What happens to a director of an insolvent company in liquidation? 

When your company enters liquidation, it’s natural to feel uncertain about what happens next – particularly around your personal exposure and legal obligations. For directors who have acted lawfully, the personal risks are limited.

In this guide, we explain what happens to a company director during a compulsory liquidation, including when your company is insolvent and cannot pay its debts. We look at your responsibilities as a director, and how these change prior to and during liquidation. Importantly, we consider ways that you can protect yourself from personal liability during the liquidation process.

How does a director’s role change when a company enters liquidation?

When a company enters liquidation, the liquidator takes control of the company, and the directors are no longer in charge. As a director, you will lose your power to manage the day-to-day affairs of the company, or make any decisions on its behalf, and you may be dismissed from your office as a director by the liquidator.

The liquidator has the power to sell the company’s assets, investigate directors’ conduct, and distribute the proceeds to creditors in accordance with the priority rules set out in the Insolvency Act 1986.

What are a director’s responsibilities during liquidation?

As a director of a company, you’ll be familiar with the duties that you owe to your company ordinarily. Your responsibilities during liquidation are slightly different – and, in an insolvent liquidation, significantly more demanding. During insolvency, the duty to prevent further losses is key.

1. A director’s primary duty shifts to creditors

In the normal course of business, a director’s primary duty is to is to 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. However, when doubts start to arise about the company’s solvency, the primary duty of the directors is to protect the interests of the creditors.

It is an important distinction and changes how the company operates. For example, you would normally pay dividends to your shareholders if the company has accumulated profits. But paying a dividend when the company is in financial difficulty drains the cash out of which creditors can be paid. For that reason, you must refuse the dividend to act in the best interests of creditors in most cases.

2. Directors have a duty to prevent further losses

Once you know that the company is likely to become insolvent, you must normally take immediate steps to stop trading. Your duty to prevent further losses means you must take immediate, proactive steps to protect the company’s assets.

Again, this prioritises creditors by preventing any further accumulation of debt, even though it prevents the shareholders from seeing a return on their investment.

3. Directors should not dispose of assets at undervalue

Selling company assets at below market value will be something that is noted by the liquidator and you could be held personally liable for losses to creditors as a result. The liquidator has the power to reverse such transactions and pursue you for the difference.

4. Directors have a duty to cooperate with the liquidator

You’re legally required to cooperate with the liquidator. For example, you must provide all requested information, documentation, and records.

Similarly, if you’re called to an interview or a meeting with the liquidator, you are legally obliged to attend.

Can a director be made personally liable for company debts?

The general principle is that directors cannot be held personally liable for company debts. However, that could change when the company enters liquidation, and personal liability can arise in the following circumstances:

1. Personal guarantees

While running a company, directors are sometimes asked to sign personal guarantees for contracts that the company is entering into, such as bank loans, overdrafts, or lease agreements.

If it comes to a point when the company cannot pay the debt, the director will be asked to cover the shortfall. Personal guarantees are the most common source of personal liability in a liquidation, and unlike other forms of liability, they apply regardless of how well you managed the company.

2. Wrongful or fraudulent trading

If a director takes the decision to keep the company trading when they know, or ought to have known, that the company was insolvent and could not avoid liquidation, they may be personally liable for some of the company’s debt. The court can order that directors pay a contribution to the company’s assets, which reflects the losses caused by the decision to continue trading.

More seriously, if a court finds that the company’s business was carried on with the intent to defraud creditors (fraudulent trading), it can order directors to contribute personally to the company’s assets. Fraudulent trading is a criminal offence, so directors could face a fine or even a custodial sentence if found guilty.

3. Breaches of director duties

As we’ve already mentioned, directors are under a duty to act in the best interests of creditors when insolvency is close. If you fail to do so, you may be required to compensate the company for losses caused by your actions.

If you’re found to be personally liable for debts, the court is entitled to access your personal finances, which could include things such as your vehicle and even your home, to repay the debts.

Can a director resign from a company in an involuntary liquidation?

Directors may resign at any point during the liquidation.

However, resigning does not mean that you can walk away and avoid engaging in the process. In fact, it may even make you look suspicious. In any event, you can still be asked to participate in the liquidator’s investigation (as part of their report), and your obligations as a director will continue even after you’ve resigned. You have obligations to cooperate with the liquidator and to help them with their investigations as far as possible.

By way of example, you can be held liable for any misconduct that was evident during your time as a director, and you can be asked to cover liabilities arising out of personal guarantees you gave while you were an active director.

What happens if a company director is found to have acted wrongly?

In all liquidations involving an insolvent company, a liquidator is legally required to report the conduct of directors who were in office during the three years leading up to the company’s insolvency.

If you have been found to have acted wrongly as a director, you can be held personally liable for some of the company’s debts, and in the worst-case scenario, you can be disqualified from acting as a director. However, disqualification is not the automatic outcome.

Wrongful trading

Wrongful trading happens when the company continues to trade when directors knew or should have known that there was no reasonable prospect of avoiding insolvent liquidation.

At this point, you must stop operations to protect your creditors. If you don’t, you may be required to compensate the company for the increase in the company’s debts from the point that you should have ceased trading. This compensation comes out of your own pocket.

Fraudulent trading

Fraudulent trading is more serious. It happens when the company continues to trade with the intention of defrauding creditors.

If it is proven in court that a director who was knowingly involved in the deceptive conduct, the court can order the director to make a personal contribution to the company’s assets. It is both a criminal and civil offence.

Directors’ disqualification

If the liquidator’s investigation reveals wrongdoing, such as wrongful or fraudulent trading, directors can be disqualified from managing companies in the future, for up to 15 years.

In many cases, the liquidator’s investigation finds that directors have acted honestly and followed professional advice. In those circumstances, no further action is taken.

However, disqualification is generally reserved for serious misconduct, so if you’ve acted reasonably and you’ve cooperated with the liquidator, it is not usually the consequence of a liquidation.

In some cases, the investigation will recommend disqualification, and if that’s the case, you will receive a summary of the alleged misconduct from the Insolvency Service, and they will explain the next steps to take. You will be invited to provide any further information you think should be considered. You should take professional legal advice to help protect your position.

Can a director start a new company after liquidation?

The good news is that you can start a new company if your previous company ended in liquidation. So long as you have not been disqualified from acting as a director, and you have not been declared bankrupt, you may start another company.

Limitations on naming the new company

There are a few limitations on what you can call your new company if the company was insolvent at liquidation. Under section 216 of the Insolvency Act 1986 you may not use the same name, or a similar name, as your previous company (that ended in liquidation) for up to five years.

This only applied to companies that were insolvent at the time of liquidation. If the company was wound up by members in a members’ voluntary liquidation (MVL) there are no restrictions on what you call the new company.

Avoid phoenixing

Phoenixing is where directors close a failing or insolvent company while immediately setting up a new company to continue the same business. By doing this, directors hope to escape old company debts, liabilities, and creditor obligations while retaining the assets.

When used to evade creditor obligations, phoenixing can constitute fraudulent trading under the Insolvency Act 1986, which is a criminal as well as civil offence.

How to protect yourself as a director facing liquidation

Acting in good faith and getting professional advice early significantly reduces your personal risk during a liquidation process.

Here are a few things you can do to protect yourself:

Take professional advice

As a director, the best thing you can do to protect yourself when your company faces liquidation is to seek professional advice from a legal professional. Your adviser can help you understand what to expect, how to handle your responsibilities as a director, and how to ensure you remain on the right side of the law at every stage.

Your insolvency practitioner can advise you on how to handle the process and answer any questions you have as the investigation unfolds. This gives you peace of mind that you’re on the right side of the law at every turn.

Preserve the company’s assets

You cannot sell assets at undervalue or move them to a new company. You must make sure all assets are preserved for the liquidator. There are certain situations in which you may be able to move assets to another company if you can do so at proper value, but you risk walking a fine line in the liquidation.

It’s always best to seek specialist advice before you decide to move assets when the company is likely to become insolvent.

Avoid preferential payments

In a liquidation, there is a hierarchy of creditors, and some creditors rank ahead of others. You must stick to that hierarchy, otherwise you could be accused of making preferential payments, which is an offence under the Insolvency Act 1986. This applies even if the creditor is a friend, family member, or connected party.

Keep detailed records

Maintain records of every decision you make, including at board meetings. Take care to explain why decisions were made.

Summary: What happens to a director of an insolvent company in liquidation?

When a company enters liquidation following insolvency, directors relinquish day-to-day control to the appointed liquidator. From that point, as a director you must cooperate with the liquidator and provide any information that is relevant to the liquidator’s investigation.

So long as you have not engaged in misconduct in running the company, it’s likely that there will be no further repercussions for you, or the other directors.

It may be the case that you have to make good on any personal guarantees you made on behalf of the company when the company was trading. However, that would have been a known risk when you gave the guarantee.

In some circumstances, the liquidator finds that directors have engaged in misconduct. If that’s the case, the directors could be at risk of paying certain debts personally and even be disqualified as a director. These outcomes are rare – directors who have acted in good faith and in accordance with their statutory duties are unlikely to face either consequence.