Directors’ responsibilities during insolvency

A company is insolvent if it can’t pay its debts.

Insolvency proceedings are processes an insolvent company goes through to try and deal with its debts. There are two main types of insolvency proceedings: some try to rescue the company, while others close the company down.

Directors’ duties

Directors are responsible for the day-to-day management of companies. Their role is set out in company law, the company’s constitution (Articles of Association) and, if they are also employees, their employment contracts.  

Directors owe legal duties. An important one is the duty to promote the success of the company for the benefit of its shareholders. But when a company is in financial difficulty and there is a risk of insolvency, directors owe a duty to creditors (people owed money) to minimise their losses.

Responsibility for mismanagement

A company is a separate legal entity from its directors, so a director can’t normally be personally sued for debts of a company. But if directors have mismanaged a company that becomes insolvent, they can be personally responsible in certain situations:

• Wrongful trading happens when directors carry on trading after there is no reasonable prospect of a company avoiding liquidation (being closed down). It could happen when directors still have hope of saving the company so continue trading beyond the point when they should. A court can order that a director committing wrongful trading be personally responsible for a company’s debts.

• Fraudulent trading happens when directors have managed a now-insolvent company with the intention of defrauding creditors, for example paying themselves a salary they know the company can’t afford. In addition to this being a criminal offence, a court can order that a director be personally liable to make a payment to the company.

• Directors who breach duties they owe (for example, by misusing company property) can be personally liable for misfeasance. This covers things like unauthorised loans or payments to directors. In such cases a court can order a director to repay misused money to the company.

The person overseeing a company insolvency (for example the liquidator or administrator) must submit a report about the directors to the Secretary of State (in practice, the Insolvency Service) covering the last three years of trading, within three months of the company’s insolvency.

The Insolvency Service will then decide whether to investigate further and apply to court for a disqualification order of up to 15 years against a director. A disqualified director must not act as a company director or be involved with the formation, marketing or running of a new company. As an alternative to an order, the Secretary of State may accept a voluntary disqualification undertaking from a director. This can save time and avoid court costs.

Reforms

The Department for Business, Energy and Industrial Strategy has consulted on proposals to improve the UK’s corporate governance and insolvency framework. Our Library briefing paper Corporate insolvency framework: proposed major reforms has more detail.

Our Library briefing paper New business support measures: Corporate Insolvency and Governance Act 2020, gives more detail on recent reforms to the UK insolvency regime and temporary modifications to it during the COVID-19 pandemic.

Corporate insolvency legislation generally applies across England, Wales and Scotland.