Key Takeaways
- When a company enters liquidation, the liquidator investigates the conduct of all directors – including former directors – for the three years before insolvency.
- Directors can face personal liability for company debts if found guilty of wrongful trading, fraudulent trading or transactions at undervalue.
- Disqualification from acting as a company director for up to 15 years is a separate sanction the liquidator can refer to the Insolvency Service.
- Directors should take legal advice as soon as a company is in financial difficulty, not after liquidation has started.
Liquidation ends a company’s existence, but it does not end the scrutiny of the people who ran it. When a company goes into liquidation, the appointed liquidator has a duty to investigate how the company was managed and whether any director’s conduct contributed to the losses suffered by creditors. For many directors, this is the part of insolvency they are least prepared for.
This article explains what directors can expect when their company enters liquidation, what the liquidator investigates and what the consequences of findings against a director can be. Our dispute resolution solicitors at Osbourne Pinner offer a free 30-minute consultation and can advise directors facing investigation or potential claims.
The Liquidator’s Role and Powers
Once a company enters liquidation, whether voluntary or compulsory, an insolvency practitioner is appointed as liquidator. Their primary job is to realise the company’s assets and distribute the proceeds to creditors. Alongside that, they are required by law to investigate the conduct of the company’s directors.
The liquidator has extensive powers. They can require directors to provide information and documents, attend for interview under oath and hand over company books and records. Directors who obstruct the investigation commit a criminal offence. The liquidator’s investigation covers all directors, including those who resigned before the liquidation, going back three years in most cases.
What the Liquidator Investigates
The liquidator reviews the company’s financial history and the decisions made by directors in the period before insolvency. Key areas of focus typically include:
- Whether directors continued to incur liabilities, such as taking on new debt or making new commitments, after they knew or should have known the company could not avoid insolvent liquidation. This is the basis for wrongful trading claims.
- Whether assets were sold or transferred at less than their market value, or whether payments were made to connected parties (such as the director or their relatives) that preferred them over other creditors.
- Whether the company’s books and records were properly maintained. Poor record-keeping is itself a breach of directors’ duties and can make it harder for a director to defend themselves against other allegations.
- Whether director loans were properly documented and whether overdrawn loan accounts need to be repaid.
Wrongful Trading
Wrongful trading under section 214 of the Insolvency Act 1986 is one of the main routes through which a liquidator can make a director personally liable for company debts. A director is liable for wrongful trading if they knew or ought to have concluded, before the formal start of the liquidation, that there was no reasonable prospect of the company avoiding insolvent liquidation, and continued to trade anyway.
The test is partly objective. A director is judged against the standard of someone with their general knowledge and experience, but also against the minimum standard of competence expected of any director, whichever is higher. Not knowing what was happening in the company’s finances is not a defence if a reasonably diligent director would have known.
If wrongful trading is established, the court can order the director to contribute to the company’s assets. There is a partial defence available if the director took every step to minimise potential losses to creditors once they recognised the position. This is why getting legal and financial advice early, before the situation becomes irretrievable, matters so much.
Fraudulent Trading
Fraudulent trading under section 213 of the Insolvency Act 1986 is more serious. It applies where the business was carried on with intent to defraud creditors or for any fraudulent purpose. Unlike wrongful trading, fraudulent trading requires dishonest intent and is both a civil and criminal offence.
The threshold for fraudulent trading is higher, but so are the consequences. A director found liable for fraudulent trading can be required to contribute to the company’s assets without any limit, and can face criminal prosecution and imprisonment.
Director Disqualification
Separately from personal liability claims, the liquidator is required to report any director whose conduct was unfit to the Insolvency Service. The Insolvency Service can then apply to court for a disqualification order under the Company Directors Disqualification Act 1986.
Disqualification periods range from 2 to 15 years. During that period, the individual cannot act as a director of any company, cannot be involved in the promotion, formation or management of a company without court permission, and cannot act as an insolvency practitioner. Breaching a disqualification order is a criminal offence.
Disqualification proceedings are separate from any civil claims and can proceed even where no personal liability claim is made. The standard required is that the director’s conduct, taken as a whole, makes them unfit to be concerned in the management of a company. This can include conduct that was not dishonest but was seriously incompetent. Our breach of directors’ duties page explains more about the duties directors owe while a company is solvent.
See also: Disputes Between Shareholders: How the Law Applies
Personal Guarantees and Director Liability
Many directors have given personal guarantees to their company’s lenders, landlords or suppliers. If the company cannot pay those debts, the guarantee holder can pursue the director personally, regardless of the outcome of any liquidator investigation. Personal guarantees are one of the most common sources of personal financial exposure for directors following a company failure.
Directors should review any personal guarantees they have given as soon as financial difficulties emerge. Understanding the exposure and whether there are any grounds to challenge the guarantee is important information to have before the company enters formal insolvency.
What Directors Should Do
The most important thing a director can do when a company is in financial difficulty is to seek legal advice early. The window for taking steps that can reduce personal liability is often narrower than directors realise. Those steps include recognising the position, ceasing to take on new credit, minuting the decision-making process and taking formal insolvency advice.
Directors who cooperate fully with the liquidator, produce records promptly and can demonstrate that they took proper steps to protect creditors are in a much better position than those who obstruct, delay or are unable to explain their decisions. Good conduct in the run-up to insolvency, and after it begins, affects both the likelihood and the outcome of a personal liability claim.
Speak to a Solicitor about Director Liability in Liquidation
A liquidator’s investigation is not something to deal with without legal advice. The questions are technical, the stakes are high and the outcome – personal liability or disqualification – can affect a director for years. Whether the company is approaching insolvency or the liquidation has already started, the earlier legal advice is taken, the more options remain available.
At Osbourne Pinner, our dispute resolution solicitors advise directors facing liquidator investigations, wrongful trading or fraudulent trading claims and disqualification proceedings. We can also advise on the liability exposure created by personal guarantees and the options available before formal insolvency begins.
Please note that this article is for informational purposes only and does not constitute legal advice. We always recommend speaking to a qualified solicitor for advice tailored to your specific circumstances.
We offer a free 30-minute consultation to discuss your situation. You can speak with us via video call or visit our offices in Harrow, Canary Wharf, Piccadilly Circus or Manchester. To arrange your consultation, call 0203 983 5080, email [email protected] or complete the form below.
