When a company enters liquidation, the focus naturally tends to be on the business itself, its assets, debts, employees and creditors. However, liquidation also has important implications for the company’s directors.
For many directors, one of the biggest concerns is what liquidation means for them personally. Will they be held responsible for the company’s debts? Can they become a director of another company? Will their conduct be investigated?
The consequences depend heavily on how the company has been managed, particularly during the period in which it experienced financial difficulties. The failure of a company does not, in itself, mean that its directors have done anything wrong. However, the liquidator has a duty to examine the conduct of directors and investigate certain transactions and activities.
Understanding what happens during this process can help directors facing financial difficulties take appropriate action and avoid making their position worse.
▶ Watch the video summaryThe Director’s Role and Responsibilities Once Liquidation Begins
Immediate Changes to a Director’s Powers and Authority
Once a liquidator is appointed, the directors effectively lose control of the company. Their powers to manage the business and act on the company’s behalf cease, except in limited circumstances where their continuation is specifically sanctioned.
Importantly, this does not mean that a director automatically resigns from their position when the company enters liquidation. They remain a director, but their ability to exercise the normal powers associated with that role is significantly restricted. You can read more about this distinction in our guide to whether a director can resign from a company in liquidation.
Control of the company’s affairs and assets passes to the liquidator. Directors can therefore no longer make normal management decisions, enter into contracts or dispose of company assets without the appropriate authority.
Although their management powers cease, their responsibilities do not disappear. Directors are required to cooperate with the liquidator and provide the information and assistance needed to deal with the company’s affairs.
Failure to cooperate can be a serious matter and may form part of the assessment of a director’s conduct.
Director’s Legal Obligations to the Liquidator
Directors have a duty to assist the liquidator in establishing the company’s financial position and understanding how the business was managed before liquidation.
Depending upon the type of liquidation and the circumstances, this can include providing or assisting with a Statement of Affairs setting out details of the company’s assets, liabilities and creditors.
Company books, accounting records, financial documents and other relevant information must also be made available to the liquidator. Directors may be required to attend meetings or interviews and answer questions concerning the company’s activities and financial affairs.
These requirements should be taken seriously. Directors must not deliberately conceal assets or information or destroy, falsify or conceal company records. Such conduct can have considerably more serious consequences than the liquidation itself and, in some circumstances, may constitute a criminal offence.
The best approach is generally to cooperate openly with the liquidator and respond promptly to reasonable requests for information. The Insolvency Service provides further guidance on a director’s duty to cooperate with an office-holder.
The Shift in Fiduciary Duty Prior to Liquidation
Directors’ responsibilities become particularly important before liquidation formally begins.
When a company is financially healthy, directors will normally make decisions with the success of the company and the interests of its members in mind. As financial difficulties become more serious and insolvency approaches, however, the interests of creditors assume increasing importance.
Directors should therefore be particularly cautious about taking on additional liabilities, disposing of assets or making payments that could disadvantage the company’s creditors.
The decisions made during this period are likely to be examined if the company subsequently enters liquidation. The liquidator may review when the directors became aware of the company’s financial difficulties, what action they took and whether their decisions increased the losses suffered by creditors.
Taking professional insolvency advice at an early stage can be important. A licensed insolvency practitioner can help directors understand the company’s financial position, consider the options available and determine how they should act while the company’s future is uncertain. Our guide to closing a company with debts explains some of the options available when a company is experiencing serious financial difficulties.
The Liquidator’s Investigation into Director Conduct
The Conduct Review Process
An investigation into directors’ conduct is a standard part of an insolvent company’s liquidation. It should not therefore be assumed that an investigation means a director is suspected of wrongdoing.
The office-holder is required to report on the conduct of relevant directors of the insolvent company. This can include individuals who were directors when the company became insolvent as well as former directors who held office during the relevant period.
The review considers how the company’s affairs were managed before insolvency and may examine matters such as financial management, record keeping, treatment of creditors and compliance with directors’ duties.
Where the review identifies conduct that may warrant further investigation, this information can be reported to the Insolvency Service. The Insolvency Service’s guidance on the insolvent company investigation process provides further information about what can happen following the office-holder’s report.
What the Liquidator Investigates
Transactions and Use of Company Assets
One important part of the liquidator’s work is reviewing transactions that took place before liquidation.
Particular attention may be paid to transactions at an undervalue, where company assets were transferred or sold for significantly less than their true value. The liquidator may also investigate payments or arrangements that could constitute preferences, where a creditor or connected party was put into a better position than they would otherwise have been in when the company entered insolvent liquidation.
Different statutory time periods and tests apply depending upon the type of transaction and whether connected parties were involved.
Where a transaction can successfully be challenged, the liquidator may seek to recover assets or money for the benefit of the company’s creditors.
If a director was personally involved in or benefited from an improper transaction, this could potentially lead to a claim against them personally.
Director Loans and Overdrawn Director’s Loan Accounts
Director’s loan accounts are another area that will usually receive attention during liquidation.
If a director has borrowed money from the company and their director’s loan account is overdrawn, the outstanding balance represents an asset belonging to the company. The liquidator will normally seek repayment of that money.
Liquidation does not simply write off an overdrawn director’s loan account. Depending on the circumstances, the liquidator may pursue the director personally to recover the outstanding balance.
The liquidator may also examine how the loan arose, whether payments were properly authorised and whether there are any unusual or unexplained transactions.
Directors concerned about an overdrawn loan account should raise the issue with an insolvency practitioner as early as possible so that the position can be properly assessed.
Wrongful Trading and Continued Trading While Insolvent
Directors are sometimes concerned that simply trading while a company is insolvent automatically constitutes wrongful trading. The position is more nuanced.
Under Section 214 of the Insolvency Act 1986, wrongful trading can potentially arise where, before the commencement of the winding up, a director knew or ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation or insolvent administration.
The court will also consider the steps subsequently taken by the director to minimise potential losses to creditors.
Where wrongful trading is established, the court can order a director to make a personal contribution towards the company’s assets.
This is one reason why obtaining professional advice promptly is important. Evidence that directors monitored the company’s position, considered creditors’ interests and sought appropriate professional advice can help demonstrate the steps taken in response to the company’s financial difficulties.
Fraudulent Trading and Criminal Misconduct
Fraudulent trading is significantly more serious than a business simply continuing to trade unsuccessfully.
It concerns situations where the company’s business has been carried on with intent to defraud creditors or for another fraudulent purpose. Establishing fraudulent trading therefore involves dishonesty rather than simply poor judgement or unsuccessful business decisions.
Where deliberate deception, concealment of assets or falsification of records is suspected, the matter can have both civil and criminal consequences.
A director found responsible for fraudulent trading may potentially be ordered to contribute personally towards the company’s assets. Serious misconduct can also be referred to the relevant authorities for criminal investigation and prosecution.
Misfeasance and Breach of Director Duties
A liquidator can also investigate whether directors have misapplied company money or property or otherwise breached the duties they owed to the company.
Examples might include using company funds for personal expenditure without a proper basis, improperly transferring company assets or failing to account for company money.
Under Section 212 of the Insolvency Act 1986, a liquidator can bring misfeasance proceedings where appropriate.
If a claim is successful, a court may require the director to repay money, restore property or make a financial contribution to compensate the company.
Importantly, these investigations are not limited to the directors who remain in office when liquidation begins. Former directors can also be investigated where their conduct falls within the relevant period.
The Insolvency Service’s Role in Director Investigations
The liquidator’s investigation and the role of the Insolvency Service are related but distinct.
The office-holder must report relevant information concerning the conduct of directors of an insolvent company. The Insolvency Service, acting on behalf of the Secretary of State, can then determine whether further investigation or action is appropriate.
Where evidence suggests that a director’s conduct makes them unfit to be involved in company management, director disqualification proceedings may be considered.
The Insolvency Service has investigatory powers and can obtain information as part of this process. Its investigation may take place alongside separate recovery action being considered or pursued by the liquidator.
For this reason, directors should not assume that resolving a particular matter with the liquidator necessarily brings every aspect of the conduct review process to an end.
Personal Consequences for Directors Following Liquidation
Director Disqualification
One of the more serious potential consequences of misconduct associated with an insolvent company is director disqualification.
Disqualification is governed principally by the Company Directors Disqualification Act 1986. However, liquidation does not automatically result in a director being disqualified.
Instead, the director’s conduct is considered. Matters that could potentially contribute to a finding of unfitness include continuing to trade to the detriment of creditors, failing to maintain adequate accounting records, misusing company money or assets and failing to cooperate with the liquidator.
A director does not necessarily have to have acted fraudulently to face disqualification. A failure to exercise appropriate oversight or fulfil the responsibilities associated with being a director can also be relevant.
Consequently, directors who took little involvement in the day-to-day running of a company should not assume that this automatically removes their responsibilities.
The Disqualification Process
Where the Insolvency Service considers that there is sufficient evidence of unfit conduct and that disqualification is in the public interest, the director will normally be informed of the allegations against them.
The director has an opportunity to respond. If the matter is not resolved through a disqualification undertaking, an application can be made to the court for a disqualification order.
These proceedings are separate from the liquidation itself and can continue after the company’s affairs have otherwise progressed significantly.
Until a disqualification order or undertaking takes effect, a director is not automatically prevented from acting as a director simply because their previous company has entered liquidation, although other restrictions could apply depending on their individual circumstances.
Anyone notified that disqualification action is being considered should consider obtaining specialist legal advice.
Disqualification Undertakings
A disqualification case does not necessarily have to proceed to a contested court hearing.
A director can instead give a disqualification undertaking to the Secretary of State. Once accepted, an undertaking has broadly the same effect as a disqualification order made by a court.
Agreeing an undertaking can avoid the need for contested disqualification proceedings, but it is nevertheless a significant legal step with potentially long-term consequences.
The details of director disqualifications are publicly available, and directors considering an undertaking should obtain appropriate advice so that they understand its implications before agreeing to it.
Consequences of a Disqualification Order or Undertaking
A director who is disqualified is prevented from acting as a director during the period of the disqualification unless they obtain permission from the court.
The restrictions extend beyond simply having the formal title of director. A disqualified person generally cannot become involved, directly or indirectly, in the promotion, formation or management of a company without the necessary permission.
Disqualification can last for between two and fifteen years, depending upon the circumstances and seriousness of the conduct.
Breaching a disqualification order or undertaking is a criminal offence and can result in serious penalties, including imprisonment. Details of disqualified directors are also recorded publicly. Further information is available in the government’s guidance on company director disqualification.
Personal Liability for Company Debts
A common concern among directors is whether they will personally inherit all of the company’s debts when it enters liquidation.
Ordinarily, they will not. A limited company is a separate legal entity and directors do not automatically become personally responsible for its liabilities simply because the business has failed.
There are, however, important exceptions.
Personal liability may arise where there has been wrongful or fraudulent trading, misfeasance or other conduct giving rise to a claim. Directors can also be required to repay money they owe the company, including an overdrawn director’s loan account.
Another important consideration is personal guarantees. Directors frequently provide guarantees to banks, finance providers, landlords or suppliers. A company’s liquidation does not normally extinguish these guarantees, and the creditor may seek repayment directly from the guarantor in accordance with the terms of the guarantee. Bridgewood’s liquidation FAQs provide further information about what can happen where a director has signed a personal guarantee.
Directors who have given personal guarantees should therefore identify them at an early stage and seek appropriate advice about their potential exposure.
The Risk of Phoenixing and Its Consequences
Some directors wish to start another business after their company has entered liquidation. Doing so is not automatically prohibited.
The term ‘phoenix company‘ is commonly used where a new company carries on the same or a similar business following the insolvency of a previous company. There are legitimate circumstances in which a business or its assets can be acquired from a liquidator and operated through a new company.
However, there are strict rules designed to prevent the process being abused.
In particular, Section 216 of the Insolvency Act 1986 places restrictions on the reuse of a liquidated company’s name, or a name sufficiently similar to suggest an association, by certain directors for a period of five years. There are statutory exceptions, but these need to be followed carefully. The government’s guidance on what happens to directors when a company is liquidated provides further information on these restrictions.
Breaching the prohibited-name rules can constitute a criminal offence and can also result in personal liability for certain debts of the new company.
The liquidator will also consider transactions involving the transfer of the old company’s business and assets. Attempting to move valuable assets into another company for less than their proper value or deliberately attempting to put them beyond the reach of creditors can lead to further investigation and recovery action.
Directors considering starting again following liquidation should therefore obtain advice before transferring assets, adopting a similar company name or beginning to trade through a new business.
Criminal Prosecution and Sanctions
Most company liquidations do not result in criminal proceedings against directors. Business failure alone is not a criminal offence.
Criminal consequences can, however, arise where serious misconduct has occurred.
Potential offences can include fraudulent trading, deliberately concealing company assets, destroying or falsifying records and acting in breach of a director disqualification order or undertaking.
Where suspected criminal conduct is identified, information can be passed to the appropriate enforcement authorities and, where appropriate, prosecution may follow.
Depending upon the offence, sanctions can include fines, imprisonment and, in certain cases, confiscation proceedings relating to the proceeds of criminal conduct.
A director who becomes aware that they are personally facing a criminal investigation should seek specialist independent legal advice. This is distinct from the insolvency advice relating to the company itself.
How an Insolvency Practitioner Can Help Directors Navigate Liquidation
One of the most useful steps directors can take when a company is experiencing serious financial difficulties is to seek advice from a licensed insolvency practitioner at an early stage.
Doing so does not necessarily mean that the company has to enter liquidation. Depending upon its financial position, there may be restructuring or rescue options available. Where liquidation is appropriate, an insolvency practitioner can explain the process and help directors understand what will be expected of them.
For an insolvent company, this may include considering whether a Creditors’ Voluntary Liquidation (CVL) is appropriate or discussing other formal insolvency and rescue procedures.
Early advice can also help directors understand how they should conduct themselves before a formal insolvency procedure begins. This may include reviewing proposed payments and transactions, considering the interests of creditors and ensuring that appropriate financial records are maintained.
An insolvency practitioner can also assist directors with the practical requirements associated with liquidation, including preparing financial information and the Statement of Affairs, understanding requests for information and dealing with the conduct review process.
Most importantly, company liquidation does not automatically mean that a director will be disqualified, prosecuted or made personally responsible for the company’s debts. In many cases, directors of failed companies are able to move on and establish or manage other businesses.
The circumstances leading up to liquidation, however, matter. Seeking professional advice early can help directors understand their responsibilities, protect creditors’ interests and avoid actions that could expose them to unnecessary personal risk.
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