Protecting Directors: Minimising Personal Risk During Insolvency
Directors across all sectors play a central role when a business begins to experience financial difficulty.
How directors respond as insolvency becomes a real possibility can have far-reaching consequences, not only for the company itself but also for their own personal exposure.
Seeking timely professional advice is often critical in reducing the risk of personal liability, particularly in relation to wrongful trading and the evolving duties owed during insolvency.
Rising Insolvency Risk for UK Businesses
In recent years, several well-known UK companies have entered insolvency, highlighting the pressures faced across a wide range of sectors. Increased operating costs, subdued consumer confidence, rising wage obligations and changes to employer national insurance contributions have all contributed to a more challenging trading environment.
When a business encounters financial distress, directors can face serious personal risks. These may include personal liability for company debts, especially where personal guarantees have been given, or directors continue trading despite insolvency being unavoidable.
Additional risks can arise from claims for misfeasance (where company assets are misapplied or directors act improperly), breaches of fiduciary duty, and penalties for unpaid tax liabilities owed to HMRC.
Directors’ Legal Duties When Insolvency Looms
Under normal circumstances, directors owe statutory duties to the company itself. These duties are primarily set out in the Companies Act 2006 and include obligations to:
- Act within their powers;
- Promote the success of the company;
- Exercise independent judgment;
- Avoid conflicts of interest; and
- Act with reasonable care, skill and diligence.
However, when a company’s financial position deteriorates to the point where insolvency is probable, the focus of those duties changes. At this stage, directors are required to prioritise the interests of the company’s creditors over those of its shareholders. This principle, commonly referred to as the “creditor duty”, was confirmed by the UK Supreme Court in BTI 2014 LLC v Sequana SA and others. In this case, the Court held that directors’ duties shift towards creditors when the directors knew, or ought reasonably to have known, that the company was insolvent or likely to become insolvent. As financial difficulties intensify, directors must give greater weight to creditors' interests, particularly where those interests conflict with the company’s shareholders.
This shift is significant to creditors and credit professionals, as it puts creditor interests at the forefront of board-level decision-making during periods of financial distress.
The extent to which the creditor duty overrides shareholder considerations will depend on how serious the company’s financial position has become.
What Is Wrongful Trading?
Wrongful trading arises where directors continue to trade a company despite knowing, or having reasonable grounds to believe, that there is no realistic prospect of avoiding insolvent liquidation. If further losses are caused to creditors as a result, the court may order the directors to contribute personally to those losses.
Only directors can be liable for wrongful trading, but the definition of “director” under the Insolvency Act 1986 is broad. It includes:
- De jure directors – legally appointed directors whose appointment is registered at Companies House.
- De facto directors – individuals who act as directors without formal appointment.
- Shadow directors – individuals who heavily influence company decision-making but without being formally appointed.
As a result, individuals who exert real influence over company decisions, even without an official title, may also face exposure if wrongful trading is established.
Key Elements of a Wrongful Trading Claim
To succeed in a wrongful trading claim, the following elements generally need to be proven:
- Insolvency – the company was unable to pay its debts as they fell due or its liabilities exceeded its assets.
- The tipping point – the point at which a director knew, or should have known, that the company was heading towards insolvency and would likely enter liquidation.
- Reasonable knowledge and skill – a director with similar experience and ability would have recognised that the company was in financial distress and taken steps to mitigate losses.
- Failure to minimise losses – the directors did not take every reasonable step to minimise losses to creditors after the tipping point.
- Loss to creditors – creditors suffered increased losses due to the directors’ actions or inaction after the tipping point.
A well-known illustration of these principles is the insolvency of British Home Stores (BHS). The court concluded that the directors knew, or should have known, at multiple stages that insolvency was unavoidable. Ultimately, two former directors were found personally liable for wrongful trading. The BHS case also highlighted how complex it can be to determine the precise moment at which insolvency becomes inevitable, with the court identifying six different tipping points before settling on the final relevant date.
Personal Liability Exposure for Directors
A finding of wrongful trading can result in significant financial consequences for directors, including personal liability for company losses and the possibility of director disqualification proceedings.
The BHS decision also demonstrated that liability is not always shared equally. The court may apportion responsibility based on each director’s level of involvement and culpability, meaning those more closely connected to the decision-making may face a greater share of the liability.
Directors may also face personal exposure in other ways, including:
- Enforcement of personal guarantees given to lenders;
- Repayment of overdrawn directors’ loan accounts following insolvency; and
- Claims linked to unpaid taxes or other statutory obligations.
Practical Steps Directors Can Take to Reduce Risk
When a company begins to struggle financially, directors should act promptly and decisively to limit further losses and reduce the risk of personal liability. Key steps include:
- Seeking early advice from an insolvency practitioner and an insolvency lawyer, particularly in relation to formal insolvency procedures such as administration or liquidation;
- Carefully documenting all board decisions and the reasoning behind them;
- Maintaining clear, written communication with creditors; and
- Avoiding transactions that may later be challenged, such as preferences or transactions at an undervalue.
The importance of obtaining and following professional advice was emphasised in the BHS case, where the total financial consequences for the directors exceeded £100 million in relation to both wrongful trading and misfeasance claims.
The Value of Independent Legal Advice
When insolvency is a real possibility, it is often advisable for directors to obtain independent legal representation, separate from the company. This ensures that directors receive clear, tailored advice on their personal duties and potential liabilities.
Taking proactive legal advice can significantly reduce the likelihood of costly litigation later. Early intervention enables informed decision-making, structured negotiations with creditors, and, in some cases, business restructuring that may avoid formal insolvency procedures altogether.
Early, informed legal advice remains one of the most effective tools available to directors seeking to protect themselves while safeguarding the interests of creditors and the wider business.
