Protecting Directors When a Company is in Financial Distress
When a company is financially stable, a director’s primary duty is to promote the success of the company for the benefit of its shareholders. However, when a company begins to show signs of financial distress or approaches insolvency, the director’s responsibilities shift — their legal duty becomes one of acting in the best interests of the company’s creditors.
To minimise personal risk and ensure compliance with directors’ duties under the Companies Act 2006 and insolvency law, the following steps are essential:
1. Seek Professional Advice Early
Directors should seek independent legal or insolvency advice as soon as there are indications that the company may not be able to meet its debts. The earlier advice is sought, the more restructuring or rescue options may be available.
At Menzies, we work closely with directors to assess the company’s position and explore all available solutions, from informal restructuring to formal insolvency procedures.
2. Avoid Incurring Further Credit Without a Repayment Plan
Directors must not allow the company to take on additional debt if there is no realistic prospect of repayment. Doing so could lead to personal liability for wrongful trading if insolvency becomes inevitable.
If there is a belief that the company can repay the debt, the director should ensure this is supported by robust financial evidence, such as up-to-date cash flow forecasts and projections.
3. Maintain Accurate and Up-to-Date Financial Records
Good record-keeping not only helps with decision-making but may also protect directors from allegations of misconduct in future insolvency proceedings.
4. Act in the Best Interests of Creditors
Once insolvency is likely, directors must prioritise creditor interests over those of shareholders. Failing to do so can expose directors to personal claims by a liquidator or administrator.
Directors facing financial distress must act with caution and transparency. By seeking early professional advice, maintaining good records, avoiding further debt without a plan, and prioritising creditor interests, directors can significantly reduce the risk of personal liability.
