When your company is insolvent or heading that way, your legal obligations as a director change fundamentally. Understanding these obligations isn't just about avoiding trouble — it's about making informed decisions during the most stressful period of your professional life.
This guide explains what the law requires of you, in plain English, so you can act confidently rather than being paralysed by fear of getting it wrong.
Important: This is general guidance, not legal advice. If your company is insolvent, get professional advice specific to your situation.
The fundamental shift: from shareholders to creditors
When a company is solvent, directors owe duties primarily to the company and its shareholders. You make decisions in the company's best interests, which usually means the shareholders' best interests.
When a company is insolvent — or approaching insolvency — that duty shifts. You must now act in the interests of creditors. This is a legal obligation under the Companies Act 2006, reinforced by the Insolvency Act 1986.
In practical terms, this means: every decision you make should be assessed against the question "does this protect or improve the position of creditors?" If a decision benefits you but harms creditors, don't do it. If a decision preserves the company's assets for creditor distribution, it's probably the right call.
This shift catches many directors off guard. The habits of running a business — paying yourself, investing in growth, prioritising some relationships over others — may suddenly conflict with your legal duties. Understanding where the lines are prevents you from crossing them accidentally.
When does insolvency start?
This question matters because your duties shift at the point of insolvency, not at the point of formal insolvency proceedings. A company is insolvent when it can't pay its debts as they fall due (the cash flow test) or when its liabilities exceed its assets (the balance sheet test).
In practice, the cash flow test is most relevant for small businesses. If you're unable to pay your bills, your staff, or HMRC when the money is due, your company is probably insolvent — even if you haven't formally acknowledged it.
The tricky part is that insolvency is often not a binary moment. It's a gradual slide. You miss one payment, then another. You juggle creditors, paying the most aggressive ones first. You convince yourself it's a temporary cash flow issue. At some point during this slide, you cross the line into insolvency — and your duties change accordingly.
The safe approach: if you're consistently unable to pay debts on time, assume you're in or near insolvency territory and start acting in accordance with your creditor duty. Getting this right early is far better than having it assessed with hindsight by a liquidator.
The seven general duties (in plain English)
The Companies Act 2006 sets out seven general duties for directors. These apply at all times, but they become more critical — and more likely to be scrutinised — when the company is insolvent.
1. Act within your powers. Only do things the company's articles allow you to do. Don't exceed your authority.
2. Promote the success of the company. When solvent, this means success for shareholders. When insolvent, this means the best outcome for creditors. This is the critical shift.
3. Exercise independent judgement. Make your own decisions. Don't blindly follow what an investor, a co-founder, or an adviser tells you to do. The law holds you personally responsible for your decisions as a director.
4. Exercise reasonable care, skill, and diligence. Act as a reasonably competent person in your position would act. Ignorance is not a defence — you're expected to have (or acquire) the knowledge and skills appropriate to your role.
5. Avoid conflicts of interest. Don't put yourself in a position where your personal interests conflict with the company's interests. This becomes especially important during insolvency, when decisions about asset sales, payments, and contracts could benefit you personally at creditors' expense.
6. Don't accept benefits from third parties. Don't take bribes or inducements related to your role as director.
7. Declare any interest in proposed transactions. If you have a personal interest in a deal the company is considering, disclose it.
Wrongful trading: the big one
Wrongful trading is the insolvency-specific risk that most directors worry about, and rightly so. Under Section 214 of the Insolvency Act 1986, a director can be held personally liable if they allowed the company to continue trading when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency.
Let's break that down:
"Knew or ought to have known" — this is assessed by both a subjective test (what did you actually know?) and an objective test (what would a reasonably diligent person in your position have known?). You can't claim ignorance if the signs were there to see. A director who never looked at the management accounts isn't protected by their failure to look.
"No reasonable prospect of avoiding insolvency" — the key word is "reasonable." You're not expected to predict the future with certainty. If you genuinely believed, based on reasonable evidence, that the company could trade its way out of difficulty, that's a defence. But "I hoped something would turn up" without concrete evidence is not a reasonable prospect.
The defence: You can avoid personal liability if you can show that, once you knew (or should have known) that insolvency was unavoidable, you took every step you ought to have taken to minimise the potential loss to creditors. "Every step" might include: seeking professional advice, considering the insolvency options, stopping taking on new debts, not paying yourself preferentially, and moving toward formal insolvency proceedings.
The practical takeaway: the moment you realise the company probably can't survive, take advice and start protecting creditors' interests. The worst thing you can do is carry on as if everything is fine while the company accumulates more debt. That's the behaviour wrongful trading provisions are designed to catch.
Things that create personal liability
Beyond wrongful trading, there are specific actions that can make you personally liable for company debts:
Trading fraudulently. This is more serious than wrongful trading. Fraudulent trading involves carrying on the company's business with intent to defraud creditors. The penalties include personal liability for company debts, criminal prosecution, and potential imprisonment. Fraudulent trading is rare — it requires proof of actual dishonesty, not just poor judgement.
Transactions at undervalue. Selling company assets for less than they're worth — especially to connected parties (family members, your other companies, your own name). A liquidator can challenge these transactions and require the assets or their value to be returned.
Preferences. Paying one creditor ahead of others when the company is insolvent, especially if that creditor is connected to you (e.g., repaying a directors' loan, paying a family member who supplied services). Legitimate commercial decisions to pay critical suppliers are generally fine. Paying your mother-in-law's invoice ahead of everyone else is not.
Overdrawn directors' loan account. If you've borrowed money from the company and the company enters insolvency, the liquidator will require you to repay the loan. This catches many directors who've taken drawings rather than dividends.
Unlawful dividends. Paying dividends when the company didn't have sufficient distributable profits. If the company subsequently becomes insolvent, you may be required to return unlawful dividends.
What to do right now
If your company is insolvent or approaching insolvency, here's a practical checklist:
Get professional advice immediately. An insolvency practitioner, a solicitor, or both. Many offer free initial consultations. The cost of advice now is tiny compared to the cost of personal liability later.
Document your decision-making. From this point forward, keep clear records of why you made each significant decision. Board minutes, emails to your adviser, notes of your reasoning. If your conduct is later investigated, contemporaneous records showing that you considered creditors' interests and sought professional advice are your best defence.
Stop paying yourself preferentially. If the company is insolvent, your salary, dividends, and loan repayments are not priorities. Employees, HMRC, and trade creditors come first.
Don't take on new debt. If you know the company can't repay it, incurring new debt is a step toward wrongful (or even fraudulent) trading.
Don't sell assets below market value. Especially not to yourself, your family, or your other businesses. Everything must be at arm's length and at fair value.
Don't strip the company. Moving assets, cash, or intellectual property out of the company to put them beyond creditors' reach is both illegal and easily detected. Liquidators are experienced at identifying asset stripping and they will pursue you personally.
Consider the insolvency options promptly. The longer you delay, the more the creditors' position deteriorates, and the more likely it is that your conduct will be questioned. For a comparison of options, read: Administration vs liquidation vs CVA: which one is right?.
Director disqualification
If the Insolvency Service finds evidence of serious misconduct, they can apply to the court to disqualify you from acting as a director for between two and fifteen years. During disqualification, you cannot be a director of any UK company, act as a receiver of a company's property, or be involved in the promotion, formation, or management of a company.
Grounds for disqualification include: allowing the company to continue trading to the detriment of creditors, failure to keep proper accounting records, failure to file accounts and returns, and general unfitness to be a director.
Disqualification is not automatic. The majority of directors whose companies enter insolvency are not disqualified. It's reserved for cases of genuine misconduct, not honest business failure.
That said, the investigation process itself is stressful. The best way to protect yourself is to act responsibly from the moment you suspect insolvency: seek advice, protect creditors' interests, and document your decisions.
The personal toll
Understanding your legal obligations is important. But I also want to acknowledge that navigating director duties during insolvency is emotionally devastating.
You're being asked to make clear-headed legal assessments while your business is collapsing, your income is disappearing, your identity is unravelling, and your stress levels are through the roof. The fear of personal liability — of losing your house, your savings, your future ability to work — sits on top of everything else.
This fear is usually worse than the reality. Most honest directors who act in good faith and seek advice are not found personally liable. The law is designed to catch deliberate or reckless misconduct, not people who tried their best and failed.
But the fear is real, and it deserves acknowledgement. If it's keeping you awake at night, read: The 3am thoughts: dealing with insomnia during business crisis. And remember: getting professional advice is the single best thing you can do both to protect yourself legally and to reduce the anxiety of not knowing where you stand.
Common mistakes during insolvency
The stress and confusion of insolvency lead many directors to make avoidable errors. Here are the most common:
Paying yourself before creditors. When cash is tight, the temptation to take your salary or repay your directors' loan is enormous — you have bills to pay too. But if the company is insolvent, paying yourself preferentially creates personal liability. Your salary becomes a preference that the liquidator can claw back.
Burying your head in the sand. Ignoring the problem doesn't make it go away. It makes it worse, because every day of insolvent trading without taking appropriate steps is a day that could be characterised as wrongful trading. The moment you suspect insolvency, act.
Taking advice from the wrong people. Your friend who "knows about business" is not a substitute for a qualified insolvency practitioner. Well-meaning advice from unqualified people can lead to decisions that create serious personal liability.
Destroying records. In a panic, some directors destroy emails, documents, or accounting records. This is both illegal and counterproductive. The absence of records doesn't protect you — it makes the liquidator assume the worst. Proper records showing responsible decision-making are your best defence.
Continuing to trade "just one more month." The hope that next month will be different is seductive but dangerous. Each month of continued insolvent trading is another month of potential wrongful trading liability. If the business is insolvent and can't realistically recover, delaying the inevitable helps nobody.
The investigation process
When a liquidator or administrator is appointed, they're required to submit a report on director conduct to the Insolvency Service. This report covers: whether the company's accounts were properly maintained, whether statutory filings were up to date, the circumstances leading to insolvency, any transactions that might constitute wrongful trading, preferences, or transactions at undervalue, and the directors' general conduct in the period leading up to insolvency.
The Insolvency Service reviews these reports and decides whether to take further action. In most cases — particularly where directors have acted honestly and sought advice — no further action is taken. But the process itself is anxiety-inducing, and it can take months for the investigation to conclude.
During this period, cooperate fully with any requests from the liquidator or administrator. Provide documents promptly. Answer questions honestly. Don't obstruct the process. Full cooperation is noted in the report and weighs in your favour.