Directors’ Risks During Insolvency

Insolvency is one of the sharpest tests a director will face. Limited liability protects directors during normal trading. Directors facing bankruptcy, and those whose companies have been liquidated, often discover that protection erodes quickly once a company approaches financial distress, particularly where the warning signs were visible and ignored. The legal ground shifts before any formal insolvency event takes place. Directors who continue to incur debts the company cannot repay, who pay themselves preferentially, or who act to protect shareholder value at creditors' expense will find that their conduct is scrutinised in detail by whoever is appointed to wind up the business.

Under section 172 of the Companies Act 2006, directors ordinarily owe duties to shareholders. When insolvency becomes probable, the Supreme Court confirmed in BTI 2014 LLC v Sequana SA [2022] UKSC 25 that directors must give appropriate weight to creditors' interests. That weighting increases with the severity of the financial position. Where insolvent liquidation becomes inevitable, creditors' interests are paramount.

Summary

1. Recognising the Warning Signs
2. How Director Duties Change at Insolvency
3. Loss of Control: When an Insolvency Practitioner Is Appointed
4. Wrongful Trading
5. Fraudulent Trading
6. Director Disqualification
7. The Personal Guarantee Trap
8. The HMRC Escalation Ladder
9. Other Routes to Personal Liability
10. Shadow Directors
11. The Systemic Dimension: Director Duties During Economic Crises
12. Intellectual Property in Insolvency
13. Protecting Yourself: A Practical Checklist

Recognising the Warning Signs

A company is insolvent under one of two legal tests, both set out in section 123 of the Insolvency Act 1986. The cash flow test: the company cannot pay its debts as they fall due. The balance sheet test: its liabilities exceed its assets. In practice, the cash flow test tends to be felt first. A company can show positive assets on paper while consistently missing creditor payments.

The warning signs arrive well before a formal insolvency event. Persistent late payments to suppliers, missed VAT or PAYE deadlines, suppliers refusing further credit, an overdraft at its ceiling, and difficulty meeting payroll all indicate a deteriorating position. A statutory demand from a creditor signals something more advanced. By that stage, the window for orderly intervention is narrowing. Directors who recognise the signs early retain options. Those who wait reduce their choices and deepen their personal exposure.

How Director Duties Change at Insolvency

During normal trading, directors must promote the success of the company for shareholders under section 172 of the Companies Act 2006, and exercise reasonable care and skill under section 174. When insolvency becomes probable, this framework changes.

The Supreme Court clarified the position in BTI 2014 LLC v Sequana SA [2022] UKSC 25. The creditor duty is engaged when directors know, or ought to know, that the company is insolvent or bordering on insolvency, or that insolvent liquidation or administration is probable. It is not triggered by a mere risk of insolvency. Where liquidation is not yet inevitable, directors must balance creditor and shareholder interests, giving creditors greater weight as the position worsens. Where insolvent liquidation becomes inevitable, creditors' interests become paramount.

In practice: do not take on debts the company cannot repay, preserve company assets, avoid paying one creditor ahead of others, and seek independent professional advice immediately. Resignation does not resolve the problem. Conduct that occurred before a director resigned can still generate personal liability after the fact.

Loss of Control: When an Insolvency Practitioner Is Appointed

When an administrator or liquidator is appointed, control of the company transfers to them immediately. Directors retain no authority to sign contracts, access bank accounts, or act on behalf of the company. They must cooperate fully: provide financial records, attend interviews, and hand over company property.

The insolvency practitioner must submit a conduct report to the Insolvency Service within three months of appointment, covering the directors' conduct over the last three years of trading. That report forms the basis of any disqualification proceedings. Directors who kept poor records, held infrequent board meetings, or delayed taking advice are in a weaker position at this stage. The investigation is retrospective, and conduct from two years ago is examined through the lens of what the director knew, or ought to have known, at the time.

Wrongful Trading

Wrongful trading under section 214 of the Insolvency Act 1986 is a civil claim, not a criminal offence. A liquidator brings it against directors who continued trading after the point at which they knew, or ought to have known, there was no reasonable prospect of avoiding insolvent liquidation. The liquidator identifies that point and calculates the increase in creditor losses from then until trading actually stopped. A court can order the director to contribute personally to the company's assets by that amount.

The defence is demanding. A director must show they took every step with a view to minimising potential losses to creditors, not merely that they tried, or that they held genuine hope of a turnaround. The court applies both an objective standard and a subjective one based on the director's own knowledge and experience. A finance director is held to a higher standard than a recently appointed non-executive.

Contribution orders in wrongful trading claims regularly run into six figures in medium-sized insolvencies. If the director cannot meet the order from personal savings, enforcement can extend to other assets, including, where sufficient equity exists, a jointly owned family home.

Fraudulent Trading

Fraudulent trading under section 213 of the Insolvency Act 1986 requires proof of intent to defraud creditors or carry on business for a fraudulent purpose. That makes it both a civil claim and a criminal offence under section 993 of the Companies Act 2006, carrying up to ten years' imprisonment. Paying directors' salaries the company cannot afford while trade creditors go unpaid, deliberately concealing the true financial position, and running up credit with no intention of meeting it, have all resulted in successful claims.

A director might begin trading unlawfully without dishonest intent, and slide into fraudulent trading as the gap between what they know and what they represent to creditors widens over months of financial deterioration. Reconstructing that trajectory is precisely what a liquidator, and where appropriate a prosecutor, will do.

Director Disqualification

The Company Directors Disqualification Act 1986 gives courts the power to ban directors for between two and fifteen years. According to Insolvency Service enforcement data for 2024-25, 1,036 directors were disqualified during that period, with the average ban running to eight years. The bandings by severity are:

• Low-level misconduct, such as failures of judgment rather than deliberate wrongdoing: 2 to 5 years
• Mid-level misconduct, conduct found to be seriously contrary to commercial morality or the public interest: 6 to 10 years
• High-level misconduct, involving intentional fraud or dishonesty: 11 to 15 years

Carillion's collapse produced two of the longest bans seen for executives of a listed company in sixty years. Zafar Khan, former finance director, was disqualified for eleven years for causing the company to rely on false and misleading financial information and sanctioning a £54 million dividend that could not be justified on the company's true financial position. Richard Adam, who served as group finance director from 2007 to 2016, accepted a 12.5-year undertaking for related conduct, including allowing Carillion's consolidated financial statements to misstate profits by at least £209 million.

Disqualification bars a director from acting as a director, from being involved in the formation, promotion, or management of a company, and from acting as a receiver. Acting while disqualified is itself a criminal offence, carrying up to two years' imprisonment and personal liability for all debts incurred by any company in which the disqualified person was involved during that period.

A disqualification undertaking, offered as an alternative to contested court proceedings, avoids a trial but carries the same legal effect as an order. Defending a full disqualification claim through to a hearing typically takes one to two years, with legal costs falling on the director and no recovery if the defence fails. An early undertaking generally produces a shorter ban period.

The Personal Guarantee Trap

Personal guarantees are the exposure most directors underestimate. Signing a guarantee to support a bank loan, an asset finance facility, or a commercial lease feels like a procedural step at the time. When the company enters insolvency, it becomes an immediate personal obligation.

Under most modern guarantee documents, the guarantee crystallises automatically on the company's default. No court process is required before the lender demands payment. Joint and several guarantees, standard where there are multiple directors, make each individual liable for the full amount. If one cannot pay, the lender pursues the others for the balance.

Three scenarios show how this exposure builds. In the first, a company with a £500,000 bank term loan, guaranteed without a cap by its two directors, enters administration. The bank issues demand letters within days of the administrator's appointment. One director has liquid assets; the other has savings of £80,000 and a jointly owned family home valued at £350,000 with equity of £200,000. The bank takes a charging order on the property. Without refinancing or a partial settlement negotiated against a credible personal financial statement, the home is at risk.

In the second, a director personally guaranteed an asset finance agreement for commercial vehicles. On administration, the vehicles are repossessed and sold at 40% of the outstanding balance. The director owes the £180,000 deficit personally. In the third, a commercial lease personally guaranteed for ten years has four years remaining when the company fails. The landlord pursues the director for outstanding rent, dilapidations, and the balance of the term, with no requirement to exhaust remedies against the company first.

Options at the point of enforcement are limited. A partial settlement supported by a detailed personal financial statement, an instalment arrangement, or a personal voluntary arrangement may all be available depending on the lender's approach. All are substantially easier to negotiate before a statutory demand arrives.

The HMRC Escalation Ladder

HMRC is consistently the petitioning creditor in a significant proportion of compulsory liquidations. The escalation typically follows a defined sequence, though HMRC retains discretion to accelerate at any stage where it concludes the company is not viable or that engagement has broken down.

• Missed payment and automatic penalty (weeks 1 to 8). VAT paid 16 to 30 days late attracts a 2% late payment penalty. From day 31, the rate rises to 4%, with daily interest accruing at 4% per annum on the outstanding balance from the due date. PAYE arrears accrue interest from the due date without a penalty-free period.
• Debt management referral (weeks 4 to 12). HMRC refers the account to a specialist debt management team. A formal demand letter is issued, setting a payment deadline. HMRC may also initiate a compliance check, particularly where prior returns are queried.
• Time to Pay negotiation window (weeks 8 to 16, sometimes later). HMRC will consider a Time to Pay arrangement, typically three to six months, occasionally up to twelve, where the company can demonstrate it is viable and capable of meeting future obligations alongside the instalments. HMRC expects full engagement and realistic proposals. This window closes without warning if HMRC concludes the company is not viable, or if the director does not engage.
• Statutory demand (day 21 trigger). A formal demand for payment of a debt exceeding £750. The company has 21 days to pay, secure, or apply to court to set the demand aside. Failure to respond is treated as evidence of inability to pay debts. Legal advice must be sought at this stage if it has not already been.
• Winding up petition (typically 4 to 8 weeks after statutory demand). HMRC files a petition at court. The petition is served at the company's registered office and, after a short period, is advertised in the Gazette. Once advertised, bank accounts are routinely frozen, and other creditors may join the petition. The reputational and credit rating damage is immediate and largely irreversible.
• Compulsory liquidation (at the hearing, typically 8 to 12 weeks after petition). If the petition is not challenged, adjourned, or resolved by payment or agreement, the court makes a winding up order. The Official Receiver takes control immediately, and directors lose all authority over the company from that moment.

Directors who engage HMRC at the Time to Pay stage retain genuine options. Directors who wait for a statutory demand have fewer. Those who receive a petition without having sought advice are, in most cases, working against a very short timetable to prevent compulsory liquidation.

Other Routes to Personal Liability

Beyond wrongful and fraudulent trading, several further provisions can make directors personally liable in an insolvency.

Misfeasance under section 212 of the Insolvency Act 1986 covers any breach of a director's legal duties, including misapplying company money, paying funds to connected parties at below market value, or failing to act with reasonable care during a period of financial difficulty. A liquidator can apply to the court for an order requiring the director to repay or compensate.

Preferences under section 239: repaying a director's loan, or settling a connected party's debt ahead of trade creditors, in the period before insolvency can be set aside. The relevant period is two years before insolvency for connected persons and six months for unconnected creditors.

Transactions at undervalue under section 238: selling company assets at below market value in the two years before insolvency can be reversed by a liquidator or administrator. Transfers to related parties, even within a group structure, are not protected.

HMRC personal liability: HMRC can issue a Personal Liability Notice making a director jointly and severally liable for unpaid National Insurance Contributions where it can demonstrate fraud or serious neglect. The Finance Act 2020 extended this further, introducing joint and several liability provisions targeting serial insolvency and deliberate tax avoidance, sometimes described as phoenixism.

Shadow Directors

A shadow director is defined in section 251 of the Companies Act 2006 as a person whose directions or instructions the board is accustomed to act upon. The definition catches investors, former directors, major shareholders, and others who exercise real control without formal appointment. Signing off key decisions, leading negotiations on behalf of the company, or acting as sole signatory on accounts without being a registered director all increase the risk of being characterised as a shadow director.

Shadow directors face the same wrongful trading exposure, the same disqualification risk, and the same misfeasance liability as formally appointed directors. The Insolvency Service is experienced at identifying shadow directors from the conduct reports it receives. The assumption that staying off the register provides protection is regularly contradicted by the cases.

The Systemic Dimension: Director Duties During Economic Crises

The standard insolvency framework assumes an isolated firm-level crisis. A director whose company is struggling assesses its position, takes advice, and decides whether to trade on or cease. That analysis becomes genuinely difficult when the wider economy is under stress, and the company's difficulty reflects conditions rather than management failure. The COVID-19 period illustrated the problem in practical terms.

During the pandemic, the UK government temporarily suspended wrongful trading liability under the Corporate Insolvency and Governance Act 2020. The suspension ran from 1 March 2020 to 30 September 2020 for most companies. The reasoning was straightforward: directors who feared personal liability for losses arising from an unforeseeable external shock might cease trading or file for insolvency prematurely, overwhelming courts, flooding asset markets with distressed sales, and extending the economic harm well beyond the companies directly affected. Germany and Australia adopted similar temporary measures.

The suspension did not remove all duties. Directors remained subject to fraudulent trading liability and the general duty to act in accordance with the company's constitution. The distinction drawn was between directors who continued to trade reasonably through a temporary period of external disruption and those who traded dishonestly or acted in their own interests at creditors' expense.

The broader debate matters now because the conditions that triggered the pandemic intervention are not unique to pandemics. Climate-related disruption, geopolitical shocks, and supply chain failures can each produce periods in which a company's liquidity position deteriorates for reasons entirely outside its control. Directors in those circumstances face a difficult judgment: whether to treat illiquidity as temporary and trade through it, or to treat it as evidence that insolvent liquidation is probable and act accordingly. Getting that judgment wrong in either direction carries legal and financial consequences. Directors who face genuine uncertainty of this kind should seek independent advice early, document their reasoning carefully, and keep the analysis under active review.

Intellectual Property in Insolvency

Intellectual property, including trademarks, patents, software, copyright, and design rights, forms part of the company's asset base and passes to the control of the insolvency practitioner on appointment. Directors have specific obligations in relation to IP assets that are distinct from their obligations in relation to physical property.

Directors should not transfer IP rights to related parties at below market value in the period before insolvency. Such a transfer is vulnerable to reversal as a transaction at undervalue under section 238 of the Insolvency Act 1986 if it occurred within two years of the date insolvency formally began. The same applies to licensing arrangements structured to strip value from the insolvent entity in favour of a connected company. An IP licence granted at nil or undervalue to an associated party shortly before administration will be examined closely.

Practical obligations on directors before and during the appointment of an IP include maintaining a record of all registered and unregistered IP rights, ensuring renewal fees and registration obligations are current, and disclosing the full IP position to the appointed insolvency practitioner. Where IP constitutes a material part of the company's value, early engagement with the practitioner about how it is to be realised will produce better outcomes for creditors. Given the breadth of considerations that arise when a company with significant IP enters insolvency, that topic warrants treatment in a separate article. Witan Solicitors advises on both intellectual property disputes and the obligations that arise in the context of corporate insolvency.

Protecting Yourself: A Practical Checklist

Directors who face, or anticipate, financial distress should work through the following as early as possible:

• Keep management accounts current and monitor financial performance closely. Accurate, up-to-date information is the foundation for every decision that follows.
• Seek independent professional advice at the first sign of trouble. An insolvency practitioner can advise on options before formal proceedings become necessary. Taking early advice is evidence of good faith and a partial defence against later criticism of inaction.
• Hold board meetings regularly and keep detailed minutes recording all decisions, the information available at the time, and the reasoning behind significant choices. Contemporaneous records are substantially more persuasive in any subsequent investigation than retrospective explanations.
• Avoid preferential payments and undervalued transactions. Stop repaying directors' loan accounts ahead of trade creditors. Do not transfer assets to related parties at below market value.
• Stop incurring new credit that the company cannot repay. Accept no deposits for orders the company cannot fulfil.
• Engage HMRC early if tax debts are building. Contacting HMRC before a statutory demand arrives preserves the Time to Pay window.
• Review all personal guarantees now. Understand which facilities are guaranteed, whether caps apply, the full exposure if the company fails, and the likely enforcement timeline.
• Consider rescue options: a Company Voluntary Arrangement, refinancing, restructuring, or administration may all be available depending on the circumstances.
• If rescue is not possible, consider a Creditors' Voluntary Liquidation. Directors retain some control over the process and timing, which compulsory winding up removes entirely.

Seek Legal Advice

The personal consequences of getting insolvency wrong extend well beyond the business itself. Disqualification, contribution orders, personal guarantee enforcement, and bankruptcy can follow directors for years after a company fails. The law does not require directors to succeed in business. It does require them to act responsibly, protect creditors from foreseeable harm, and take action before the position becomes irretrievable.

Witan Solicitors' insolvency and bankruptcy solicitors advise directors facing financial distress, creditors pursuing recovery, and shareholders with concerns about how an insolvency has been managed. We also advise on director disqualification defence, personal guarantee liability, and the full range of exposure that bankrupt directors and those facing liquidation may encounter. Contact us on 0300 303 2071 or complete our online enquiry form.

FAQs

What is a Bankruptcy Director?

The term is used in two distinct ways. In its strict legal sense, a bankrupt director is a director who has been made personally bankrupt, usually because personal liabilities such as personal guarantees exceeded their personal assets and a creditor obtained a bankruptcy order. More loosely, it is used to describe a director of a company that has become insolvent. The two can occur together, but they are separate outcomes governed by different legal processes.

How does Liquidation Affect Directors?

Liquidation triggers an automatic investigation into directors' conduct by the insolvency practitioner, who submits a conduct report to the Insolvency Service within three months. Disqualification proceedings may follow. A liquidator can bring civil claims for wrongful trading, misfeasance, preferences, and transactions at an undervalue. Personal guarantees become enforceable immediately, and directors lose all authority over the company from the date of liquidation.

What Are the Consequences of Liquidation for Directors who Gave Personal Guarantees?

Personal guarantee liability becomes a direct personal debt the moment the company defaults. The lender can enforce against the director without first exhausting remedies against the company. Joint and several guarantees make each guarantor liable for the full amount. Where the director cannot pay, enforcement can extend to personal assets, including savings and, where equity exists, the family home.

What Happens to Directors when a Company Goes Into Administration?

Administration places the company under the administrator's control. Directors' powers are suspended and cannot be exercised without the administrator's consent. Directors must cooperate with requests for information and documents. The administrator investigates directors' conduct throughout the process and will report concerns to the Insolvency Service.

How Serious is Wrongful Trading for a Director?

Wrongful trading is a civil claim under section 214 of the Insolvency Act 1986. A court can order a director to contribute personally to the company's assets in an amount equal to the increase in the net deficiency from the point at which trading should have stopped to the date of liquidation. There is no statutory cap. In medium-sized business failures, six-figure orders are common.

Can HMRC Make a Director Personally Liable for Company Tax Debts?

HMRC has several routes to personal liability. A Personal Liability Notice can make a director jointly and severally liable for unpaid National Insurance Contributions where fraud or serious neglect is established. The Finance Act 2020 introduced joint and several liability provisions targeting deliberate tax avoidance arrangements and serial insolvency. Directors who have been involved in a series of failed companies, leaving HMRC unpaid, face the greatest exposure under these provisions.