Understanding the legal risks, heightened scrutiny and governance obligations facing company directors during periods of financial distress.
Economic uncertainty places businesses under intense pressure and places company directors under greater legal scrutiny. Decisions taken during a downturn can affect employees, creditors, shareholders, and the long-term viability of the business. Understanding directors’ duties during challenging financial periods is therefore essential.
In this article, our corporate law team explains the legal framework governing directors’ duties as insolvency approaches, the areas most likely to attract scrutiny, the potential consequences of getting it wrong, and the practical governance steps directors can take to reduce risk.
What Are Directors’ Legal Duties as Insolvency Approaches?
Under the Companies Act 2006, directors must act in good faith to promote the success of the company and exercise reasonable care, skill and diligence. As a company approaches insolvency, the legal focus increasingly shifts towards protecting creditors’ interests rather than maximising returns for shareholders. The closer a company is to insolvency, the greater the expectation that directors will prioritise minimising loss to creditors and avoid steps that worsen the company’s financial position.
High-Risk Decisions Directors Should Approach with Caution
Directors should exercise particular caution when considering:
- Cash flow management and payment priorities
- New borrowing or security arrangements
- Dividend declarations and distributions
- Workforce reductions and restructuring
- Asset disposals and related‑party transactions
Continuing to trade where directors know, or ought to know, that insolvency cannot reasonably be avoided may give rise to allegations of wrongful trading or breach of duty. Insolvency practitioners and courts will examine whether reasonable steps were taken to minimise losses to creditors once financial difficulties became apparent.
How Directors’ Conduct Is Scrutinised on Insolvency
When a company enters administration or liquidation, director conduct is routinely reviewed. Scrutiny may come from insolvency practitioners, creditors, shareholders, regulators, or government bodies such as the Insolvency Service.
Investigations commonly focus on:
- Trading while insolvent
- Preferential treatment of certain creditors
- Misuse or misapplication of company assets
- Failure to maintain adequate accounting records
- Unlawful dividends
- Transactions at an undervalue entered into before insolvency
Where misconduct is identified, actions may include claims for wrongful trading, fraudulent trading, breach of fiduciary duty, misfeasance, or recovery of assets transferred improperly. In serious cases, directors may face disqualification proceedings under the Company Directors Disqualification Act 1986.
What Are the Potential Consequences for Directors?
The consequences can be severe. Directors may face:
- Personal liability for company losses
- Orders to repay monies or compensate creditors
- Disqualification from acting as a director for up to 15 years
- In cases involving dishonesty or fraud, potential criminal sanctions
Practical Governance Steps to Manage Risk in a Downturn
Good governance is critical during periods of financial distress. Directors should:
- Keep rigorous, contemporaneous board records of decisions and the information considered
- Review up‑to‑date financial information regularly, including cash flow forecasts
- Monitor indicators of potential insolvency and reassess decisions as circumstances evolve
- Seek early professional advice from legal and insolvency specialists
- Communicate transparently with key stakeholders to manage expectations and reduce legal and reputational risk
Final Thoughts from Our Corporate Team
Economic downturns inevitably require difficult choices. Directors who act carefully, remain informed, and obtain timely advice are better placed to meet their legal obligations while navigating uncertainty and protecting stakeholder value.
If your business is facing financial pressure or governance concerns, our team can help you assess risk, plan next steps and engage with stakeholders. To discuss how we can support you, please contact our firm today.
For related reading, see our previous guide, ‘Can You Lose Legal Professional Privilege by Using ChatGPT’, which covers other corporate governance and confidentiality risks in the current business environment.
Need Advice on Directors’ Duties or Managing Insolvency Risk?
If your business is facing financial pressure, contemplating restructuring or concerned about potential exposure for its directors, obtaining legal advice at an early stage can help protect both the company and its board.
Our Corporate team advises directors, boards and shareholders on directors’ duties, governance in distressed situations, restructuring, disputes and pre-insolvency risk management.
Contact Our Corporate Law Solicitors – The Law Firm on Baker Street
Muscatt Black Graf is a long-established specialist law firm on Baker Street, London. Our highly experienced legal teams pride themselves on exceptional client care and straightforward advice.
For more information on how we can help, please call 0207 586 1141 or email contact@muscattblackgraf.com, or alternatively, fill in our online contact form.
Disclaimer
This article was produced and published in August 2026 and provides general information only. It does not constitute legal, tax, or financial advice and should not be relied upon as such. Specific advice should always be sought based on your specific circumstances.