Published: 03/04/2025 By Andrew Bailey
When a director is running a business they face a mountain of challenges in managing a company’s affairs whether that be pursuing sales, managing the finances, staff, regulatory requirements or anything else.Add to this the challenges of trying to navigate financial difficulties and it becomes extremely difficult.
When we are advising directors, we will inevitably refer them to their duties and recent Court decisions have brought these into the spotlight again. In particular, when directors become aware or should be aware that their company is in the ‘zone of insolvency’ they need to be especially vigilant.
Effectively this means the closer to a possible insolvency event the greater a director’s duty and considerations shift to creditors instead of the shareholders. If an insolvency is unavoidable then the interests of the creditors become paramount.
As a director, you hold a position of responsibility — and the law is clear about your duties. Under the Companies Act 2006, you must:
✅ Act within your powers (s.171) – Adhere to the authority granted in the company’s constitution.
✅ Promote the success of the company (s.172) – Make decisions that benefit shareholders as a whole.
✅ Exercise independent judgement (s.173) – Think for yourself; don’t just follow others blindly.
✅ Apply care, skill, and diligence (s.174) – Meet the standard expected of a competent director.
✅ Avoid conflicts of interest (s.175) – Keep personal and company interests separate.
✅ Refuse benefits from third parties (s.176) – Don’t accept perks that could compromise integrity.
✅ Declare interests in transactions (s.177) – Be transparent about potential conflicts.
Has a Director Breached Their Duties?
Determining a breach involves two key tests:
🔍 Subjective Test – Did the director genuinely believe their actions were in the company’s best interests? Even if they were wrong, their honest belief might protect them—unless they ignored clear red flags or failed to consider key risks.
🔍 Objective Test – Would a reasonable, competent director in the same situation have made the same decision? If not, the director may be held accountable.
When a company is facing insolvency there is even more scrutiny and importantly directors need to recognise that there is a shift in their responsibilities and whose interests they need to prioritise. Instead of focussing on the shareholders their focus will move to the creditors; directors need to think carefully whether their intended actions are in the best interests of the creditors.
Warning Signs of Insolvency
A company may be at risk if you notice these red flags:
⚠ Client & Supplier Issues – Losing key clients, receiving demand letters, or suppliers putting their accounts on stop.
⚠ Financial Struggles – Failed financing, cash flow problems, failure to pay liabilities on time or reliance on emergency loans.
⚠ Leadership Instability – Frequent senior resignations or internal disputes.
⚠ Operational Strains – Overdue payments, rising costs, or arrears with H M Revenue & Customs.
⚠ Lender Concerns – Banks restricting funds or refusing to provide further funding.
⚠ HM Revenue & Customs enforcement – Refusal to negotiate payment plans, issuing final demands or threats of a Winding Up petition.
What are the consequences?
The failure to recognise the financial difficulties being faced, to act accordingly and recognise the creditors position needs to be prioritised otherwise it will result in serious implications for the directors involved.
Directors must document key decisions and seek professional advice early. Failing to act could lead to personal liability as a consequence of wrongful trading or misfeasance trading.
Holding Directors Accountable: Misfeasance and other risks
If a director does not act appropriately, later on in the process they could face claims against them for misfeasance due to breaches of their fiduciary duties.
Despite the limited liability of corporate entities, Directors can be found personally liable in certain circumstances and when a company enters into an insolvency process such as a Liquidation or Administration then the office-holder will look back at what has happened and consider whether the director’s action were reasonable in the circumstances.
Examples of matters to be conscious of and where we see consistent oversights are as follows:
- Where directors have preferred connected parties over stakeholders when they were aware that the company was insolvent. For example where directors repay loans from family members or connected companies in preference to other creditors.
- Where shareholders received dividends when it was evident that the company did not have the distributable reserves to pay dividends.
- Where assets have been transferred/sold to connected parties when it was not appropriate to do so and/or they were sold for less than their market value.
Not only can this lead to directors becoming personally liable to repay and restore the position but in the more serious cases it can lead to disqualification proceedings being brought against directors. Recovery action can also be taken against the beneficiaries of the above transactions, who may not be the directors.
Directors: Protect Yourself!
Before making decisions, ask yourself:
✅ Does this decision make sense from a business perspective?
✅ Would an independent third party (not just a friend at the pub) find my rationale reasonable?
✅ Could I confidently explain my decision under scrutiny and I have I documented my decisions?
✅ Am I thinking independently, or just following someone else’s advice?
✅ Have I taken professional advice and taken this into consideration?
Navigating through financial difficulties can be extremely challenging but following these important steps will help to stay on the right path. If efforts to rescue a business and avoid insolvency are not successful it will also provide protection for directors and peace of mind that they did everything appropriately in what will no doubt have been stressful and difficult circumstances.