Directors' liability for businesses in financial difficulty

When a business falls into difficulty, a large part of the financial burden can fall on the shoulders of the company directors. Here, our business recovery team attempt to answer some of the questions you may have about insolvency, and your liability as a business owner.

A business becomes insolvent either when it cannot pay its debts as and when they fall due, or when the value of its liabilities exceeds the value of its assets. However, the process of insolvency is not always as straightforward as this. 

For example, a large customer contract might be lost, an unexpected bad debt arise or the bank withdraws support (or a combination of one or more events that collectively mean) that the company becomes unable to survive.  It is not always clear at the time when a company has become insolvent. 

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How does insolvency affect the role of a director?

As a director, you will be duty bound to act in the best interests of the company and its shareholders at all times. However, when the company becomes insolvent, the focus of the duty shifts towards the creditors of the business. 

Who else within the company can be affected by insolvency?

Whilst registered directors will undoubtedly take on most of the financial burden of insolvency, there are other parties who may also find themselves at risk. This can include anyone who has a level of control of the company, who is responsible for the direction of the company’s affairs, or who advises the directors in any capacity. 

When can a director become personally liable?

In the process of insolvency, there are various different circumstances within which a director can find themselves personally liable for their business’s debts, including:

  • Wrongful Trading
  • Fraudulent Trading
  • Misfeasance
  • Personal Guarantees
  • Preferences
  • Transactions at Undervalue (TUV)

What is a transaction at undervalue?

A transaction at undervalue (TUV) occurs when a company has transferred one of its assets at a price that is significantly less than its market value. If a court decides that the company has entered into a TUV, it may order you as a director to refund part or all of the value of the transaction to the company.

The court will also have to determine whether the company and the recipient of the asset were dealing with each other “at arm’s length”. For example, if the two parties are related to each other, the recipient would be deemed a connected party.

The court may order you a connected party to pay the difference between the amount  paid for the assets and the fair market value, or return the assets.

What is meant by the term 'preferences'?

A preference transaction means you have made a payment or transfer to a creditor in preference of another. When a company becomes insolvent, the director must treat the interests of all the creditors equally. A common example is when the directors direct their company to pay off part or all of a loan or overdraft that the directors have guaranteed to the bank.  This is often alleged to be a preference payment.
As with TUVs, the directors can be ordered by the court to repay the full value of transactions that are found to be preferences.. 

What should I do if my company becomes insolvent?

If your company has fallen into insolvency, or you think it may become insolvent in the near future, there are a number of steps you should take as company director. 

  • Seek professional advice as soon as you can; the sooner you do this, the more options there will be available to your company that will reduce your risk of personal liability.
  • Ensure you have accurate, up-to-date financial records for your business.
  • Do not continue to trade if your company is insolvent, unless you believe there is a strong possibility that you can do so without the company falling into insolvent liquidation.
  • Evaluate your business, consider what it is that has caused the problem within your operation, and develop a financial strategy that will reduce costs and highlight which aspects of your business are not profitable. 
  • All creditors have equal priority when you become insolvent. Do not pay certain creditors in preference to others.
  • Do not take on additional credit if you know there is little chance of you being able to repay it, and do not write cheques if there is a possibility that they may bounce. 
  • If there are other directors at your company, and they disagree with your insolvency plans, ensure that your thoughts are made clear, whether it be in writing or within the minutes of a board meeting. 
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