What should directors do when a company is in financial distress?
When a company experiences financial difficulty, the responsibilities of its directors come under increased scrutiny. Both case law and the Insolvency Act 1986 set out clear expectations for director conduct during periods of insolvency or near-insolvency, with a strong emphasis on protecting creditor interests.
Understanding when these duties arise and how to respond appropriately is critical. Failure to act in line with statutory obligations can result in severe consequences and personal liability.
What are the signs of financial distress?
Some of the common warning signs that a company may be experiencing financial distress include:
- defaulting on bills/creditor payments;
- cashflow issues;
- low/falling profits;
- creditor threats/action;
- neglecting tax affairs.
A company is deemed insolvent if it satisfies the below tests:
- inability to pay its debts as and when they fall due (cash flow insolvency), or
- has liabilities exceeding assets (balance sheet insolvency).
Many of the signs above can emerge before insolvency is formally established. Seeking advice at an early stage can help directors better understand their options and responsibilities.
What practical steps should directors take?
Ordinarily, under the Companies Act 2006, directors have a fiduciary duty to promote the success of a company for the benefit of its members as a whole. However, when a company is insolvent or at risk of insolvency, the directors’ duties change to act in the best interest of creditors, as per the Supreme Court’s ruling in Sequana.
As a result of this, directors must take practical steps to preserve available assets, act in creditors’ best interests as a whole and avoid worsening the company’s financial position. Directors should consider taking the following practical steps:
- strengthen oversight;
- hold frequent board meetings
- keep detailed minutes
- monitor financial health;
- prepare and review cash flow forecasts regularly
- maintain up-to-date management accounts
- keep a record of all key decisions made
- seek advice early;
- consult insolvency practitioners and legal advisors in a timely manner
- explore restructuring or recovery options
- ensure fairness across creditors, with regards to payments;
- do not take deposits unless fulfilment of services is possible.
What happens if directors fail to comply with their duties?
Should a company then later be placed into a formal insolvency procedure (such as a Creditors’ Voluntary Liquidation), a director may face various claims from the appointed Insolvency Practitioner if they have failed to act in accordance with their duties to creditors or mitigate any losses.
These claims can, in some circumstances, result in directors facing personal liability, which underlines the importance of taking appropriate action at an early stage.
Misfeasance claim
A misfeasance claim can be brought against a director of an insolvent company where there has been a breach of any fiduciary or other duty in relation to the company. If successful, the Court will order the director compensates the Company.
Wrongful trading claim
A wrongful trading claim can be brought by an office holder where a company continued to trade when the directors knew or should have known insolvency was unavoidable and the director(s) failed to minimise losses. If successful, a director will become personally liable for the losses made in the period of insolvency.
Antecedent Transactions
An office holder has a duty to investigate a company’s affairs and recover assets for the benefit of creditors. The following transactions could be identified and challenged:
1. Preferences
Payments to any connected creditor or a creditor they have any desire to prefer may be challenged as a preference payment. This can lead to repayment from the recipient and/or personal liability for directors.
2. Transactions at undervalue
Any asset disposals at a time where a company is deemed insolvent must be for fair value. Should assets be disposed of or sold at an undervalue, a transaction at undervalue claim is viable. This can lead to the recipient being made to be liable for further sums or be forced restore the asset position.
Directors may also face wider consequences, including disqualification for up to 15 years, reputational damage and, in some circumstances, criminal sanctions.
How we can help
If your company is navigating financial distress, our experienced restructuring and insolvency team at Moore Kingston Smith can help directors understand their obligations, assess the options available to them, and take practical steps to protect the interests of creditors.
Seeking advice at an early stage can help safeguard directors’ positions, support decision-making, maximise available options and reduce the risk of claims at a later date.
