Directors' responsibilities in times of financial distress: how to mitigate against personal liability

Company directors play a pivotal role in guiding a company toward success and profitability. When a business is trading well and has a healthy balance sheet, directors’ duties include promoting the success of the company for the benefit of its shareholders. However, when a company faces financial distress or the possibility of insolvency, the responsibilities of its directors shift significantly. The greater the company’s financial difficulties the more priority directors should give to creditors’ interests over that of the shareholders.

It is inevitable that some businesses will be adversely impacted by the current sluggish economic conditions and the changes to National Minimum Wage and Employers' National Insurance which come into effect in April 2025. Sectors such as hospitality, care and retail, where a large number of staff are employed on a part-time basis, or on relatively low salaries, are likely to be disproportionately impacted.

Given this economic backdrop, it is important that directors fully understand their duties and responsibilities, and take steps to ensure they mitigate against risks of personal liability should the company ultimately enter into an insolvency process. In certain circumstances directors may be held personally liable for a company’s debts. The personal liability of directors can extend beyond financial penalties to include disqualification from holding directorial positions for up to 15 years.

The relevant legislation makes no distinction between non-executive directors, part-time directors or trustees of incorporated charities. Therefore, all directors need to ensure they have a full understanding of the company’s financial position. The legislation around directors’ duties and responsibilities also applies to designated members of LLPs.

Key steps for directors

Every situation is different, but some steps directors should take to mitigate personal liability include:

1. Seek professional advice early

Take advice from your accountant or lawyer at the earliest opportunity even if this is just as a plan B. They will have the experience and knowledge to help you find the best solution. Remember, the earlier you take advice the more options there will be available for the company.

2. Document

Document key decisions taken by the board, making it clear why the board believes the decisions taken are reasonable and the rationale for the decisions

3. Up-to-date financial information

Ensure there is up-to-date and accurate management information. This is the only way you can make informed decisions.

4. Forecasts

Prepare forecasts with particular emphasis on short-term cash flow forecasts. These will enable pinch points and funding gaps to be identified and allow time to seek a funding solution where possible.

5. Engage with stakeholders

Key stakeholders may well hold the key to a potential solution if consulted early enough. Stakeholders could include lenders, shareholders, HMRC, pension trustees, landlords, key customers or suppliers

6. Hold regular board meetings

Hold regular meetings and ensure these meetings are minuted. Where possible, involve all directors including any non-executive directors.

7. Dividends, deposits and loans

Don’t take dividends or sell or transfer company assets without taking professional advice. Likewise, don’t take customers' deposits or repay loans, without seeking advice from a professional.

8. Credit

Don’t take on further credit or additional debt unless you believe, and can document, there is a reasonable prospect of repayment.

9. Review your Directors’ and Officers' (D&O) insurance policies.

A well-drafted policy can offer valuable protection to directors in the event that a claim is made against them, including claims from a liquidator or creditors.

Improve outcomes

Directors of companies in financial distress face difficult challenges, but those who take advice early will ensure their company has the best chance of survival. Even if insolvency cannot be avoided, the process can be planned in an orderly manner to ensure the best possible outcome for creditors, and those directors who act responsibly and in the best interests of creditors, can minimise their own risks of personal liability.