Directors' duties when a company is in financial difficulty

Directors' duties in normal times

The Companies Act 2006 sets out seven general duties that every director owes to the company. A director must act in accordance with the company's constitution and use powers only for the purposes for which they were given; act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole; exercise independent judgment; exercise reasonable care, skill and diligence; avoid conflicts of interest; not accept benefits from third parties because of their position; and declare any interest in a proposed transaction with the company.

The standard of care is measured against a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of someone carrying out the director's functions, and also with the knowledge, skill and experience the director actually has. A director with an accounting background can therefore be held to a higher standard on financial matters than one without. The general duties also apply to shadow directors, so far as they are capable of applying.

When creditors' interests come first

Section 172 of the Companies Act 2006 says that the duty to promote the success of the company is subject to any rule of law requiring directors, in certain circumstances, to consider or act in the interests of the company's creditors. In BTI 2014 LLC v Sequana SA, decided in October 2022, the Supreme Court confirmed that this creditor duty exists and explained when it applies.

The majority of the court held that the duty is engaged when the directors know or ought to know that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. A real risk of insolvency, even one that is not remote, is not enough on its own. Once the duty is engaged, the directors must consider the interests of the creditors as a whole and balance them against the interests of the shareholders where they conflict, giving creditors more weight the worse the company's financial difficulties become. When an insolvent liquidation or administration is inevitable, the creditors' interests become paramount.

The court also confirmed that shareholders cannot authorise or ratify a transaction that breaches this duty, and that the duty can apply to a decision to pay a dividend that is otherwise lawful. Once a company is in serious difficulty, a decision that suits the owners, such as paying a dividend, repaying a director's loan or moving assets to a connected company, therefore has to be tested against its effect on the creditors.

How to tell whether the company is insolvent

There are two main tests, both in section 123 of the Insolvency Act 1986. Under the cash-flow test, a company is unable to pay its debts if it cannot pay them as they fall due. Under the balance-sheet test, it is unable to pay its debts if the value of its assets is less than its liabilities, taking into account contingent and prospective liabilities. A company can fail one test while passing the other, and either can matter to the directors' position.

Warning signs usually appear before either test is clearly failed. They include arrears of VAT or PAYE, using money set aside for tax to pay suppliers, stretching supplier payment terms, breaching bank covenants, an overdraft permanently at its limit, county court judgments or statutory demands, important customers paying late or leaving, and management accounts that are out of date or not prepared at all. Up-to-date management accounts and a rolling cash-flow forecast are what allow a board to judge whether the company can pay its debts over the coming weeks and months.

Wrongful trading and the every step defence

Under section 214 of the Insolvency Act 1986, if a company goes into insolvent liquidation, the liquidator can ask the court to order a director to contribute to the company's assets. The claim succeeds if, at some time before the liquidation began, the director knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation or insolvent administration. An administrator can bring an equivalent claim under section 246ZB where the company enters insolvent administration, and shadow directors are covered in both cases.

The court will not make an order if it is satisfied that, from the time the director knew or ought to have reached that conclusion, they took every step with a view to minimising the potential loss to the company's creditors that they ought to have taken. What a director ought to have known, concluded and done is judged by the same two-part standard as the general duty of care, taking account of the functions entrusted to them as well as their own knowledge and experience.

Wrongful trading does not require dishonesty, and the law does not say that a company must stop trading the moment it becomes insolvent. Continuing to trade can be the right decision where it is likely to reduce the loss to creditors, for example by completing profitable contracts or allowing the business to be sold as a going concern. The risk comes from carrying on in the hope that things will improve, taking new credit and running up debts that will not be paid, without a realistic plan or advice. Where a court does order a contribution, it is generally measured by the extent to which trading on after that point made the creditors' position worse.

Payments and transactions that can be challenged later

If the company goes into liquidation or administration, the office-holder will look back at what happened beforehand. The following transactions can be reversed, and the directors responsible can face claims. For preferences and transactions at an undervalue, the company must also have been unable to pay its debts at the time, or have become unable to pay them as a result, and for a transaction at an undervalue with a connected person that is presumed.

• Preferences. A payment or other step that puts a creditor or guarantor in a better position than they would otherwise have in an insolvent liquidation can be reversed if the company was influenced by a desire to prefer them. The look-back period is six months, or two years for a person connected with the company, such as a director or a director's relative, and for connected persons that desire is presumed. Repaying a director's loan, or a bank debt a director has personally guaranteed, can fall into this category.
• Transactions at an undervalue. A gift, or a transaction for significantly less than the value the company gives, made in the two years before the insolvency can be reversed, unless it was entered into in good faith for the purpose of carrying on the business with reasonable grounds for believing it would benefit the company.
• Misfeasance. A director who has misapplied or kept company money or property, or breached a duty to the company, can be ordered to repay it or to pay compensation.
• Unlawful dividends. A company can only pay dividends out of profits available for distribution, and a shareholder who knew or had reasonable grounds to believe a dividend was unlawful is liable to repay it.

Our guide to when company directors become personally liable covers these claims in more detail, together with fraudulent trading, personal guarantees, disqualification and the notices HMRC can issue to directors.

What the board should do when trouble starts

Hold regular board meetings and minute them properly, recording the financial information the board considered, the options discussed, any advice received and the reasons for each decision. Keep management accounts and cash-flow forecasts up to date and review them at each meeting. If a director disagrees with a decision, the minutes should say so.

Take advice from a licensed insolvency practitioner early, while there are still options, and consider separate legal advice on the directors' own position. The Insolvency Service's guidance for directors of insolvent companies says they must protect the company's assets, treat all creditors the same, make sure the company does not worsen the creditors' position, and consult or consider appointing an insolvency practitioner. In practice that means being cautious about taking customer deposits or placing orders the company may not be able to pay for, not paying connected parties, including the directors, ahead of other creditors, and not selling or transferring assets for less than they are worth. Keep statutory filings and VAT and PAYE returns up to date even where the tax cannot be paid, and speak to HMRC about a payment plan instead of letting arrears build up.

Resigning as a director does not remove the risk of personal liability. A director's conduct while in office can still be examined after they leave, and a resignation that leaves the company without effective management can make matters worse. If directors disagree about whether the company should keep trading, each should record their view and take advice before acting.

The formal options available

If the business can be rescued, the options include an informal arrangement with creditors, a moratorium under Part A1 of the Insolvency Act 1986, which gives an initial period of 20 business days' protection from most creditor action, a company voluntary arrangement, a restructuring plan and administration. If it cannot be rescued, a creditors' voluntary liquidation allows the shareholders and directors to close the company in an orderly way through a licensed insolvency practitioner, instead of waiting for a creditor to petition for compulsory liquidation. Each procedure has its own conditions. Our guide to the options for a company in financial difficulty explains how they work and compare.

What happens to directors after an insolvency

When a company enters liquidation or administration, its current and former officers must cooperate with the office-holder, giving information about the company's affairs and attending when reasonably required. In a creditors' voluntary liquidation, the directors must also prepare a statement of the company's affairs, verified by a statement of truth, and send it to the creditors within seven days after the day the resolution to wind up is passed.

The office-holder must send the Secretary of State, in practice the Insolvency Service, a conduct report on everyone who was a director on the insolvency date or at any time in the three years before it, normally within three months of the insolvency date. If a director's conduct makes them unfit to be concerned in the management of a company, the court must disqualify them for between two and fifteen years, or the Secretary of State can accept a disqualification undertaking instead. An application must usually be made within three years of the company becoming insolvent, and a disqualified director can also be ordered to compensate creditors who lost money because of their conduct.

There are also restrictions on reusing the name of a company that has gone into insolvent liquidation. For five years, a person who was a director in the twelve months before the liquidation cannot, without the court's permission or unless a prescribed exception applies, be involved in another company or business using the same name or one so similar as to suggest an association with it. Breaching this restriction is a criminal offence and makes the person personally liable for the debts incurred while they were involved.

Getting advice early

Early advice keeps more options open, and a record of that advice and of the board's decisions is the best evidence that the directors acted properly if their conduct is examined later. An insolvency practitioner can advise on the company's options and, once appointed as an office-holder, acts in the interests of the creditors as a whole. Directors who want advice on their own exposure, such as personal guarantees, overdrawn loan accounts or possible claims against them, need advice of their own.

We advise directors on their duties and their personal position when a company is under financial pressure, and we work alongside the company's accountants and insolvency practitioners. We agree the scope of our work and the cost with you in writing before we start.

Frequently asked questions

When do a director's duties shift towards creditors?

According to the Supreme Court in BTI 2014 LLC v Sequana SA, the duty to consider creditors' interests is engaged when directors know or ought to know that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable. A real risk of insolvency is not enough on its own. As the company's position worsens, creditors' interests carry more weight, and once insolvent liquidation or administration is inevitable they become paramount.

What is wrongful trading?

Wrongful trading is a claim against a director of a company that has gone into insolvent liquidation or administration, where the director knew or ought to have concluded beforehand that there was no reasonable prospect of avoiding it. The liquidator or administrator can ask the court to order the director to contribute to the company's assets. The court will not make an order if the director took every step they ought to have taken to minimise the potential loss to creditors, so board minutes and records of advice are important evidence.

Do I have to stop trading if my company is insolvent?

No, not necessarily: continuing to trade can be the right decision if it is likely to reduce the loss to creditors, for example by completing profitable work or allowing the business to be sold as a going concern. The danger lies in trading on without a realistic plan and running up debts that will not be paid. If the company is insolvent, take advice from a licensed insolvency practitioner, minute the board's reasons for its decision and review the position regularly.

Can I resign as a director to avoid liability?

Resigning does not remove liability for what happened while you were a director. A liquidator can examine your conduct up to the date you left, and the office-holder's conduct report covers anyone who was a director in the three years before the insolvency. Resigning can also leave the company without proper management when it needs it most. If you disagree with the board's decisions, record your objection, take advice and treat resignation as a decision to make with that advice.

Can a director be disqualified if the company goes into liquidation?

Yes. If the court is satisfied that a director of an insolvent company is unfit to be concerned in the management of a company, it must make a disqualification order of between two and fifteen years, and the Secretary of State can accept a disqualification undertaking instead. Applications must usually be made within three years of the company becoming insolvent. Acting as a director while disqualified is a criminal offence and makes the person personally liable for debts incurred while they were involved in management.

Can I repay money the company owes me before it goes into liquidation?

It carries real risk. If the company goes into insolvent liquidation or administration within two years and was unable to pay its debts when it repaid you, the payment can be challenged as a preference, and because a director is a connected person the company is presumed to have intended to prefer you. The office-holder can ask the court to reverse it, and it can also count against you in a disqualification investigation. Take advice before the company repays any money owed to a director or to a lender whose debt a director has guaranteed.

Sources & further reading

• The Supreme Court — BTI 2014 LLC v Sequana SA and others [2022] UKSC 25
• legislation.gov.uk — Companies Act 2006, section 172: duty to promote the success of the company
• legislation.gov.uk — Insolvency Act 1986, section 123: definition of inability to pay debts
• legislation.gov.uk — Insolvency Act 1986, section 214: wrongful trading
• legislation.gov.uk — Insolvency Act 1986, section 239: preferences
• legislation.gov.uk — Company Directors Disqualification Act 1986, section 7A: conduct reports
• The Insolvency Service — Director information hub: director duties upon insolvency

This article is general information, not legal advice. The law changes and depends on your circumstances — always take advice on your specific situation before acting. Last reviewed 17 September 2026. AD Solicitors is a trading name of AD Solicitors Limited, a recognised body regulated by the SRA (no. 8011228).