When Directors Keep Trading Through Financial Distress: Duties, Risks, and the Liquidator’s Lens
MENARA ASPEN ADVISORY LTD - AUTHORED WORK - NOT FOR REPRODUCTION OR DISTRIBUTION
Author Elaine Obika
Date August 2024
Directors owe statutory duties under the Companies Act 2006, including the obligation to act in the company’s best interests and to exercise reasonable care, skill, and diligence. These duties apply to all directors — de jure, de facto, shadow, executive, and non‑executive alike.
When a company approaches insolvency, the Insolvency Act 1986 introduces further responsibilities. The key question becomes whether the directors honestly believed that continuing to trade was in the company’s interests. Courts apply a subjective test: what did the director actually believe at the time? Cases such as Re Smith v Fawcett Ltd and Regentcrestplc v Cohen emphasise that the court does not substitute its own view for the directors, though directors who cause significant harm face a tougher task proving good faith.
In this scenario, the directors experienced cash‑flow problems seven months before liquidation and sought informal legal advice. They were told to keep detailed records and to cease trading once they believed liquidation was likely. Whether they followed that advice is crucial. If records show decisions were made for the benefit of the company as a separate legal entity, their honest belief may be defensible. If not, they risk allegations of breach of duty, misfeasance, wrongful trading, or even fraudulent trading.
A director’s belief must also be supported by reasonable conduct. The law expects directors to act with care and diligence, and those with specialist expertise are held to a higher standard. If the directors genuinely believed the company would recover — and there is no evidence to the contrary — that belief may protect them. But if their actions worsened the company’s position, liability becomes more likely.
The Companies Act 2006 s 171-177 details the generic obligations that the director of a company has towards the company. The duties are owed by de jure, de facto, shadow executive and non-executive directors.
In Re Smith v Fawcett Ltd, the court stated that a director must act ‘bona fide’ in what they consider and not what the court may consider the best interests of the company. In Regentcrest plv c Cohen, Parker J explained, and I summarise that the issue is as to the director’s state of mind, however, where it is evident that the director's actions led to significant damage to the company, the director will have a more difficult task proving good intentions but this does not diminish the subjective nature of the test.
In our scenario, in assessing the subjective belief of the directors that their actions were in the interests of the company, the court would consider the decisions that the directors took in light of the prevailing factors present around the time that the decisions were taken.
The directors began to experience cash flow problems and sought informal legal advice.
They were told by a lawyer (informally) to keep a record of all their decisions from that point onwards and stop trading once they believed that the company might enter liquidation. The company records will need to be checked to see if the advice given was followed.
The important factor in any of the decisions taken is whether they were made for the benefit of the members and the company as a separate legal entity If upon checking the records it is found to the contrary, there may have been a breach of director’s duties, misfeasance fraudulent and or wrongful trading.
Legislation provides that a director must exercise reasonable care, skill and diligence. Also, a director owes a common law duty of care not to act negligently in managing the affairs of the company. A higher standard of care is expected where directors are experts in a particular field.
Since the directors held an honest belief that their actions would make the company profitable again, this could be used as a defence if there is no evidence to the contrary. But if there is evidence to the contrary, a claim for fraudulent trading may be brought against the directors. One fraudulent transaction that takes place in a company may be viewed as fraudulent but does not prove intent to commit fraud. For intent to defraud to be made out, actual dishonesty is a necessary ingredient.
The directors of a company may continue to trade during difficult times because they have a genuine belief that the company will resume its buoyancy. If, however, it becomes apparent that the company is unable to pay its debts and the directors have continued to trade in spite of this, a liquidator may be able to bring a claim for wrongful or fraudulent trading against all or some of the directors. This is dependent on the roles that each director has in the company.
A liquidator can apply to the court to obtain a contribution from those who knowingly carried on the business of the company in a fraudulent manner. There must be clear dishonesty and culpability. The liquidator must reveal the director’s knowledge and reasoning based on the actions they took at the time of the events, compare it to the objective standard of an ordinary decent person and show that the director was fraudulent.
In claims brought for wrongful trading, culpability only arises if it can be shown that the continued trading made the company worse off. The directors' defence would be to show that they used every avenue possible to prevent going into insolvent liquidation, being mindful of not becoming indebted to their creditors.
It is tenable for a liquidator to bring two claims, one for wrongful trading and one for fraudulent trading in the same case. Evidencing dishonesty is not required.
The Insolvency Act provides the court with unrestrained powers to order the guilty directors to contribute to the company in liquidation. Section 214 is not intended to be punitive but compensatory. However, the courts can decide to be more severe in their judgement when directors deserve it and each case will turn on its facts.
Legal advice – formal or informal?
Assumption of responsibility
In Burgess v Lejonvarn the claimant appealed against the decision of a lower court in a case where she (a trained architect) helped and advised her neighbour to complete a garden project. The Court of Appeal, after listing out her contribution to the project, held that she assumed the professional responsibility in the capacity of an architect and project manager.
The parties to the case had been friends and neighbours for many years. Lejonvarn believed that she was helping the Burgess’s, but the court found that since she offered her skills over a period of time and while there was no written contract, there was an assumption of responsibility due to the nature of their relationship.
In our scenario, it could be argued that a duty of care arose from the special relationship between Eddie and his brother (the lawyer). Eddie would have been trusting of his brother's advice as his brother would have known that he would rely on him, although, unlike our case, the services rendered by Lejonvarn were in return for benefits.
However, in Hedley Byrne & Co Ltd v Heller & Partners Ltd, Lord Reid said that ‘the objective standard of what a reasonable man would have done is applied ... the reasonable man would have three courses open to him knowing that he was trusted or his skill and judgement are being relied on...keep silent or decline to answer....give an answer with a clear qualification that he accepted no responsibility...simply answer the question with no clear qualification...’Eddie’s brother chose the latter and so a duty of care would arise.
In Merrett v Babb (6) the judge stated that where economic loss is caused by negligent misstatement, Henderson v Merret Syndicates Ltd can be substituted for Caparo Industries plc v Dickman.
Dependence is necessary for Henderson v Merret Syndicates Ltd plus an assumption of responsibility. He also said that an assumption of responsibility and duty of care are the same thing.
Directors could be vicariously liable, or liability could be attributed to them even if they have heeded the advice of fellow directors and continued to trade.
A liquidator can request that the court examine the conduct of any person connected to the company directly or indirectly if it appears that the person has ‘misapplied, retained or become liable or accountable for any money or property of the company. or been guilty of any misfeasance or breach of trust in relation to the company. The court can order the person to restore, repay or contribute to the assets of the company by way of compensation as the court sees fit
In summary, a claim could be brought against anyone by the liquidator if it can be evidenced that his advice has contributed to the insolvency of the company.
A decision to make full use of the overdraft facilities provided by the bank after cash flow problems and an intimation of possible insolvency?
Fraudulent trading
Wrongful trading
Insolvency Act 1986
Company Directors Disqualification Act 1986
If during the liquidation of a company it becomes evident that the directors of the company continued to trade even though they were cognizant of the fact that they were unable to pay their creditors, the Insolvency Act (4) provides that the directors have been trading fraudulently.
Also, under section 214 of the Insolvency Act, a director or directors can have an action of
Wrongful trading can only be brought by a liquidator against the directors of a company while fraudulent trading can be brought against any business of a company.
The liquidator would need to provide immense evidence that shows that the directors should have known about the insolvency. Evidence such as pressure from creditors, only paying creditors after demands have been made, warnings by auditors of the company and inaccurate record keeping. The liquidator should indicate when he thinks, based on the evidence provided, that the directors should have been aware or actually realised that the company had become insolvent as it is vitally important that the company must have entered liquidation for a claim to be brought.
Taking on debt that cannot be paid and lying to creditors can be viewed as fraudulent depending on the facts of the case and the knowledge of the directors. In Re DKG Contractors Ltd, it was held that even though the directors claimed that they had no idea about companies and what being a director entailed, they should have realised that when they became ‘aware of pressing creditors’ and ‘a supplier refusing to make further deliveries...they should have instituted some form of financial control’.
A defence against wrongful trading is that the director would have to show that they made decisions and took steps to mitigate financial loss.
A disqualification order may be made against someone who is found guilty of misconduct while running a company. In Re Westwood Packing Services Ltd it was said that in determining a period of disqualification by a civil court, the period must reflect the seriousness of the offence,
have preventative measures, an assessment of the correct period and must allow for attenuating factors. Also, the former director's age, state of health and their admittance of the offence before and after the offence may be relevant and admissible. However, another view is that in determining the period of qualification of a director, protection of the public from the past wrongdoing of the director should be paramount. Every other factor is irrelevant.
Experiencing cash flow problems seven months earlier and stil deciding to make full use of the overdraft facilities provided by their bank is probable cause for a liquidator to bring an action in respect of wrongful trading and or fraudulent trading. Wrongful trading if they continued to trade knowing that they could not afford to pay their creditors and fraudulent trading if they falsified accounts to get full use of the overdraft facilities.
Failure to present a true picture of TCL’s financial state.
Fraudulent trading
Presenting false information amounts to dishonesty and may be viewed as fraudulent activity, specifically the defrauding of a creditor. However, as already mentioned, the intent would have to be evidenced.
Intent to defraud can be viewed in two ways. The intent to defraud a creditor and to achieve certain objectives. A liquidator could prove intent by providing a record of a business’s accounts at any material time during its trading. Also, records of the minutes of meetings held around specific times would need to be provided.
Is the sale of a company’s stock after the commencement of the winding up allowed?
Wrongful trading
Insolvency Act 1986
As long as the sale of stock after the commencement of winding up is done with the consent of the liquidator and is to raise funds for the creditors, there should be no issues. The decision to sell shares must be made with the knowledge and consent of the liquidator. If the reverse is the case, the directors will be trading wrongfully, and an action can be brought against them. The directors could also face liability for personal debt. This is because once a liquidator is appointed, all the powers of the directors cease apart from when the creditors allow them to continue.
DUTIES OF THE LIQUIDATOR
Where the winding up of a company is compulsory, the official receiver continues as the liquidator. Legislation states the role of the liquidator. Where a company is being wound up by the court, the liquidator is to make sure that the assets of the company are collated, realised and distributed to the company’ creditors. The role is to some degree the character of a trustee, the officer of the company and the agent of the company. The role is also predominantly administrative but when performing the directives of the judges, it is semi-judiciary.
The liquidator is not a trustee according to legislation because the company property does not legally belong to him, but the court can make an order giving the liquidator such authority if needed. The liquidator assumes the powers of the directors and owes a duty to the company. They cannot buy the property of the company or make a profit from the sales of the company.
.
The liquidator is in a more delicate position than a lay trustee because he is always paid to assume his responsibility. A high standard of care and diligence is expected from a liquidator. Moreover, it has not been categorically stated that a liquidator can claim protection of the Trustee Act if he has acted honestly and reasonably and ought to be excused. In Re Windsor Steam Coal Ltd, the court decided that where a liquidator had not acted reasonably, by taking a decision without the direction of the court, the question of whether Trustee Act 1925 s 61 could be used as a defence was inconclusive.
A liquidator negotiates on behalf of the company and so has the character of an agent. If needed, he makes contracts on behalf of the company for winding up purposes. However, he controls the actions of the company and so is not an agent in every sense of the word.
Legislation provides that the liquidator is an officer of the company. He is also described as the person whom proceedings may be taken for misfeasance.
A liquidator is controlled by the court because an action may be brought against him by anyone who is disgruntled by his recommendation or conduct. However, the courts are seen to generally favour whatever decision the liquidator arrives at.
In a compulsory winding up, such as in our scenario, about half of his power is controlled by the court. He will need to seek the approval of the court to bring or defend actions, pay creditors in full and any business of the company as it relates to winding it up. But duties like selling the company’s properties or raising money from the company’s wealth can be done without the oversight of the court. In a case such as in our scenario, he will need the approval of the court to make a compromise with creditors, to compromise calls and debts and to pay creditors.
The liquidator takes charge of all the assets and money in the bank that the company has but not money controlled by a trust. Also, assets still in the process of sale before the commencement of the winding up process cannot be recuperated by the liquidator.
In this scenario the liquidator will usually pay all the money into the Insolvency Services Account at the Bank of England and bring actions to enforce debts due to the company.
The liquidator prepares a list of members of the company and then writes to them asking for their proposal for payment. If no response is received or no conducive offer made, then he will make an application to the court for permission to make calls. Also, legislation provides that the liquidator can ask the court for powers to order any contributory, past or present, to release any property, books, money or records under their control to the liquidator.
The failure of a contributory to cooperate on a continual basis with a liquidator is a criminal offence and punishable with imprisonment or a fine.
Another of the duty of a liquidator is to swell the assets of the company and this can be done in a number of ways:
Secret Profits
If the directors have made unauthorised profits out of their positions, for example where the directors help the parent company out by putting up money for shares in a subsidiary company but were made to repay to the parent company a profit on those shares when they were sold. The directors may have also paid themselves unauthorised salaries which need to be returned.
As already mentioned, the company’s officers may have actions brought against them for wrongful or fraudulent trading. Any money recovered from this is put into a fund for all the creditors.
Legislation also provides that the actions of a promoter can be examined. This could be a previous or current promoter. If it is evident that the promoter has misapplied, retained or become liable for any property of the company, the court can order the promoter to repay, restore or contribute to the assets of the company.
Under the Insolvency Act, the order of priority as it relates to payment of creditors is: Liquidators costs, fixed charge creditors, other costs and expenses, preferential debts, prescribed part funds, floating charges, unsecured creditors, interest in unsecured debts and last of all shareholders. The liquidator receives payments from part of the expenses of the winding up procedure.
CONCLUSION
In this scenario, if the directors of the company continued to trade during difficult times because they had a genuine belief that the company would resume its buoyancy they may not be liable. The courts would look at what the director actually believed, but also what a reasonably diligent director should have known in that position.
However, if it became apparent that the company was unable to pay its debts as the company and the directors continued to trade while arrears were amassed. The liquidator may be able to bring an action for wrongful or fraudulent trading against all or some of the directors. depending on the roles that each director has in the company and the evidence he can collate to support his cases.
If the liquidator can prove fraudulent or wrongful trading against a director or officer, the court may order that person to become personally liable for the debt. However Wild and Weinstein state that it is not prudent for the liquidator to enter into litigation for the company as there is no more funding available for matters of company and partnership law. Further if the judge finds for the directors of the company, the cost is borne by the liquidator. Cases that are likely to be successful have their costs paid for by the creditors. Also, if litigation were to commence it is normally recouped by the money set aside from the company funds.
Ultimately, the case illustrates the fine line directors walk when trading through financial difficulty. Honest belief is important, but it must be accompanied by careful, diligent, and well‑documented decision‑making
Sources
Companies Act 2006 s 171 – 177.
Companies Act s 250.
Revenue and Customs Commission v Holland [2010] UKSC 51 [21] (Lord Hope).
Re Hydrodram (Corby) Ltd (in Liquidation) [1994] 2 BCLC 180 [182C] - [182E] (Millett J).
Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498 [505F] - [505H] (Foster J).
Re Smith v Fawcett Ltd [1942] 1 AII ER [543G] (Lord Greene).
Re Smith v Fawcett Ltd [1942] Ch 304 [306 (Lord Grene).
Francis Beaufort Palmer and Geoffrey Morse, Palmers Company Law (Sweet and Maxwell) para 8.508.
Regentcrest plc v Cohen [2001] 2 BCLC 80 [105B] - [105C] (Jonathan Parker LJ).
Regentcrest plc (in liquidation) v Cohen v Another [107] - [108] (Jonathan Parker LJ).
Practical Law Restructuring and Insolvency ‘Insolvency and Consideration for Directors’ <https://uk.practicallaw.thomsonreuters.com/5-107-3984?transitionType=Default&contextData=(sc.Default)> Accessed 2nd August 2024.
Practical Law Restructuring and Insolvency ‘Insolvency and Consideration for Directors’ <https://uk.practicallaw.thomsonreuters.com/5-107-3984?transitionType=Default&contextData=(sc.Default)> Accessed 2nd August 2024.
Mutual Life Insurance Co of New York v Rank Organisation Ltd [1985] BCLC 11 [23G] - [24A] (Goulding J).
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 210.
Mutual Life insurance Co of New York v Rank Organisation Ltd [1985] BCLC 11 [24B] - [24E] (Goulding J).
Companies Act 2006 Chapter 5 s 415.
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 232.
Insolvency Act 1986 s 238.
Arlidge A and Fisher J, Arlidge and Parry on Fraud (6th Edition Sweet and Maxwell 2020) 21-018.
Report of the Insolvency Law Review Committee, Insolvency Law and Practice (HMSO 1982) Cmnd 858 (routinely referred to as the Cork report) paras 1776 – 1780.
Companies Act 2006 s 174.
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 216.
Lister v Romford Ice and Cold Storage Co [1957] 1 AC 555 [572] - [573] (Viscount Simonds).
Philip R Wood, Principles of International Insolvency (3rd Edition Sweet and Maxwell 2019) 31- 004.
Re White v Osmond Parkstone Ltd (1960 unreported).
C.M Scmitthoff Palmers Company Law (23rd Edition vol 1 1982) 1192.
Morphitis v Bernasconi and others [2001] BCLC 1 [28] – [29], [41 - [42] (Anthony Elleray QC).
Hogg v Cramphorn [1966] 3 All ER 420 [426E] - [426G] (Buckley J).
Taylors Industrial Flooring Ltd v M & H Plant Hire (Manchester) Ltd [1990] BCLC 216 [219I] (Dillon J, [221C] - [221E] (Staughton LJ).
R v Grantham (Paul Reginald) [1984] QB 675 [684] (Lord Lane CJ).
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 571.
Thomas Saunders Partnership v Harvey (1989) 30 Con LR 103 [122] (Mr Recorder Thayne Forbes QC).
Insolvency Act 1986 s 213 and s 246ZA.
Re Patrick and Lyon Ltd [1933] Ch 786.
Re JD Group Ltd [2022] EWHC 202 (Ch).
Re Marini Ltd (the liquidator of Marini Ltd and Dickenson and Others) [2003] EWHC 334.
Re Produce Market Consortium Ltd (No 2) [1989] BCLC 520.
Re Brian D Pierson Contractors Ltd [1999] BCC 26.
Insolvency Act 1986 ss 148 - 151, 158.
Re Produce Marketing Consortium [598].
Nicholson v Fielding [2017] AII ER (D) 156 (Oct) [110].
Lejonvarn v Burgess [2017] EWCA Civ 254.
Burgess v Lejonvarn [2016] EWHC 40 TCC [201] - [202] [205] (Mr Alexander Nissen QC).
Robinson v National Bank of Scotland [1916] 4 WLUK 16.
Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465 [486] (Lord Reid), [502] - [503] (Lord Morris).
Merrett v Babb [2001] QB 1174 [1189H] - [1191A], [1193B] (May LJ).
Henderson v Merret Syndicates Ltd [1995] 2 AC 145.
Caparo Industries plc v Dickman [1990] 2 AC 605.
Insolvency Act 1986 s 212(1)(c).
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 571.
Insolvency Act 1986 s 21.
Alix Adams Law for Business Students (10th Edition Pearson Education Ltd 2018) 478.
Re Produce Marketing Consortium Ltd (No 2) [1989] 5 BCC 569
Stephen Griffin, Personal Liability and Disqualification of Company Directors (1st Edition Bloomsbury 1999) 92-94.
Wright v Chapell [2024] EWHC 1417 Ch [1153] (Mr Justice Leach).
Re DKG Contractors Ltd [1990] BCC 903 (J Weeks QC).
Insolvency Act 1986 s 214(3).
Company Directors Disqualification Act 1986 (c 46) s 2.
Re Westwood Packing Services [1998] 2 AII ER 124 [132] (Lord Woolf).
Abbas Mithani, ‘The Flawed Approach of the Criminal Courts to the Making of Disqualification Orders – options for intervention’ [2023] Criminal Law Review 762, 769.
Arlidge A and Fisher J, Arlidge and Parry on Fraud (6th Edition Sweet and Maxwell 2020) 21-024.
R v Inman [1967] 1 QB 140 [148A] (Marshall J).
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 570.
Insolvency Act 1986 s 143.
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 568.
Re Chevron Furnisher Pty Ltd (1994)12 ACSR 565 [569].
Insolvency (Amendment) Rules 2010 (SI 210/686).
Re Home and Colonial Insurance Co [1929] AII ER Rep 231.
Trustee Act 1925 s 61
Re Windsor Steam Coal Ltd [1929] 1 Ch 151.
Charles Wild and Stuart Weinsten, Smith and Keenan’s COMPANY LAW (18th Edition Pearson 2019) 568.
Companies Act 2006 s 30 (4).
Insolvency Act 1986 s 212.
Leon v York O-Matic [1966] 3 AII ER 277.
Insolvency Act 1986 s 167.
Insolvency Act 1986 s 165.
Re Kayford [1975] 1 AII ER 604
Insolvency Act 1986 s 237.
Insolvency Act s 208.
R v McCredie [2000] BCLC 438
MENARA ASPEN ADVISORY LTD - AUTHORED WORK - NOT FOR REPRODUCTION OR DISTRIBUTION
