Running a business always involves balancing risk and opportunity. However, when financial pressure begins to build, the legal responsibilities of directors can shift in important ways.
Many directors assume their duties remain the same regardless of circumstances. In reality, when a company approaches financial difficulty, the focus of those duties can change – and the risks increase.
Andrew Campbell, Partner at Allsopp Campbell Rainey, explains: “When a business is performing well, directors are generally focused on promoting the success of the company for the benefit of its shareholders.
“When financial pressure arises, the position becomes more complex, and directors must be increasingly mindful of the interests of creditors.”
The Core Duties
Under the Companies Act 2006, which applies across the UK, directors owe a number of statutory duties, including acting in good faith, exercising reasonable care and avoiding conflicts of interest.
In normal trading conditions, these duties are typically framed around the success of the company and its shareholders. Directors are expected to take commercial decisions, even where there is an element of risk. And it follows that the law will not reprove them for decisions which do not achieve commercial success, although it is sensible to minute reasons.
When Pressure Builds
The position begins to change where a company is, or is approaching, insolvency.
At this stage, directors must shift their focus towards protecting the interests of creditors. This does not happen at a single defined moment, but rather develops as financial difficulties become more apparent.
Continuing to trade without properly assessing the company’s financial position can expose directors to personal risk.
Wrongful Trading and Risk Exposure
One of the key risks in this context is so-called ‘wrongful trading’.
This can arise where directors continue to trade when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency.
If established, the court can require directors to contribute personally to the company’s losses.
This is why early awareness and proactive decision-making are critical.
Practical Steps for Directors
When a business comes under pressure, directors should take a structured and documented approach to decision-making.
This includes ensuring that financial information is up to date, holding regular board discussions and recording the rationale for key decisions.
Seeking professional legal and other advice at an early stage is also important. This can help directors understand their position and demonstrate that they have taken reasonable steps in response to emerging difficulties.
Balancing Commercial Reality
Difficult decisions are often required when a business is under pressure. In some cases, continuing to trade may be appropriate. In others, it may be necessary to consider restructuring or formal insolvency options.
As Andrew Campbell notes: “There is rarely a single ‘right’ answer when a business is under pressure. What matters is that directors are informed, take advice where necessary and make decisions that can be properly justified.”
Key Takeaways for Directors
When a business faces financial distress, the legal ’rules of engagement’ change. Here is what you need to know in short:
- The Focus Shifts: In healthy trading, your duty is to the shareholders, essentially to try to make profits for them. As insolvency approaches, your primary legal obligation shifts to protecting the interests of creditors
- The Risk of Wrongful Trading: If you continue to trade when there is no reasonable prospect of avoiding insolvency, you could be held personally liable for the company’s losses
- NI Specifics Matter: While the Companies Act 2006 sets the duties, any insolvency proceedings in Northern Ireland are governed by the Insolvency (NI) Order 1989
- Proactive Documentation is Key: To protect yourself, ensure financial records are up-to-date and board minutes clearly record the rationale behind every major decision
- Don’t Wait to Seek Advice: Acting early reduces the risk of personal exposure and provides more options for recovery or restructuring.
We have recently advised clients, and also advised members of the Federation of Small Businesses on their legal helpline, who are struggling to meet their financial obligations.
The difficult job they often have is to try to determine the tipping point between being able to justify a reasonable prospect of avoiding insolvency and having no reasonable prospect. Might one more roll of the dice commercially bring the company back from the brink? Can it be justified if it doesn’t do so?
If your business is navigating these complexities, you can speak directly to Andrew Campbell or the Allsopp Campbell Rainey team. Andrew’s dual-jurisdictional experience in both London and Northern Ireland ensures you receive sophisticated, large-firm level advice with our signature personal touch.