Directors’ Duties in Financial Distress: A Practical Guide for UK Company Directors

A director’s duties are owed to the company at all times, but the way those duties must be discharged changes materially once the company is in, or approaching, insolvency. At that point, the long-standing focus on the interests of shareholders gives way to a duty to have proper regard to the interests of creditors. Directors who do not recognise that shift, or who continue to manage the business as though it had not occurred, carry the risk of exposing themselves to a range of personal liabilities under the Companies Act 2006 and the Insolvency Act 1986, as well as to disqualification under the Company Directors Disqualification Act 1986.

This guide sets out the duties that apply, when and how they change in financial distress, the warning signs that should prompt action, the governance and decision-making steps that most reliably protect the company and the directors personally, and the categories of transaction that warrant particular care. It is written for directors of UK companies who want to address these issues properly before a crisis develops, and for those already managing a difficult trading period who need to be confident that the steps they are taking are the right ones.

Director’s General Duties 

The starting point is sections 171 to 177 of the Companies Act 2006, which codify the seven general duties owed by every director to the company.

1. Duty to act within powers (s.171). A director must act in accordance with the company’s constitution and exercise powers only for the purposes for which they were conferred. In a distress context, this matters because expedient decisions taken under pressure must still be properly authorised by the articles and any shareholders’ agreement.
2. Duty to promote the success of the company (s.172). Directors must 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, having regard to the long-term consequences of decisions, the interests of employees, relationships with suppliers and customers, the impact on the community and the environment, the desirability of maintaining a reputation for high standards of business conduct, and the need to act fairly between members. As discussed below, this duty is recalibrated towards creditors once the company is in, or approaching, insolvency.
3. Duty to exercise independent judgement (s.173). A director must form their own view and not simply defer to others. This does not prevent them from taking advice or acting in accordance with agreements the company has properly entered into, but it does mean a director cannot abdicate decision-making to a dominant founder, shareholder or fellow director.
4. Duty to exercise reasonable care, skill and diligence (s.174). This duty is judged on a combined standard: objectively, by reference to what a reasonably diligent person carrying out the same functions would do; and subjectively, by reference to the director’s own actual knowledge, skill and experience. For example, a director with a financial background will be held to a higher standard on financial matters.
5. Duty to avoid conflicts of interest (s.175). Directors must avoid situations where they have, or could have, a direct or indirect interest that conflicts (or possibly may conflict) with the interests of the company. In distress, conflicts most often arise around personal guarantees, director’s loans and connected-party transactions.
6. Duty not to accept benefits from third parties (s.176). A director must not accept any benefit from a third party conferred by reason of their being a director or doing or not doing anything as a director.
7. Duty to declare interests in proposed or existing transactions (ss.177 and 182). Any direct or indirect interest in a proposed or existing transaction with the company must be declared to the other directors and properly recorded in the board minutes.

These duties are owed by all directors, including de facto directors (those who act as directors without formal appointment) and shadow directors (those whose directions or instructions the board is accustomed to follow). In our experience, this catches more people than they realise: founders who have stepped back but still give instructions, investors who exert directional control, parent-company executives, and senior managers exercising board-level authority should all consider whether they are exposed.

How Duties Change as a Company Approaches Insolvency

While a company is comfortably solvent, the duty to promote its success is read as a duty to act in the interests of the members as a whole. As financial difficulty develops, that focus shifts: directors must give appropriate weight to the interests of creditors. This is commonly referred to as the creditor duty.

The Supreme Court confirmed the modern shape of this duty in BTI 2014 LLC v Sequana SA UKSC 25. The creditor 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. It is a duty of appropriate weight: in the early stages of distress, creditors’ interests must be considered alongside those of shareholders; as the position deteriorates, creditors’ interests increasingly take priority; and once an insolvent outcome is inevitable, creditors’ interests become paramount.

In practice, the Sequana trigger is often crossed before directors recognise it internally. The classic pattern is a board that has been managing a “tight” cash position for some time, has lost or is about to lose a key facility, customer or covenant headroom, and is relying on optimistic forecasts to justify continued trading. We routinely advise boards that, once the trigger is even arguably engaged, the cadence of board meetings should increase, the analysis should be recorded in board minutes, and certain categories of transaction should not proceed without specific consideration of the creditor duty.

When Is a Company “Insolvent”?

Section 123 of the Insolvency Act 1986 sets out two tests of insolvency. A company is insolvent for these purposes if either is met.

The cash-flow test – asks whether the company is unable to pay its debts as they fall due. This is almost always the first test to bite. It is engaged not only when an actual default occurs, but when the realistic short-term forecast shows that the company will be unable to meet a payment obligation when it falls due. Reliance on stretching creditor days, deferring HMRC, or assuming a not-yet-secured facility, are all warning signs that the test may already be met.

The balance-sheet test – asks whether the value of the company’s assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities. The Supreme Court’s decision in BNY Corporate Trustee Services v Eurosail-UK plc UKSC 28 confirmed that this is a forward-looking test rather than a snapshot.

For directors, the value of these tests lies in their use as governance triggers. Once either is even arguably engaged, the way the board operates needs to change.

Warning Signs Directors Should Be Alert To

Directors commonly lose the protection of limited liability is that they did not recognise that the company was already in distress. No single indicator proves insolvency is inevitable, but the following, particularly in combination, should prompt close attention and, in most cases, professional advice:

• Persistent negative cash flow from operations.
• Missed or late payments to suppliers, lenders or HMRC.
• Lengthening creditor days and stretched accounts payable.
• Breaches, or anticipated breaches, of loan covenants.
• Rising debt with no matching asset or revenue growth.
• Creditor lawsuits, statutory demands, winding-up petitions or enforcement notices.
• Late wages or layoffs driven by cash constraints.
• Inventory build-up combined with falling sales.

Directors should be honest with themselves about what these indicators mean in combination. Optimism and a “wait and see” approach are the responses most often regretted afterwards.

Governance Under Pressure: What Directors Should Do

The single most important message of this guide is that the law rewards directors who can demonstrate they were informed, advised and deliberate during the period of distress. The steps below are the ones we routinely advise boards to take, and they are the ones that materially change the legal position if matters do not improve.

1. Increase the cadence and quality of board meetings

As the financial distress builds, it may be prudent to hold board meetings more often. Minutes should record the financial position discussed, the assumptions in any forecast, the risks identified, the alternatives considered (including formal insolvency processes), the advice received, the decision taken and the reasons for it, and any dissent. 

2. Monitor the financials closely

Up-to-date management accounts, rolling 13-week cash-flow forecasts and stress-tested scenarios are essential. Forecasts should be revisited frequently as conditions change, and directors should be able to explain the assumptions underlying them. Vague or out-of-date information is one of the patterns that can be the subject of criticism after the event.

4. Take professional advice early 

Once warning signs emerge, instruct qualified advisers: solicitors, accountants and, where appropriate, licensed insolvency practitioners. Early engagement gives the board an objective view of the position and the realistic options, whether that is restructuring, refinancing, a company voluntary arrangement, an accelerated sale process or a formal insolvency process. 

5. Treat connected-party transactions as high risk

Any payment to, or transaction with, a director, shareholder, group company or associate during distress should be paused and considered carefully. If in doubt, take advice before the payment goes out, not after.

High-Risk Transactions in the Distressed Period

Certain categories of transaction routinely attract challenge after an insolvency, even where they had a perfectly sensible commercial logic at the time. Directors should approach the following with particular care.

Director’s loan repayments. Repayment of a director’s loan in the months before insolvency will almost always be reviewed as a potential preference under section 239 of the Insolvency Act 1986. Where the recipient is a connected person, the law presumes the directors intended to prefer that party — and the burden then shifts to the directors to prove otherwise.

Director remuneration. There is no rule that directors must work unpaid; reasonable remuneration for actual services is entirely defensible. What attracts challenge is remuneration that is excessive, undocumented, increased during distress, or paid while trade creditors and HMRC go unpaid.

Personal guarantees. A guarantee given by a director to a lender, landlord or key supplier creates an obvious conflict between the director’s personal interest and the board’s duty to creditors as a whole. Disclose guarantees to the rest of the board and ensure that any relevant ratifications are obtained.

Asset sales and intra-group transfers. Transactions at an undervalue can be unwound under section 238 of the Insolvency Act 1986 within a two-year look-back. Obtain a proper valuation, document it, and avoid hurried disposals to balance day-to-day losses.

New security to existing creditors. Granting a new floating charge to an existing unsecured creditor in exchange for forbearance can be set aside under section 245 of the Insolvency Act 1986. Take advice before signing forbearance or standstill documentation.

Preferring some creditors over others. Outside a coherent, advised strategy, paying favored creditors ahead of others is one of the patterns most reliably picked up by a liquidator. A consistent, considered approach to creditor management is far safer than ad hoc decisions made under pressure.

HMRC, Lenders and the Practicalities of Engagement

HMRC is now a secondary preferential creditor in respect of certain taxes (PAYE, NICs, VAT and CIS deductions) and is, in practice, the most active and well-resourced creditor most distressed companies will face. Time to Pay arrangements remain available, but only where the company can present a credible repayment plan. Allowing PAYE or VAT arrears to build without engagement is one of the conduct patterns most commonly cited in subsequent disqualification proceedings under the Company Directors Disqualification Act 1986.

Engagement with secured lenders during distress requires equal care. Requests for additional security, fresh personal guarantees, or accelerated repayment in exchange for forbearance need to be considered against the antecedent transaction provisions and the creditor duty. Take legal advice before signing anything material.

D&O Insurance, Indemnities and the Limits of Protection

Directors often assume that a directors’ and officers’ liability policy will cover them in any insolvency-related claim. The position is more nuanced. D&O policies typically respond to defence costs and certain categories of claim, but commonly exclude or limit cover for fraud, dishonesty, deliberate breach of duty, and certain insolvency-related claims brought by an office-holder. Run-off cover (often six years) is usually essential where a company is heading into insolvency and should be put in place before, not after, an insolvency event.

Indemnities given by the company to its directors are limited by section 232 of the Companies Act 2006, which prohibits provisions exempting directors from liability to the company for negligence, default, breach of duty or breach of trust. Qualifying third-party indemnities under section 234 are permitted but cannot cover liability to the company itself, criminal fines or regulatory penalties and are, in any event, often of limited practical value in an insolvency because the company has no assets to meet them.

What Happens If Duties Are Breached

Where directors’ duties are breached in the run-up to insolvency, the consequences are well established. Directors should understand them at a high level so that they can recognise the risks they are managing.

Regime	Statute	What it catches	Consequence
Wrongful trading	s.214 / s.246ZB IA 1986	Continued trading after no reasonable prospect of avoiding insolvent liquidation/administration	Personal contribution to assets
Fraudulent trading	s.213 IA 1986 / s.993 CA 2006	Carrying on business with intent to defraud creditors	Contribution; up to 10 years’ imprisonment
Misfeasance	s.212 IA 1986	Breach of fiduciary or statutory duty	Restoration / compensation
Preferences	s.239 IA 1986	Putting a creditor in a better position (with desire to prefer; presumed if connected)	Transaction set aside
Transactions at an undervalue	s.238 IA 1986	Disposal at no, or significantly less than, market value	Transaction set aside
Director disqualification	CDDA 1986	Unfit conduct as a director	Disqualification for 2–15 years

 

These regimes can apply in combination. A single set of facts (for example, repaying a director’s loan while continuing to trade in the run-up to liquidation) may give rise to a preference claim, a misfeasance claim, a wrongful trading claim and a disqualification application all at once.

How We Can Help

At The Jonathan Lea Network, we advise UK company directors, founders, boards and investors on directors’ duties during financial distress. We can help you assess whether the creditor duty is engaged, improve governance and board minutes, review high-risk transactions, respond to creditor or HMRC pressure, and defend threatened claims where matters have already escalated. Our work in this area typically includes:

• Advising boards on the Sequana creditor duty, the trigger for its engagement, and the governance changes required once it is engaged.
• Reviewing board governance, minute-taking and decision-making processes during periods of financial pressure, and identifying gaps before they become evidential problems.
• Advising on specific transactions in the distressed period, including new lending and security, intra-group transfers, asset sales, director remuneration and director’s loan repayments.
• Working alongside accountants and licensed insolvency practitioners to give joined-up advice at the point it makes the biggest difference — early.
• Advising on D&O cover, run-off arrangements, and the use and limits of company indemnities under sections 232 to 234 of the Companies Act 2006.
• Defending directors against threatened or actual claims for wrongful trading, misfeasance, preferences, transactions at an undervalue, and disqualification, where matters have already moved to that stage.

We act for owner-managed and investor-backed companies across Sussex, London and the wider UK, and routinely work with boards under acute time pressure. Early engagement materially improves both the range of options available and the strength of any subsequent defence.

Contact Us

We will respond to most enquiries with both an indicative scope of work and fee estimate, as well as the offer of a complimentary 20-minute discovery video call to discuss your issues and how we can help, before sending a more considered formal fee estimate via email.

In some limited cases, if you would just like initial advice and guidance on a call, we may instead offer a fixed fee appointment (commonly charged between £280 to £500 + VAT) whereby we will review the information you provide, hold a video call consultation and then follow up with an advisory email (as well as a fee estimate for any further work identified).

Please email wewillhelp@jonathanlea.net or call us on 01444 708640 as a first step. We first need an overview of the background and your issues, together with any significant documents, to provide an indicative scope of work and fee estimate.

 

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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.