summary
This article explains the circumstances under which company directors in the United Kingdom may become personally liable during insolvency and offers practical strategies to mitigate those risks. Prepared by LegalVision, a commercial law firm specialising in advising clients on insolvency and director responsibilities, it highlights common pitfalls, preventive measures, and the importance of early intervention.
A company entering insolvency can be a considerable concern for directors, especially regarding their responsibility for business debts. A key advantage of running a company is limited liability, which means that your personal assets are generally protected from risk and your company’s debts. As such, directors will typically not be responsible for debts incurred by their company when it becomes insolvent. However, such protection is not absolute, and directors can face liability in specific scenarios.
When a business faces serious financial trouble, the responsibilities of its directors change, as does the level of personal risk. If insolvency becomes likely, then your duty as a director changes, and your focus must shift away from shareholders and towards the company’s creditors. From this point, every decision you make should aim to protect creditors’ interests and minimise potential losses. Insolvency practitioners and the courts can scrutinise how you have acted, and if you have fallen short of your duties, they can hold you personally responsible in insolvency situations. Consequently, there can be circumstances where you need to pay out compensation to certain parties and could face other risks and liabilities as a result of your conduct.
This article explores essential situations to understand where personal liability can arise in insolvency for directors and steps that you can take to reduce risk.
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When Might You Be Personally Liable as a Director?
Put simply, a company is considered insolvent when it is unable to pay its debts as they fall due or when its liabilities exceed its assets. Once that happens, an insolvency practitioner can be appointed to take control of affairs. Their role includes reviewing the conduct of the directors and what led to the insolvency. If they find that directors acted inappropriately or made decisions that worsened the company’s position, they can bring personal claims to recover losses or unwind certain transactions.
All directors will share the same obligations, regardless of whether they are:
- executive;
- non-executive; or
- informal ‘shadow’ directors who influence company decisions without being formally appointed.
Personal liability can further arise if you have:
- given personal guarantees;
- failed to keep up with key tax obligations; or
- breached your general duties under company or insolvency law.
What Are Key Risks for Directors?
In simple terms, some key risks to be aware of as a director in insolvency situations include:
Wrongful Trading
Wrongful trading occurs when you continue trading despite knowing or being aware that insolvency cannot be avoided. If the court finds that you did not take every reasonable step to minimise losses to creditors, you can be ordered to contribute personally to those losses. Acting responsibly means:
- seeking appropriate advice early;
- maintaining accurate financial information; and
- regularly assessing whether the company can continue to trade realistically.
Fraudulent Trading
Fraudulent trading involves you acting dishonestly during insolvency with the intent to defraud creditors. For example:
- taking deposits when you know goods or services will not be provided;
- hiding company assets; or
- misleading creditors.
Misfeasance or Breach of Duty
Misfeasance encompasses the misuse of company funds or property, or the failure to act with the care and skill expected of a director. Examples include:
- unauthorised payments;
- diverting money for personal benefit; or
- failing to maintain proper records.
The court can order you to repay or compensate the company for any resulting loss. Misfeasance claims are often linked with other allegations, such as wrongful trading or preference claims.
Transactions at an Undervalue
If the company disposes of assets for less than they are worth before insolvency, the court can set aside the transaction and order repayment or recovery of the assets. This typically applies to transactions made within two years before insolvency. Where the deal involves a connected party, it is presumed that the company was insolvent at the time, unless proven otherwise.
Preferences
A preference occurs when one creditor is paid or treated more favourably than others in the run-up to insolvency, for example, by repaying a loan to a director or family member. If the court finds that you intended to put that creditor in a better position, it can undo the transaction and require repayment.
Transactions Defrauding Creditors
The court can reverse the transaction if you deliberately move assets to prevent creditors from accessing them. For example, by transferring money to another company or a relative. This type of behaviour is treated seriously and can lead to both civil and criminal penalties.
Director Disqualification
After insolvency, the Insolvency Service may review a director’s conduct. You could be disqualified for up to fifteen years if it is decided that you acted irresponsibly, for example, by:
- trading recklessly;
- failing to keep proper records; or
- breaching your duties.
Acting as a director while disqualified is a criminal offence and will make you personally liable for any debts the company takes on.
These are simplified summaries of important matters, and you should consult a lawyer if you are concerned about these potential risks.
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How to Reduce the Risk of Personal Liability
When financial pressure starts to build for your business, taking early action can help reduce risk. You should ensure that you fully understand the company’s financial position and seek professional advice as soon as difficulties arise. There are a number of steps you can take to prevent risk.
Keep Robust Records
This is a key form of protection. Your business should keep accurate records of:
- accounts;
- forecasts; and
- correspondence.
Document why key decisions were made and any advice you received from professionals. These records can help show that you acted reasonably and responsibly, which can make a difference if your conduct is later reviewed.
Hold Regular Board Meetings
Holding regular board meetings and keeping minutes of key discussions and decisions can help protect your position. You should review financial reports regularly and ensure that your fellow directors are informed about the company’s financial position.
Manage Business Finances Responsibly
Avoid taking on new borrowing, repaying connected creditors, or transferring assets unless you are confident that those actions are in the best interests of all creditors. If the business can no longer trade solvently, you should stop trading and work cooperatively with the insolvency practitioner.
Key Takeaways
Limited liability is a key benefit of a limited liability company. However, once insolvency becomes likely, your legal duties will shift, and your actions can be scrutinised, potentially resulting in personal liability. Keeping accurate records, taking advice and acting transparently are ways to protect yourself from personal liability exposure.
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Frequently Asked Questions
Yes potentially. Though limited liability will usually protect you, that protection can fall away if you act irresponsibly, e.g. by continuing to trade when insolvency is unavoidable, favouring certain creditors or misusing company assets. In such situations, you may be personally required to contribute to the company’s losses.
Precise and accurate records (such as financial accounts, board minutes and evidence of professional advice) can help show that you acted responsibly and in good faith. This evidence can be crucial in defending claims or investigations into your conduct after insolvency.
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